Associations Highlight NDF Problem in Proposed UK Benchmark Regulation

In a response to the UK government’s consultation on a future regulatory regime for benchmarks and benchmark administrators, four industry associations have highlighted as part of their feedback, the challenges associated with a proposed requirement to include FX rates from offshore providers in the Specified Authorised Benchmarks Regime (SABR).

The four bodies, ISDA, GFMA’s Global FX Division, the Loan Market Association and UK Finance have provided comprehensive feedback on the broader proposals, but under a generally supportive response, they have called for offshore FX NDF benchmarks to be exempted from the regulation.

“These FX rates have no available substitute, as they are calculated based on rates from trades executed on-shore (i.e. in other jurisdictions),” the bodies write. “Therefore, trade level data is not available to administrators located in the UK. Use of a benchmark based on offshore executed rates, i.e. NDF trades, would result in unmatched (i.e. imperfect) hedges, meaning there would be basis risk between the onshore rate and the offshore fix.

“This could lead to potentially significant losses or commercial risk for FX market participants transacting through the London market,” they continue. “For example, prices used in transactions executed in offshore markets would not match prices used in transactions executed in onshore restricted currency markets.”

The associations also stress that the use of several of these FX rates is significantly in excess of the threshold for significant benchmarks under the revised EU Benchmark Regulation, from which the UK is breaking away. In addition they observe that the greater size of the FX market in London (eight times larger than the EU), and the fact that the majority of users of these benchmarks are end users, means an inability to access these rates “would result in end users closing out their exposures thereby impacting returns, or moving their FX hedging activities to another jurisdiction, impacting the UK’s competitiveness.”

The response also notes that because several of the FX benchmarks are used to set and implement monetary policy, the respective national authorities would not permit them to be determined and published outside of their home jurisdictions, “Nor would [they] permit a third party to have any oversight/control over the production or publication of these rates,” it warns.

“As these FX rates are not predominantly produced for commercial gain, there is no economic incentive to access the UK through recognition or endorsement, and many of the administrators would lack the resources to pursue these avenues,” the response to the FX question concludes.

A source familiar with the issue tells The Full FX, that an exemption is likely. “It makes the most sense for the FCA to provide an exemption for NDFs in particular,” the source asserts. “There is rarely a strategic or economic reason to use these benchmarks, they are largely for administrative purposes, so why put everyone through unnecessary pain?

“I am not convinced it was ever part of the UK’s plan to have these FX benchmarks included, but they need to follow the process and get the appropriate response from the industry, which has now happened,” the source concludes. “The box has been ticked, I am confident that FX will be unaffected by the new SABR.”