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European CommissionRue de la Loi/Wetstraat 2001049 - BrusselsBelgium

London, 29 November 2012

Consultation Document on the Regulation of Indices – A Possible Framework for the Regulation of the Production and Use of Indices serving as Benchmarks in Financial and other Contracts

Dear Sirs,

BlackRock welcomes the opportunity to respond to the European Commission consultation on the regulation of indices.

BlackRock is a leader in investment management, risk management and advisory services for institutional and retail clients worldwide. As of 30 September 2012, BlackRock’s assets under management totalled $3.67 trillion (€2.88 trillion) across equity, fixed income, cash management, alternative investment and multi-investment and advisory strategies including the iShares® exchange traded funds (“ETFs”). Through BlackRock Solutions®, the firm also offers risk management, strategic advisory and enterprise investment system services to a broad base of clients, including governments and multi-lateral agencies.

In Europe specifically, BlackRock has a pan-European client base serviced from close to 20 offices across the continent. Public sector and multi-employer pension plans, insurance companies, third-party distributors and mutual funds, endowments, foundations, charities, corporations, official institutions, banks and individuals invest with BlackRock.

We have summarised our views below that we develop further in our attached response.

BlackRock does not produce or contribute to either rates or indices. However, we use an extensive list of rate benchmarks and market indices in managing portfolios on behalf of our clients. BlackRock has an “index” business in which we construct and manage portfolios that are designed to track market indices. In managing client assets, we use both publicly available rate benchmarks such as LIBOR, EURIBOR, EONIA, SONIA, the Overnight Index Swap (‘OIS’) and privately owned market indices such as MSCI, FTSE, Russell, S&P/Dow Jones, STOXX, Markit iBoxx, Barclays, S&P/Dow Jones GSCI and DJ-UBS. In the case of the privately owned market indices, we license these benchmarks from the relevant index provider.

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BlackRock strongly believes that it is important to differentiate between benchmarks such as LIBOR and EURIBOR which are currently based on subjective estimates (for the purposes of this note, we shall refer to these as ‘rate benchmarks’) and indices which are either wholly (equity and commodity futures) or largely (fixed income) based on financial transactions (for the purposes of this note, we shall refer to these as ‘market indices’). We believe that they demand very different regulatory approaches.

We recommend that the regulatory priority should be on the reform of rate benchmarks such as LIBOR and EURIBOR to restore their market credibility. Such rate benchmarks form the foundation of the interest rate swaps and Eurodollar markets and remain a key reference rate for floating rate loans. As an investment manager, we use rate benchmarks in three main ways: as a purely indicative reference rate to calibrate the expected performance of a fund; as an explicit reference rate used to determine the coupon paid on a security of a fund; and to calculate coupon payments on a wide variety of medium to long dated interest rate derivatives with a floating leg.

We support the following reform objectives for rate benchmarks such as LIBOR and EURIBOR: focusing on the shorter tenors and the maturities most representative of bank funding activity; augmenting subjective submission data with the use of transaction data (with private reporting, time lags and/or aggregation as appropriate); and strengthening their regulatory oversight coupled with sanctions under the Market Abuse Regulation.

At the same time, a “one size fits all” for rate benchmarks such as LIBOR or EURIBOR may no longer be the optimal solution. The reform agenda should, therefore, include an explicit objective to allow market evolution to other benchmarks such as the OIS, GCF Repo Index, Eurodollars futures market and EONIA. As different investors and different borrowers have different needs and preferences, this is likely to lead to multiple solutions with those benchmarks providing the greatest liquidity gaining the greatest traction. For these reasons, we do not believe that it is appropriate to mandate an alternative benchmark to replace LIBOR or EURIBOR or that those particular rate benchmarks should be mandated for specific activities.

BlackRock uses market indices in its “index” and ETF businesses in which we construct and manage portfolios that are designed to track market indices (so-called “passive investments”). In doing so, we use an extensive list of index providers for the calculation of market indices. We do not contribute any data to such market indices but determine their efficacy by measuring them against a number of key criteria such as whether the index is representative of its opportunity set, is ‘investable’, transparent and sufficiently diversified (taking into account, in all cases, any applicable regulatory requirements in respect of such market indices). BlackRock and its clients have extensive choice in the selection of an index provider and key metrics help to determine the best provider for a particular product. The ability to substitute one market index for another ensures a competitive and innovative marketplace. BlackRock takes an active interest in the construction of

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indices and provides feedback through index consultations and on index committees, where applicable. In addition, while BlackRock is not in a position to verify the construction or accuracy of an index (nor guarantee that a chosen index will be appropriate for any given investor), BlackRock carries out certain validation exercises in respect of the market data used to construct indices and closely monitors index turnover as part of the daily portfolio management process to the extent reasonably possible.

BlackRock supports the inclusion of market indices in the market abuse regime and acknowledges that further regulation of market indices is also an option. However, as market index providers are not currently regulated, we anticipate that the introduction of a new regulatory regime would result in additional cost for providers which would ultimately be passed onto the end investor. As such, we consider that the benefits of any proposed regulation need to be carefully considered and weighed against any negative impacts. In our view, it may be more appropriate to address potential risks associated with market indices (for example, losses that investors may suffer where there is an error in the relevant index and/or as a result of extraordinary rebalances required in connection therewith) through enhanced risk disclosures and investor education. Finally, because of competition and innovation in the marketplace, index providers will be incentivised through market forces to ensure their products are of a certain quality and viable indices for the end investor.

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We attach our more detailed responses to the individual questions posed in the Consultation. We are prepared to assist the European Commission in any way we can, and welcome continued dialogue on these important issues. Please contact any of the undersigned if you have comments or questions regarding BlackRock’s views.

Yours faithfully,

Joanna CoundManaging Director,Head of EMEA Government Affairs& Public PolicyBlackRock+44 (0)20 7743 [email protected] Throgmorton AvenueLondon, EC2N 2DLUnited Kingdom

James DesMaraisManaging Director,General Counsel, EMEALegal & ComplianceBlackRock+44 (0)20 7743 4805james@[email protected] Throgmorton AvenueLondon, EC2N 2DLUnited Kingdom

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mailto:james@[email protected]

mailto:[email protected]


Detailed response to the European Commission Consultation on the Regulation of Indices – A Possible Framework for the Regulation of the Production and Use of Indices serving as Benchmarks in Financial and other Contracts

Chapter 1. Indices and Benchmarks: What they are, who produces them and for which purposes

(1) Which benchmarks does your organisation produce or contribute data to?

BlackRock does not directly produce or contribute to either rate benchmarks or market indices.

(2) Which benchmarks does your organization use? What do you use each of these benchmarks for? Has your organization adopted different benchmarks recently and if so why?

BlackRock uses a wide range of rate indices including LIBOR and EURIBOR in a variety of currencies and tenors, EONIA, SONIA and the Overnight Index Swap (‘OIS’). A significant proportion of the investment portfolios we manage use LIBOR or EURIBOR as implicit or explicit reference rates. Further information on their use is given in our responses to Questions 4 and 5. However, we started to make greater use of the OIS benchmark after the financial crisis as more interest rate swaps became collateralised by cash (and hence the credit risk of cash flows should reflect the risk free rate rather than rates derived from LIBOR).

We also expect the Eurodollars futures rate and the DTCC GCF Repo Index rate to attract greater use in the future. The Eurodollar futures market has developed into a robust, deep and liquid market which is transparent and based on transactions. LIBOR rates for longer maturities can be extracted from this market, obviating the need for LIBOR “fixings” for these longer maturities. The GCF Repo Index is the weighted average of the interest rates paid each day on General Collateral Finance Repurchase Agreements based on US Government securities. It has a high daily volume of interdealer trading of tripartite repo and it mirrors bank to bank transactions.

BlackRock’s index and ETF businesses construct and manage portfolios that are designed to track market indices. We license benchmark data from many index providers, including MSCI, FTSE, Russell, S&P/Dow Jones, STOXX, Markit iBoxx and Barclays and are continually assessing and adopting new benchmarks. This is largely driven by client-specific requirements, innovation, and incremental improvements made by the providers in the construction of equity indices.

(3) Have you recently launched a new benchmark or discontinued existing ones?

As stated in our response to Question 1, BlackRock itself does not publish or generate rate benchmarks or market indices. Our index and ETF businesses are,

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however, continuously using new indices as benchmarks in response to the demands of our client base. In contrast, fewer alternatives exist for our legacy products that reference rate benchmarks such as LIBOR. We have started to use the OIS benchmark. The GCF Repo Index was only introduced in July 2012 and hence its derivative term structure is still quite young. The scale of adoption of alternative rate benchmarks will also depend on their liquidity.

(4) How many contracts are referenced to benchmarks in your sector? Which persons or entities use these contracts? And for which purposes?

We do not consider that the number of contracts provides a meaningful indication of the significance of index usage. As an asset manager, we estimate that the vast majority of our funds either track rate benchmarks or market indices directly or use such rate benchmarks or market indices as a reference in some manner.

Clients use rate benchmarks such as LIBOR and EURIBOR largely as a proxy for a generic low risk alternative investment to be able to make fair comparisons across different investment opportunities. Such clients tend to be at the conservative end of the spectrum and include client segments such as corporate treasurers, pension funds, insurance companies and private clients. Other clients use such rate benchmarks to calculate performance over cash rates.

The potential uses of market indices are extensive and varied. Institutional long term investors are increasingly turning to index funds to represent the core of their portfolios.

(5) To what extent are these benchmarks used to price financial instruments? Please provide a list of benchmarks which are used for pricing financial instruments and if possible estimates of the notional value of financial instruments referenced to them.

Benchmarks such as LIBOR and EURIBOR are used extensively as explicit reference rates to determine the coupon paid on a security or interest rate derivatives. As such, LIBOR and EURIBOR are of prime importance to pension funds, money market funds and short term bond funds. Pension funds following liability driven investment (LDI) strategies typically use interest rate swaps with maturities of up to 40 or 50 years. Such pension funds represent over 50% of the UK and 90% of the Dutch pension fund market. Money market funds are exposed to LIBOR in two ways: instruments with LIBOR maturities can represent up to 30% of the portfolio; and custodians typically use LIBOR as a pricing tool for European commercial paper, floating rate notes and certificates of deposit.

(6) How are benchmarks in your sector set? Are they based on real transactions, offered rates or quotes, tradable prices, panel submissions, samples? Please provide a description of the benchmark setting methodology.

The methodology ranges from benchmarks such as LIBOR and EURIBOR (the benchmark setting process of which is described in the Consultation) to equity indices where the data comes from stock exchanges and data providers such as

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Bloomberg and which are calculated based on real transactions completed at a particular point in the trading day. Commodity futures indices tend to use actual prices, quantities and data which may be considered objective and verifiable. The data typically comes from commodity futures exchanges and from national and supranational organisations responsible for producing fundamental data on commodity markets (in particular world production quantities used for index weightings). Fixed income indices differ in that no single price discovery process exists. As fixed income instruments trade over-the-counter (“OTC”), the same bond can therefore have different prices in different index providers’ indices. In addition, some fixed income instruments can trade very infrequently or by appointment only. In such cases, indicative or model derived prices may be used in the relevant indices.

For further information please refer to our response to Question 8.

(7) What factors do you consider to be the most important in choosing a reliable benchmark? Could you provide examples of benchmarks which incorporate these factors?

It should be noted that BlackRock cannot guarantee that a chosen benchmark will be appropriate for a given investor and cannot guarantee the quality or accuracy of a benchmark (including whether such benchmark is reliable). That said, BlackRock employs certain techniques and takes into account certain considerations to help identify benchmarks which may be appropriate for the relevant objective.

At the most simplistic level, BlackRock undertakes commercially reasonable endeavours to determine whether a benchmark is representative, can be replicated, measured, has appropriate transparency and governance and is sufficiently liquid.

For rate benchmarks, such as LIBOR, the single most important precondition for adoption by the market is liquidity. For our index businesses, we use commercially reasonable endeavours to determine the efficacy of a benchmark by considering its performance against a number of key criteria. If a benchmark does not meet these criteria, it will struggle to gain acceptance in the market. The key questions we ask are:

Is the benchmark representative of the target opportunity set? Is the benchmark sufficiently diversified and reflective of the

country/region/sector that is the target of a client’s index equity investment? Is the benchmark constructed using market capitalisation weights or an

alternative methodology?

We further test potential indices against the following questions before determining whether they may be acceptable for use.

Are real life investment constraints incorporated into the calculation of the benchmark to make it investable?

o Are foreign investor limits incorporated into the free float calculation of a stock?

o Are strategic holdings incorporated into the free float calculation of a stock?

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o Are market liquidity screens incorporated?o Can foreign investors gain access to an equity market?

Are the rules governing index calculation sufficiently transparent?o Are the index calculations clear and replicable?o Is the process of adding and removing stocks clear and based on

clear, pre-determined criteria?o Is the treatment of corporate events based on clear, pre-determined

criteria?o Are free float changes incorporated based on clear rules and data

available to the marketplace? Other factors

o What is the level of annual turnover for the index?o How reliable is the data that is delivered by the index provider?o Does the index have investor acceptance and what are the reasons

for that acceptance? Chapter 2. Calculation of Benchmarks: Governance and Transparency.

(8) What kinds of data are used for the construction of the main indices used in your sector? Which benchmarks use actual data and which use a mixture of actual and estimated data?

Benchmarks such as LIBOR and EURIBOR are currently based on estimations. In contrast, the OIS and GCF Repo Index use transactional data. Whilst the daily fix for OIS is based on actual transactions, the term structure is based on a market snapshot of indicative quotes at any given time; whilst there are a reasonable number of OIS transactions every day, these are currently not centrally reported and are biased towards shorter tenors in more liquid currencies. The term structure for the GCF Repo Index is relatively young as the benchmark was only recently launched. Whilst current regulatory initiatives will improve transparency around transaction reporting, this will not address the fact that these trades are not contemporaneous and not every tenor in every currency will trade every day.

Equity indices are calculated based on real transactions completed at a particular point in the trading day: generally the closing pricing mechanism of a given exchange. In addition to stock prices, equity indices must incorporate the number of shares and free float in order to calculate market values and weights for each asset. These can then be aggregated to calculate the index level.

Fixed income indices can be based on real transaction data as well as modelled or estimate prices. The latter is a reflection of the fact that many fixed income assets do not trade daily. Modelled and estimate prices are used to avoid out of date prices.

Data for commodity futures indices typically comes from commodity futures exchanges and from national and supranational organisations responsible for producing fundamental data on commodity markets (in particular world production quantities used for index weightings).

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(9) Do you consider that indices that do not use actual data have particular informational or other advantages over indices based on actual data?

BlackRock considers that, for rate benchmarks such as LIBOR and EURIBOR, a mixed or hybrid methodology for calculating benchmarks is more likely to restore market confidence than the current methodology or one based solely on transactional data.

Gary Gensler, Chairman of the US Commodity Futures Trading Commission (“CFTC”), highlighted in the European Parliament Public Hearing on LIBOR (24 September 2012) the fact that LIBOR rates can be different to those of other benchmarks and posed the question whether LIBOR should be reformed or replaced. Chairman Gensler’s questions included “why is US Dollar LIBOR so different from US Dollar EURIBOR?”, “why have LIBOR and other benchmark rates typically not been aligned, since 2008, with the borrowing rates that would be implied by FX markets?”, “why is the volatility of dollar denominated LIBOR so much lower than the volatility of other dollar denominated short term interest rates?” and “why do the one year borrowing rates that the majority of the panel banks submit to the BBA for LIBOR not appear to fully incorporate the market rates for their credit risk as indicated by the rates for the institution’s one year credit default swap?”

We outline below our brief response to these questions and would be pleased to provide further data and discuss these issues in greater depth if appropriate. Our conclusion remains that we should support the reform of LIBOR, specifically that LIBOR should adopt a hybrid methodology, while encouraging the development of alternative benchmarks.

We believe that the differences highlighted by Chairman Gensler reflect the fact that LIBOR and EURIBOR each have a different selection of banks on their panels coupled with recent stressed conditions in the funding markets. For example, banks in the EURIBOR survey represent banks from the European Union countries which typically lack significant sources of US dollar deposits. This raises their cost of borrowing in dollars relative to banks that have significant dollar deposit taking franchises. Additionally, because of this relative lack of access to dollar deposits, Central Bank liquidity swap lines (also referred to as reciprocal currency arrangements) were established amongst several Central Banks. Of most relevance here are those swap lines established between the US Federal Reserve and the European Central Bank (“ECB”). The European banking system can benefit from access to dollar liquidity provided to the ECB through these facilities but that liquidity comes at a cost. Initially, in the first phase of usage following 2008, the Federal Reserve charged 100 basis points over the U.S. dollar overnight index swap rate. Beginning with the 30 November 2011 extension of the program the rate was cut by 50 basis points. European banks accessing dollar funding through these sources would register this additional cost of borrowing into their survey responses accounting for the higher borrowing rates indicated in USD Euribor relative to USD LIBOR. Hence, the EURIBOR US dollar rate is typically higher than that for LIBOR. Similarly, the differences in LIBOR, EURIBOR and the currency swap markets reflect

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the differences in the underlying composition of participating banks and their relative dependencies on the wholesale funding markets.

The relationship between one year borrowing rates indicated by panel members in the LIBOR submissions and their one year Credit Default Swap (CDS) spreads is affected by several factors, any of which can account for meaningful differences between the two financial series.

First and foremost, the comparison suffers from a critical definitional difference: CDS spreads represent the cost of obtaining protection from a counterparty on the default of the reference entity while LIBOR rates reflect the remuneration for lending to the reference entity dollars. These two are fundamentally different: the first isolates the default risk of the reference entity while the later incorporates both the cost of interest rates in the financial market and the risk of nonpayment (i.e. the credit risk of the entity).

Second, particularly during the crisis and post crisis periods after 2008, longer dated term funding market transaction volumes declined significantly. This led to greater estimations and judgment likely being used to determine the LIBOR submissions as real transaction data did not exist. Hence our recommendation that the matrices of LIBOR maturity submissions be reduced to shorter tenors and to those tenors that are both most frequently used as benchmarks and are most likely to have a greater capacity to support transaction based submissions under the hybrid approach.

Third, the market for CDS for short tenors is impacted by several issues unique to both credit and credit derivative markets: the general level of risk aversion leading to imbalance in the supply of and the demand for credit protection; the unique demand and differences in the supply of and demand for short dated versus longer dated credit protection; and the level of credit risk in the financial system and the increase in demand in particularly short tenor CDS as protection from “Jump to Default” risk. All of these factors can contribute to meaningful differences between rates observed in 1 year CDS versus 12M LIBOR submission rates.

BlackRock notes that this question is not applicable to market equity indices which are only and properly calculated using actual market transactions.

(10) What do you consider are the advantages and disadvantages of using a mixture of actual transaction data and other data in a tiered approach?

A number of reasons exist why a hybrid approach may be superior. Where the underlying assets of a fixed income market index do not trade frequently, for example, the modeled prices can provide a more accurate price valuation than the last actual trade. In addition, transactional data without some measure of volume may not provide an accurate indication of the amount that can be traded at a particular price.

BlackRock also believes that a hybrid approach for rate benchmarks such as LIBOR and EURIBOR, coupled with a reduction of the number of tenors and currencies, will focus rates appropriately on those most representative of interbank funding and

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those where most transactions are likely to take place. Together with auditing of submissions and greater regulatory oversight, we believe that such a hybrid approach is the most likely to restore investor confidence in such benchmarks and the least likely to cause unforeseen consequences for savers and pensioners. In general, the more radical the change, the greater the impact on potential winners and losers.

(11) What do you consider are the costs and benefits of using actual transactions data for benchmarks in your sector? Please provide examples and estimates.

Many benchmarks and indices use transactional data, typically market indices such as equity and many fixed income indices. In the case of the index and ETF businesses, the only significant cost incurred is for the market data provided by exchanges.

Replacing benchmarks such as LIBOR and EURIBOR with benchmarks based purely on transactional data will, in contrast, represent a significant change and incur substantial costs which will inevitably be borne by the end investor. Many securities use LIBOR and EURIBOR as an explicit reference rate to determine the coupon. Moving the baseline to EONIA or SONIA, for example, would have implications for the overall risk and return profile of the investment: a straight substitution of LIBOR + 300bp with EONIA + 300bp would in many cases be economically inequitable resulting in the need to rebase the whole contract. Attempts to ‘fix’ the credit component at a specific spread would not be an accurate reflection of how the evaluation of credit risks evolves over time.

This issue around contractual change is accentuated by the long term nature of many interest rate derivatives, typically 40 and 50 years for liability driven pension fund strategies. Early termination of such contracts may result in potentially substantial economic and liquidity impacts. A significant change in the value of swaps will change, for example, the value of a pension fund’s assets, including its interest rate swap positions, while its cash flow liabilities will remain unchanged. This would impact the pension fund’s funding ratio and its ability to pay its liabilities, that is, the pensions it is designed to pay.

(12) What specific transparency and governance arrangements are necessary to ensure the integrity of benchmarks?

We set out our thoughts on transparency for indices in our response to Question 7. Such a high degree of transparency to the market is, however, not appropriate, for benchmarks such as LIBOR and EURIBOR. We recommend instead that raw transaction data should be communicated with a modest time lag to regulators ensuring that any material deviations be swiftly investigated. Commercial reasons also exist to further delay or aggregate transaction data for public consumption.

BlackRock would support the inclusion of non-participating members on the oversight committees of benchmarks such as LIBOR and EURIBOR.

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(13) What are the advantages and disadvantages of imposing governance and transparency requirements through regulation or self-regulation?

BlackRock supports greater transparency and clear standards of governance as we believe that both are fundamental to restore market confidence in rate benchmarks such as LIBOR and EURIBOR. We would recommend a binding code of conduct, subject to independent audit, coupled with sanctions as set out in the market abuse regime. We note in this context that IOSCO has recommended self-regulation principles for price reporting agency (“PRA”) benchmark governance (coupled with an independent audit) but will apply regulation to PRAs should compliance be unsatisfactory.

(14) What are the advantages and disadvantages of making contributing data or estimates to produce benchmarks a regulated activity? Please provide your arguments.

BlackRock believes that the market is best served by representative panels providing a combination of subjective and transactional data which is subject to both transparency and audit requirements. If the costs for contributing banks become too great, they may decide to withdraw from participating in a panel and consequently the panel becomes less representative. The decision centres around weighing up the greater protection users may receive through regulation against the risk that regulation could make the rate benchmark less representative. Greater regulatory oversight (as suggested in the Wheatley Review) coupled with sanctions under the Market Abuse Directive could achieve a reasonable balance as long as the regulation is appropriately calibrated.

(15) Who in your sector submits data for inclusion in benchmarks? What are the current eligibility requirements for benchmarks' contributors?

This question is not applicable for BlackRock.

(16) How should panels be chosen? Should safeguards be provided for the selection of panel members, and if so which safeguards?

BlackRock believes that the principal safeguard is afforded by transparent governance standards. These should include the seniority of panel members, methodology and operations, a requirement to make public the panel’s performance against the governance standards as well as consultation with end-users of the relevant rate benchmark. BlackRock would also support the inclusion of non-participating members on oversight committees (not panels).

(17) How should surveys of data used in benchmarks be performed? What safeguards are necessary to ensure the representativeness and integrity of data gathered in this way?

BlackRock believes that volume metrics, the submission of raw data, the process for validating and auditing submissions, transparent governance and a framework for

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managing conflicts of interest are all critical in ensuring the representativeness and integrity of the data gathering.

(18) What are the advantages and disadvantages of large panels? Even in the case of large panels could one panel member influence the benchmark?

BlackRock prefers larger (voluntary) panels over smaller panels precisely because larger panels reduce the likelihood that any individual submission can impact the rate, particularly when it is calculated by the “trimmed mean” methodology. A move from the mean to the median might reduce further the potential for such an impact. We note however that the difference between the mean and the median in US Dollar 3 month LIBOR since the beginning of 2011 is modest. The average difference was 0.14 bps with the median being higher (taking the median on the trimmed panel).

(19) What would be the main advantages and disadvantages to auditing of panels? Please provide examples.

The main advantage of auditing panels is the greater security and confidence it gives to market participants about the benchmark. Panel members may have concerns that sensitive data might inappropriately become public as a result of the audit process and at the cost of carrying out regular audits.

We note that withdrawals from panels have taken place where banks see limited benefits and unknown costs.

(20) Where indices rely on voluntary contributions, do you consider that there are factors which may discourage the making of these contributions and if so why?

A number of factors might discourage banks from contributing to voluntary panels, including the level of regulation, reputational risk, additional costs (do they pay for their own audits?) and potentially sensitive data becoming public.

(21) What do you consider to be the advantages and disadvantages of mandatory reporting of data? Please provide examples.

Mandatory participation could result in large panels. The benefit which one would expect from a large panel could, however, be undermined by mandatory participation if this means that the panel becomes unrepresentative or if it creates uncertainty in the construction of the panel. Who, under a mandatory system, would have responsibility for defining the criteria to select the banks that must contribute? Who would monitor and maintain the criteria and hence the banks selected? Any benchmark should reflect ‘volume weighting’ to some degree – an arithmetic mean established from a very broad panel with a large number of marginal participants could result in fixes which were not representative of the economically significant activity.

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(22) For entities contributing to benchmarks which are regulated by financial regulation, what would be the advantages and disadvantages of bringing their benchmark submissions under the scope of this framework?

As previously stated, in respect of rate benchmarks, BlackRock would be supportive of introduction of audit requirements, and the requirement that panels be representative and of sufficient size to reduce the likelihood that an individual member can influence a rate. Participation in the setting of rate benchmarks such as LIBOR and EURIBOR is, however, voluntary whilst the benefits of a credible benchmark accrue to all in the financial system. Changes in the rate setting process need to take into account the impact on the voluntary nature of the rate setting process. Any proposed reforms to such benchmarks should therefore weigh both the benefits of the reform against direct and indirect costs in the form of the effect the changes may have on dissuading participation.

(23) Do you consider that responsibility for making adjustments if inadequate data is available should rest with the contributor of the data, the index provider or the user of the index?

In respect of rate benchmarks, responsibility for benchmarks such as LIBOR should generally lie with the contributor of the data, subject to appropriate regulation and oversight. We acknowledge the role that those validating the submission of rates play in highlighting material deviations between the rates submitted and the raw data submitted and would encourage further measures to enhance the effectiveness of this process.

This question is not applicable to equity indices.

(24) What is the formal process that you use to audit the submissions and calculations?

While BlackRock is not in a position to verify the construction or accuracy of a market index and assumes no liability in connection with any index errors or omissions, we use commercially reasonable endeavours to conduct best practice due-diligence exercises with our benchmark providers. These assist in delivering efficacy in operational processes, calculations, data-delivery, quality control and error resolution. In addition, we participate on advisory committees where relevant and provide guidance in client consultations that the index providers undertake when considering methodology changes.

(25) If there are any weaknesses identified in the audit, who are they reported to and how are they addressed? Is there a follow up process in place?

Our due diligence exercises do not audit data but do assess operational processes and controls. When deficiencies are discovered they are fed back to the index provider along with BlackRock’s vendor management, index equity management, and risk teams.

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(26) How often are submissions audited, internally or externally, and by what means? Do you consider the current audit controls are sufficient? What additional validation procedures would you suggest?

While we are not in a position to perform daily audit checks, our data integrity team seeks to validate equity market prices every day to assist in ensuring that discrepancies are appropriately managed and kept to a minimum. Any deviations so identified are promptly investigated and escalated, where necessary. In addition, our index research team analyses index changes as a daily process and queries unexpected changes and variances with the index providers and portfolio managers. For fixed income, we cannot validate prices as there is not a confirmed price to compare against but we do check for any big variances in price and employ other appropriate quality control measures. That said, in respect of both equity and fixed income indices, where an index is being re-balanced, the index re-balance files will often be issued at very short notice by the index provider with a tight turn-around for the re-balancing trades. Where this occurs, it will limit the extent to which data can be verified in practice.

Furthermore, it should be noted that, for passive funds which have the investment objective of tracking a particular index, the investment manager is mandated to track that index notwithstanding the fact that there may be latent errors, inaccuracies or omissions in the index data itself.

In respect of market indices, we acknowledge that regulation of market indices may be an option in enhancing validation procedures and minimising data-related issues. However, as index providers are not currently regulated, we anticipate that the introduction of any regulatory regime specifically targeted at index providers would result in additional cost for such providers. We also suspect that such costs will ultimately be passed onto the end investor (undermining the benefits of passive investing, making such instruments uneconomical). As such, we recommend that the impacts of any proposed regulation be carefully measured to weigh the advantages against the disadvantages. On balance, we consider that it may be more appropriate to address potential risks associated with market indices (for example, losses that investors may suffer where there is an error in the relevant index and/or as a result of extraordinary rebalances required in connection therewith) through enhanced risk disclosures and investor education. We consider this in more detail in our response to Question 29 below.

(27) What are the advantages and disadvantages of a validation procedure? Please provide examples.

Once again, while BlackRock is not in a position to verify the construction or accuracy of an index and assumes no liability in connection with any index errors or omissions, we would be supportive of validation procedures which are designed to mitigate incorrect data feeds into the portfolio management process. As a result, we use commercially reasonable endeavours to validate equity price data and monitor the changes to all indices tracked on a daily basis to ensure that any index turnover

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is correct. Part of BlackRock’s index investment philosophy is to minimize costs to funds by only transacting when necessary.

That said, as above, in respect of both equity and fixed income market indices, where an index is being re-balanced, the index re-balance files will often be issued at very short notice by the index provider with a tight turn-around for the re-balancing trades. Where this occurs, it will limit the extent to which data can be verified in practice.

(28) Who should have the responsibility for auditing contributed data, the index provider or an independent auditor or supervisor?

In respect of market indices, index providers are responsible for performing and calculating index data in accordance with the specified methodology. As it is a competitive marketplace, the inability to deliver accurate equity indexing solutions will render such index providers and the adoption of their indices as benchmarks less attractive.

(29) What are the advantages and disadvantages of making benchmarks a regulated activity? Please provide your arguments.

Please refer to our response to Question 14 for rates indices.

In respect of market indices, index calculation is a competitive marketplace and index providers do consult with end-users on methodology changes and improvements. Directly competing products can be substitutes for each other, giving end-users options and the recourse to change providers if governance and transparency are deemed to be insufficient. As we note above, in respect of index-tracking funds (including ETFs) passive investing represents a low-cost and efficient means of delivering the desired exposure to a wide variety of investors. Index funds (particularly ETFs) can be simple, flexible, cost-effective and offer opportunities to spread risk:

Lower costs – index funds can be less expensive than many traditional pooled funds.

Spread risk – index funds provide diversification and reduce investment concentration risks.

Transparency – ETFs, in particular, offer a high degree of transparency regarding the ETF portfolio holdings, performance and costs.

Flexibility – there is a wide choice of index funds (and ETFs) available, and ETFs can be bought and sold simply and quickly.

The wide range of index products available allows investors to build portfolios that aim to fulfill many investment goals. The ability to simply and efficiently invest in many different asset types, from stocks and shares, bonds, commodities, property is, in such a way, accessible to investors.

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Should regulation and/or audit requirements be imposed on index providers directly, we have concerns that the costs of compliance in relation thereto would be passed back onto the end investor in index products. As such, the introduction of such measures may render passive investing uneconomical, undermine the benefits set out above and/or lead to a reduction in the choice of such products available.

As already noted, we would support alternative measures which focus on enhancing disclosure requirements (ensuring that end investors understand the relevant risks of index-tracking products), rather than the implementation of a regulatory regime directly applicable to index providers, the costs of which are ultimately passed back to the end investor. The alternative approach to regulation we set out above would assist in ensuring that end investors understand the risks associated with index-tracking products, while retaining access to, and a broad selection of, investments with the benefits outlined above.

Finally, it should be noted that the use of market indices as benchmarks for index-tracking funds is already regulated, to an extent, through the UCITS Directive and the new ESMA Guidelines on ETFs and other UCITS issues. Such regulations provide, inter alia, that a chosen market index for an index-tracking UCITS must be representative of the relevant market and must be sufficiently diversified.

Chapter 3: The Purpose and Use of Benchmarks

(30) Is it possible and desirable to restrict the use of benchmarks? If so, how, and what are the associated costs and benefits? Please provide estimates.

BlackRock does not believe that it is desirable to restrict the use of rate benchmarks or market indices. Market participants should be allowed to select benchmarks or indices that meet the needs of borrowers and lenders. Different investors and different borrowers have different needs and preferences and these evolve over time. We note that this question is not applicable to equity indices.

(31) Should specific benchmarks be used for particular activities? By whom? Please provide examples.

We refer to our answer above.

(32) Should benchmarks developed for wholesale purposes be used in retail contracts such as mortgages? How should non-financial benchmarks used in financial contracts be controlled?

This depends on the individual circumstances. BlackRock would generally suggest that any benchmark be chosen as ‘best fit for purpose’ to meet the relevant investment objective. If a wholesale benchmark achieved the same objective for retail purposes, there should be no reason to exclude it from retail contracts.

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(33) Who should have the responsibility for ensuring that indices used as benchmarks are fit for purpose, the provider, the user (firms issuing contracts referenced to benchmarks), the trading venues or regulators?

For rate benchmarks such as LIBOR and EURIBOR, the panel members and regulator should have responsibility for ensuring that indices are fit for purpose. As stated previously, the submission of data and administration of such indices should be subject to greater regulatory oversight as set out in the Wheatley Review.

For market indices, we feel that it is the responsibility of the index providers to ensure that their indices are designed and structured in such a way that they deliver the return on their intended exposure. The assessment of whether something is “fit for purpose” will depend on the individual circumstances (and it may be appropriate for providers acting in an advisory and/or fiduciary function to assume a degree of responsibility for such assessment).

In any case, all indices (rate benchmarks and market indices) should be subject to the market abuse regime and we strongly support an enhanced transparency and disclosure regime whereby investors are provided with sufficient information such that they can make an assessment as to whether the relevant index is fit for purpose to achieve their investment objective.

Chapter 4: Provision of Benchmarks by Private or Public Bodies

(34) Do you consider some or all indices to be public goods? Please state your reasons?

We do not believe that indices, with the exception of those referred to in our response to Question 37, are public goods. However, we support the European Commission’s proposals to expand its provisions for market manipulation in the Market Abuse Directive and initiatives aimed at achieving greater transparency and regulatory oversight for benchmarks such as LIBOR and EURIBOR.

We note that significant investment and research is involved in creating and calculating indices and it is a competitive market place with providers differentiating through incremental improvements and innovation. As a result there exists intellectual property within this space. We believe that end investors are better served by existing market competition within the index sector than by a potentially smaller subset of calculation agents.

(35) Which role do you think public institutions should play in governance and provision of benchmarks?

For benchmarks such as LIBOR and EURIBOR, authorities should ensure that the key participants involved in the establishment of benchmarks and fixing rates are subject to broad regulatory oversight in relation to these activities. We are supportive of greater regulatory oversight coupled with sanctions as set out under the Market Abuse Regulation.

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(36) What do you consider to be the advantages and disadvantages of the provision of indices by public bodies?

We believe that end investors are generally better served by competition between market participants and their greater ability to respond to market conditions and market liquidity.

(37) Which indices, if any, would be best provided by public bodies?

Public bodies are best placed to provide overnight deposit rates such as EONIA, SONIA and FED Funds.

Chapter 5: Impact of Potential Regulation: Transition, Continuity and International Issues.

(38) What conflicts of interest would arise in the provision of indices by public bodies? What would be the best way of avoiding these conflicts of interest?

Conflicts of interest may arise in the provision of indices by public bodies. For this reason, where public bodies provide benchmarks (e.g. gilt DMO closing prices), they should only be used pari-passu with commercially-provided benchmarks.

(39) What are the likely transition challenges, costs and timelines for relevant benchmarks? Please provide examples.

We outlined some of the challenges in our response to Question 11 and comment here further on the costs and timelines.

Where benchmarks such as LIBOR and EURIBOR are used as a purely indicative reference rate to calibrate the expected performance of a fund, without any contractual or mathematical impact on the investors’ return, alternative indicative reference rates could be established with minimal repercussions, provided that sufficient time for contractual notification or renegotiation is allowed.

Where LIBOR and EURIBOR are used as an explicit reference rate, a move away will be more problematic as there would be significant economic impacts of any contractual shift, not least due to the implicit credit spread embedded in LIBOR. In the case of money market funds, it might take two to three years to transition to another benchmark and longer for short term bond funds.

This legacy impact is far more significant for pension funds following liability driven investment strategies that invest in long dated interest rate derivatives (commonly up to 40 and 50 years). Re-calibration of existing LIBOR and EURIBOR contracts, for example, to a rate no-longer based on an interbank unsecured lending rate would represent a significant challenge and could potentially lead to greater dislocation and disruption than any distortion of LIBOR and EURIBOR that may have occurred over the past few years.

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Finally, we note that LIBOR and EURIBOR are contractually embedded in a number of financial instruments; replacing them in such instances may not be contractually possible or may be too costly to implement.

We therefore strongly recommend reform of LIBOR and EURIBOR to a hybrid system based on a reduced number of tenors and currencies and subject to volume metrics, the auditing of raw data and greater regulatory oversight. A move to a benchmark based purely on transactions would represent a significant change and would require and lengthy and orderly transition period – possibly of the order of 5-10 years.

As a footnote, substituting one equity or fixed income index for another, is also not an exercise to be undertaken without consideration over the costs and benefits of the action, along with significant advanced notification to clients of the change in order to give them enough time to disinvest if this is the preference. Any portfolio transitioning an equity index would likely incur transactions costs. These would be measured by the amount of overlap between the indices, the commission cost in various markets, local market taxes, and bid/ask spread of the underlying securities.

(40) How do you consider that the adoption of new benchmarks could be ensured? Is this best framed in terms of encouraging or mandating the use of particular benchmarks?

Alternatives to LIBOR and EURIBOR already exist and include the OIS, GCF Repo Index, EONIA and SONIA. Generally, the market has moved toward the use of OIS curves for discounting the present values of future cash flows for derivative contracts. However, these alternatives also have drawbacks. For example, OIS curves are still the market’s estimation of the future path of (overnight deposit) rates and therefore subject to some of the same types of weaknesses as LIBOR fixings as they are a ‘snapshot’ of an OTC market.

BlackRock supports greater diversity in the range of benchmarks used; a one size fits all rate benchmark may no longer be the optimal solution as different investors and borrowers have different needs and preferences. Given the volume of legacy business based on LIBOR and EURIBOR and the implications of a radical move away from them for the end investor, we would strongly recommend that the first priority should be on the reform of LIBOR to restore its credibility but that encouraging the use of alternative benchmarks should form an explicit part of the reform agenda. We do not believe that the use of certain benchmarks should be mandated for the reasons listed in our response to Question 30.

(41) How can reforms of the regulation of benchmarks be most easily implemented?

Reforms of rate benchmarks should permit an orderly transition to avoid unintended negative impacts on Europe’s pensioners and investors. The implementation of reforms should therefore reflect the nature of the legacy business as set out to our response to Question 39. We would stress here that it is important that the industry is given time to develop the mechanisms and processes to support new requirements

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and that such requirements, for example, for additional trade reporting, should leverage existing infrastructure wherever possible.

Finally, we note that the various rate benchmarks exhibit some important differences and are themselves located in a number of different regions. We therefore support IOSCO’s initiative to define global principles for the setting of benchmarks.

(42) What positive or negative impacts, if any, do you see on small and medium-sized enterprises of the possible regulation of indices, and how could any negative impacts be mitigated?

BlackRock has no comment on this question.

(43) Are there other impacts which should be considered? If so please specify the nature of these impacts and provide evidence.

We refer to our responses to Questions 5, 11, 39 and 40.

(44) In which countries are benchmarks used in your sector produced? From which countries are data used for the production of benchmarks in your sector sourced? In which countries are benchmarks used in your sector used?

Index providers are based in countries all over the world. The data used to calculate equity indices comes from exchanges globally. In contrast, LIBOR for historical reasons, is centred principally in London and EURIBOR in Frankfurt, commodities futures indices in the US and bond indices are global and are not tied to any particular region.

(45) Are there non-EU benchmarks which could serve as substitutes? Are there non-EU benchmark providers which could produce similar benchmarks?

A number of non-EU benchmarks could serve as partial substitutes, for example the OIS or the GCF Repo Index as already highlighted.

Although equity index substitutes can be reasonably interchanged, it should be noted that the underlying stock price data used to calculate both is largely the same as it is based on market transactions. Most fixed income index providers are global investment banks and, as such, it is neither meaningful nor accurate to tie them to a specific geographical location.

(46) Are there international benchmarks which could serve as substitutes for national benchmarks?

As stated previously, there are index substitutes that can be reasonably interchanged. However, as an example, a UK equity index cannot serve as a substitute for an emerging markets index. The underlying investment universes must match and construction methodology must be similar in order for the equity indices to be reasonable substitutes.

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