Consultation on renewal of FMC Market Index Exemption Notice
The Financial Markets Authority (FMA) is consulting on the renewal of the FMC Market Index Exemption Notice 2018 (Exemption Notice). The Exemption Notice allows MIS Managers to use alternative approaches to benchmarking fund performance in fund updates and to calculate the risk indicator, where an "appropriate market index" is not available for at least a portion of the fund's assets. A number of MIS managers rely on this notice. If you rely on it, you should read the consultation.
The FMA is asking for views on:
- whether the Exemption Notice should be renewed in its current form or whether amendments are needed;
- whether additional indices for 'single assets' should be permitted by the Exemption Notice (to improve benchmark performance information available to investors).
Submissions are due by 5pm, Thursday 30 March 2023.
How the current Exemption Notice works
The Financial Markets Conduct Regulations 2014 (FMCR) require fund performance to be measured against an ‘appropriate market index’ in fund updates. An "appropriate market index" is a "broad based securities index" that is appropriate in terms of assessing movements in the markets that the fund invests into. If a fund doesn’t have 5 years of actual returns, the FMCR also requires the risk indicator to be calculated using returns of an "appropriate market index" for that part of the five-year period for which actual returns are not available.1
However, some funds have assets that do not have appropriate market index – referred to as "relevant assets". For example, a fund may invest in "single assets" (such as commodities or cryptocurrencies) that won't have a corresponding broad-based securities index and/or where the asset is not a security. In such cases, MIS Managers must rely on the Exemption Notice. This requires the MIS Manager to use reasonable endeavours to identify a peer group index for each relevant asset, then;
- if a peer group index is identified, it is used in place of the "appropriate market index" for the purpose of the fund update and risk indicator (with some modifications given a peer group index is different to a market index);
- if a peer group index cannot be identified, comparisons against the market index can be omitted from the fund update and the disclose register and the risk indicator must be calculated using a method the MIS Manager considers would reflect the potential future volatility of the fund.
Broadening the Exemption Notice to include additional alternative indices
Funds investing in "single assets" can't usually satisfy the requirement for an "appropriate market index" because there is no relevant broad-based securities index against which to compare performance. Peer group indices may also be hard to identify because the nature of a fund's assets may mean there are not enough peer funds to comprise a peer group. In these cases, even though there may be a market price providing market performance data (for example, a commodity or cryptocurrency price), MIS Managers of "single asset" funds often have to rely on the Exemption Notice with the result that investors do not receive any benchmark information.
To address this, the consultation document proposes that funds investing in single assets could use a "single asset index" to benchmark performance for their "single assets". A "single asset index" is an index that is widely recognised and used, independently administered and appropriate for measuring price movements of that asset. Where a "single asset index" is available, the FMA proposes that it must be used, and a peer group index cannot be used instead.
Absolute return indices
The FMA is not proposing to allow the use of absolute return indices (e.g., cash rate plus margin indices) as part of this proposal on the basis they are inconsistent with underlying policy of the market index requirement (being to benchmark fund performance against the markets that the fund invests in). The FMA is also concerned that absolute return indices have a discretionary element that means such indices lack independence.
Funds with "relevant assets" need the Exemption Notice because they cannot comply with the FMCR's appropriate market index requirements. It therefore seems clear the Exemption Notice should be renewed. We would, however, encourage each manager relying on it to submit in support of renewal and not assume it is a foregone conclusion. The FMA has said that it needs evidence the Exemption Notice is required to meet the statutory threshold for renewal.
The broadening of the exemption to allow the use of single asset indices for single assets also seems sensible. Currently, funds investing in these asset classes are not able to use relevant market price information simply because the market comprises a single asset and/or the asset is not a security. Neither of those features is relevant to the underlying policy of providing a market-based benchmark against which to measure fund performance.
Any additional coverage of the Exemption Notice would need to be balanced against the cost. The payment of index licensing fees for the use of index data is a de facto requirement of the regime and effectively borne by investors. As such, we query whether, for single asset funds, the use of a single asset index should be optional rather than mandatory feature of any renewed exemption.
Real estate and mortgage funds are classes of funds that tend to rely on the exemption. However, the "single asset" terminology and definition used in the consultation doesn't sit well with these funds' underlying assets. Any revised exemption might benefit from additional flexibility, so as to accommodate these funds, if the manager so chooses. For example, by permitting the benchmarking against a relevant property index or credit indices.
Please see below a summary of important upcoming dates in terms of FMA's consultation and decision:
- 30 March 2023 Consultation period closes, consideration of feedback begins.
- July 2023 Current notice expires on 16 July; interim notice with the same terms comes into force for 1 year before current notice expires.
- Approximately September 2023 Decision whether to extend relief under the interim exemption notice for a further 5 years and on what terms.
- October 2023 onwards If the decision is made to extend relief, during this period FMA will draft a replacement notice to give effect to the policy decision.
- Before July 2024 Replacement notice (if granted) comes into effect in advance of the expiry of the interim notice.
Please get in touch if you have any questions or would like any assistance with the current consultation.
1Although the manager can use an alternative risk indicator calculation method cl 8, Sch 4, FMCR