Asian NDF fixings threat signals yet another deadline drama

Extraterritorial reach is not new to the region, but the EU Benchmarks Regulation poses real risks

Through the deluge of post-crisis regulation, Asian entities have not only had to implement rules developed by their own jurisdictions, but have had to contend with the extraterritorial nature of US and European rules.

Often, these issues only emerge at the eleventh hour, leaving firms scrambling to comply to keep markets operating. The latest example stems from three popular Asian foreign exchange rates that are likely to fall foul of the European Union’s Benchmarks Regulation, meaning new derivatives products will be unable to reference them after 2020.

The BMR prohibits EU-supervised firms from using non-authorised indexes and benchmarks after January 1, 2020. If Asian index administrators fail to register, EU investors will be prevented from buying or selling instruments linked to those benchmarks from that date.

That is concerning, given the three products make up 40% of cleared non-deliverable forwards volumes at clearing house LCH, and a lack of substitute rates in these currencies is only ratcheting up industry woes.

In some ways, the market has become accustomed to do-or-die deadlines, where, despite dire warnings, firms scramble to comply in the nick of time. A case in point was the introduction of Europe’s second Markets in Financial Instruments Directive in January this year, where – contrary to most expectations – disruptions in Asia were hardly felt.

Some market participants may be assuming that, yet again, the industry will work out some sort of solution.

However, not meeting the BMR rules could have severe consequences, including slashing liquidity as investors dump positions ahead of the deadline or leave legacy non-deliverable forwards books exposed as banks can’t open a new transaction referencing the benchmark.

For now, that risk is real. A December 2017 survey by the Asia Securities Industry and Financial Markets Association and law firm Herbert Smith Freehills revealed the appalling state of preparedness in the region when it came to the BMR. Three-quarters of Asian administrators surveyed had benchmarks that would be affected by the new rules, with more than half intending to seek EU recognition. However, it also showed very few have concrete plans in place to meet the rules.

Market participants and administrators in the region believe the process for seeking registration is unclear or too complex. Some are also complaining about the lack of engagement by EU regulators. While the deadline is still 18 months away, the entire process is complex. It involves substantial documentation and a reworking of existing agreements by those submitting data to the administrator, to demonstrate compliance.

There are few options available, and each one has its own hurdles. Administrators can seek regulatory equivalence, recognition from an EU regulator or endorsement by an authorised index administrator. But time is running out. Eighteen months may be too short a time to pass appropriate legislation to ensure equivalence or obtain the recognition or endorsement.

A Singapore-based regulation executive at a global bank summed it up neatly: faced with a torrent of regulation, overstretched regulatory teams are trying to chronologically prioritise their workflow. So far, they seem to have met deadlines, but all it takes is one slip to spark a large-scale disruption.