Reserve Bank of India (RBI) for overhaul of financial benchmarking methods

Reserve Bank of India (RBI) on Friday suggested an overhaul of existing financial benchmarks, including steps to strengthen the quality, methodology and governance framework.

Apart from this, the central bank also called for amending the statutes to empower RBI to determine the policy for benchmarks and issuing binding directions to all the agencies involved in the benchmark-setting process.

These suggestions are made in a ‘Draft report of the committee on financial benchmarks’ and sought public comments on the report by January 17.

The RBI had set up a committee under its Executive Director P Vijaya Bhaskar on June 28, 2013 with a mandate to study the various issues relating to financial benchmarks and to submit the report by December 31.

The panel was set up in the aftermath of revelations that several key global benchmark rates like the Libor, Euribor of European Union, Tibor of Tokyo, etc were rigged by leading market operators like RBS, and several global standard setting bodies, national regulators.

This led to self-regulatory bodies reviewing the benchmark setting processes and coming out with wide ranging reforms to enhance the robustness and reliability of financial benchmarks.

The RBI draft report, while noting that the existing system is generally satisfactory, called for “several measures/principles to strengthen the benchmark quality, setting methodology and governance framework of the benchmark administrators, calculation agents and submitters.”

It also called for “amendments to the RBI Act, as a long- term measure, to explicitly empower RBI to determine the policy with regard to benchmarks used in money, G-secs, credit and forex markets and to issue binding directions to all the agencies involved in the benchmark-setting.

Pending amendments to the RBI Act, the report recommended “appropriate regulatory and supervisory framework to be put in place by RBI for financial benchmarks under its existing statutory powers.”

Financial benchmarks are primarily used for pricing, valuation and settlement purposes in financial contracts, the RBI said in the report.

The aggregate volume of underlying financial contracts referenced to or valued through financial benchmarks being quite huge, the robustness and reliability of financial benchmarks play a critical role for the stability of the financial system, it added.

Financial benchmarking is a process by which the central bank can arrive at global best practices by comparing and evaluating the various aspects of the existing practices in money, government securities (G-Secs), credit and forex markets.

It can be noted that Iosco (International Organisation of Securities Commissions) released its final report on ‘Principles for Financial Benchmarks last July, which was endorsed by the FSB. The benchmark administrators are required to disclose their compliance with the Iosco principles by July 2014.

The panel had the mandate to review all the major rupee interest rate and forex benchmarks like the Mibid-Mibor, Mifor, INBMK, Miois, Miocs, G-Secs yield curve, prices for SDL, spreads for GoI FRBs, prices for corporate bonds, T-bills etc, based on their extent of usage and relevance to the financial system.

The major forex benchmarks are RBI reference rate, Fedai’s spot fixings, month-end revaluation rates for forex spot and forward contracts, forex-rupee option implied volatility and FCNR-B rates.

The committee reviewed these major benchmarks with regard to their quality, setting methodology and governance systems.

On the benchmark quality and setting methodology, report observes that although the methodologies followed are generally satisfactory, several measures need to be taken to further strengthen the benchmark quality and setting methodology.

“The benchmark administrators and calculation agents need to suitably augment their resources for being up to the rather onerous tasks allotted or expected of them,” the report said.

Other major suggestions include designating FIMMDA and Fedai as administrators for all the rupee interest rate and forex benchmarks respectively, with primary responsibility for the entire benchmark setting process.

Making benchmark administrator to publicly disclose individual submissions after a suitable lag, periodically review each benchmark and undertake necessary changes; and register new benchmarks with the administrator concerned before being introduced in the market.

Making credible contingency provision and putting in place written policies and procedure to handle possible cessation of a benchmark, overnight MIBID-MIBOR setting may be shifted from existing polling method to volume weighted average of trades executed between 9 am and 10 am.

Making FIMMDA to coordinate the transition of legacy contracts referenced to NSE Mibid-Mibor through multilateral and bilateral amendment agreement.

Making a G-Secs yield curve suing volume weighted average rate of the trades executed over longer time window in place of last traded yields and use the transaction data to calculate INBMK, T-bills, CP, and CD curves as the first layer of data inputs among others.

The report also wants RBI to continue with the existing system of fixing the reference rates, keeping in view the recent international moves where the official sector is assuming greater role in fixing financial benchmarks and also the fact that several central banks in developed as well as emerging economies publish such reference rates.