South Korea prepares for EU benchmark equivalence

New regulatory framework aims to allow European firms to continue using local benchmarks


South Korea is tightening its rules on financial benchmarks in a likely bid to seek equivalence with new European laws overhauling index supervision. The move would enable European entities to buy and sell securities linked to benchmarks in Asia’s fourth largest economy after 2020.

Korean indexes such as the Kospi 200 are an important part of structured products sold by European banks to Asian investors. The Kospi has also been a popular underlying of corridor variance swaps for hedge funds and European pension funds. This trade sees one party go long Korean index volatility and short volatility of the S&P 500, and profits as long as spot on the first index remains within a certain range.

South Korea’s Financial Services Commission is working on a draft bill to introduce new supervisory rules for financial benchmarks, the FSC confirmed in an emailed statement. A spokesperson for the regulator explains that the new bill includes measures to improve transparency in the calculation process.

“The new legislation will include details about the process of benchmark calculations, internal controls to conflicts of interest, and a contingency plan in case of such benchmarks becoming unavailable,” the spokesperson says. 

That would mean South Korea is pursuing a route similar to Australia and Singapore in adopting new benchmark regulation to improve the transparency in how values are set for instruments from credit default swaps to mortgage rates.

“The Korean regulator will announce sooner or later a new draft law in order to regulate Korean benchmark producers and is considering equivalence or recognition process as a way of complying with European benchmark regulations,” says a Seoul-based lawyer with knowledge of the matter. “Japan, Singapore and Australia have benchmark laws and the FSC also carefully reviewed those laws. The FSC will probably follow a similar path to those countries.”

The FSC are developing an action plan to possibly have an equivalent regime to the EU BMR

Hyelin Han, Isda

The European Union’s Benchmarks Regulation, or BMR, aims to overhaul the supervision of firms that administer indexes and reference prices. Under the regime, EU-regulated firms can only market products referencing indexes from countries that have undergone an approval process known as equivalence.

Two further options are available to non-EU regulators and benchmark administrators. Either the administrators can seek recognition from a regulatory authority in an EU member state or persuade a European index administrator to endorse a specific non-EU benchmark.

To obtain an equivalence decision, a non-EU regulator must put in place rules that are demonstrably similar and achieve the same outcome as those in place in the EU. The equivalence process, though, has previously been fraught with difficulties in areas such as central counterparty supervision and swaps trading. The EU has not yet announced equivalence decisions under its new legislation.

Hyelin Han, assistant director of public policy at the International Swaps and Derivatives Association, says the FSC appears to be leaning towards equivalence.

“With the EU BMR coming, we’ve been engaging with the FSC since last year and I am glad to say that they are one of the regulators that really stood up and took notice,” she says. “They have been asking questions about what they need to do and are developing an action plan to possibly have an equivalent regime to the EU BMR.”

The BMR came into effect in January 2018, but the EU has granted a two-year grace period for non-EU jurisdictions. However, fears that liquidity could drain away from products tied to local benchmarks amid the uncertainty have put pressure on regulators outside Europe to start setting out their plans.

“Markets are going to start shifting well ahead of 2020,” says Wayne Arnold, head of policy and regulatory affairs at Asian financial trade body, Asifma. “We think we will see liquidity move out of indexes that the market doesn’t believe are going to either seek or achieve authorisation, and into indexes that they see are applying and are likely to get it.”

A survey by Asifma in 2017 identified 55 important benchmarks that could be affected when the BMR’s two-year grace period expires at the start of 2020. In South Korea, these include the Bank of Korea base rate, and the three-month certificate of deposit rate – a benchmark commonly used by market participants in interest rate swaps and cross-currency swaps.

Korean benchmark administrators can’t afford to relax. They need to work on the assumption they won’t have equivalence

Wayne Arnold, Asifma

However, a host of other important financial benchmarks also fall under the scope of the regulation – not least the Kospi 200, administered by the Korea Exchange.

According to Bank of America, the Kospi is currently the fourth most used underlying in autocallables sold to Korean investors – behind the Euro Stoxx 50, Hang Seng China Enterprises Index and S&P 500. The amount of investment products linked to the index is considerable: monthly volumes for Kospi-linked autocalls stood at roughly $900 million in March.

It remains unclear which of the country’s benchmarks the FSC will seek to designate as equivalent if and when the Korean National Assembly passes the required legislation into law.

Australia is proposing to implement reforms based on global principles from the International Organisation of Securities Commissions, to include a broad range of its indexes. Singapore amended its Securities and Futures Act last year to allow the Monetary Authority of Singapore to seek equivalence for its financial benchmarks. For now, MAS has only confirmed plans to designate the Singapore interbank offered rate and Singapore swap offer rate for regulation.

The lack of clarity over the scope of Korea’s new regulatory framework is one reason why Arnold believes the country’s benchmark administrators and index providers should not become complacent about the BMR. Another reason is the short amount of time the FSC has to draft and go live with the new regulatory framework, and then begin a potentially lengthy dialogue with European authorities.

In total the process could take at least nine months from scratch to achieve compliance, a consultant previously told

Arnold says: “The bigger question is still timing. The South Koreans will need to draft and pass legislation, then get Europe’s blessing, all by the end of next year. That means Korean benchmark administrators can’t afford to relax. They need to work on the assumption they won’t have equivalence and keep pursuing their own options for registration.”

Editing by Narayanan Somasundaram and Alex Krohn

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