Financial benchmark reform may stumble on patchy take-up
A global blueprint intended to stamp out manipulation of financial benchmarks, expected to be published late this week, risks failure if individual countries persist in pursuing their own regimes.
Regulators are expected to unveil final guidelines for improving transparency and oversight of benchmarks covering everything from interest rates to oil and gold.
But the Madrid-based International Organisation of Securities Commissions (IOSCO) has no power to enforce its recommendations and with Hong Kong and Singapore already forging ahead with their own proposals, the signs are that implementation will be patchy.
“There is no global regulatory trade body with a mandate strong enough to demand a country change its implementation of the principles which are, by nature, subject to interpretation,” said Tom White of JWG, a UK-based regulatory think tank.
This could result in different regulators taking different approaches, leaving weak spots in the system that could be exploited, he said.
Trust in financial industry benchmarks, central cogs in the global economy, has been shattered by revelations last year that traders had routinely manipulated the London interbank offered rate (Libor), used to help price some US$550 trillion in contracts worldwide, from Spanish mortgages to US credit card bills.
European authorities are also investigating allegations of price rigging in the oil market and in Britain, the financial regulator is looking into allegations that traders rigged benchmark rates on the US$5.6 trillion-a-day foreign exchange market.
Despite influencing trillions of dollars worth of contracts, many of the world’s benchmarks are unregulated and determined by people who can profit from their levels.
To minimise the risk of manipulation, IOSCO indicated in April that it would like benchmarks based on actual transactions, where possible, rather than estimates. It also sought more protections for whistle-blowers, a code of conduct for individuals who submit figures for benchmarks and stronger policing of institutions that compile and administer rates.
IOSCO’s final report will be used by the Financial Stability Board, an influential regulatory group headed by Bank of England governor Mark Carney, to oversee reform of benchmarks in the interbank market.
But the FSB will not report back until next year and by then, it may be too late to get individual countries to change reforms already introduced.
Using actual market transactions rather than estimates to calculate benchmarks, as IOSCO wants, is tough in illiquid markets.
Trading in the interbank market has dried up since US investment bank Lehman Brothers collapsed in September 2008 with banks preferring instead to rely on deposits or cheap loans from central banks to fund their loans.
Regulation also risks undermining a benchmark if it puts banks and trading houses off making the submissions needed to compile it.
Trading volumes in Singapore’s once-vibrant interest rate and emerging market currency trading desks are way down following probes into rate-fixing and brokers and analysts interviewed by Reuters said volumes would struggle to recover any time soon.
After uncovering rate-rigging by more than 100 traders, Singapore has made benchmark manipulation a criminal offense and the city state will now regulate the setting of key benchmarks such as Sibor, the Singapore interbank offer rate.
It will discontinue six benchmark rates and four of the remaining five will be based on actual trade data in the foreign exchange market. Sibor will continue to be based on estimates submitted by banks.
In Hong Kong, the city’s de facto central bank has awarded the administration of the interbank lending process to an industry group headed by its own chief executive and said it would phase out interbank rates with little demand.
In Japan, where some bank branches were found to be at the heart of the Libor manipulation cases, the country’s banking industry group said it will tighten monitoring of how its interbank lending rates are set.
Regulators in Europe are considering a more radical approach.
In Britain, authorities are replacing banking trade body the British Bankers Association (BBA) as the administrator of Libor with NYSE Euronext, the transatlantic exchanges operator.
The British regulator wants NYSE Euronext to look at ways of tying the Libor rate more closely to actual transactions.
The UK regulator has suggested running a parallel system - one based on bank estimates to support existing contracts and a transaction-based rate for new contracts. But the United States, which wants to ditch the use of estimates altogether, may insist on a transaction-based benchmark for rates used there.
Thomson Reuters, parent of Reuters, has calculated Libor and distributed the rates on behalf of the BBA since 2005.
In Europe, the authorities are looking at making submissions for interbank rates mandatory as a growing list of international banks, including Citi, UBS and Rabobank , have stopped participating in the calculation of Euribor, the European equivalent of Libor.
Euribor might also be phased out and replaced with a ‘hybrid’ rate which would combine actual transaction prices with estimates to ensure the rate was a valid yardstick when market volumes are weak, people familiar with the plans said.
Even with traded prices underpinning the benchmark, investors may still be wary.
In the spot foreign exchange market, allegations that banks were using advance knowledge of client orders to try and manipulate the WM/Reuters benchmark rate, used by investors and companies to value their holdings, has prompted an investigation by authorities in the UK.
Traders said trying to regulate the currency markets would prove difficult given their large size.
“This market is so huge with all kinds of players ranging from Asian central banks to large hedge funds that you will not see anyone sticking to a code of conduct. You can have a code of conduct, but the market will chase liquidity (for better prices),” said a head FX trader at a London-based hedge fund.
Some investors have long suspected that they were being short-changed by banks in the foreign exchange market, where rates are calculated hourly and the closing rate is calculated at 4 pm in London.
To get around that, asset manager Russell Investments opened its own FX desk over a decade ago.
“There’s no other market in the world where such large trades are known hours before they are executed. When we trade equities, we go to extreme lengths so no-one knows what our actual trade size is - we will slice it and dice it and use 100 different venues to disguise how much we are trading,” said Daniel Birch, head of implementation services at Russell Investments in Sydney.
“If you are an FX trader and you are fixing at the London 4pm you get orders from Australia, New Zealand, Japan, and Hong Kong that are on your desk for up to eight, nine hours before you execute at the 4pm. So the potential incentive for FX traders to manipulate this information can be very high.”
World Markets Co, a unit of Boston-based State Street Corp, is the administrator for the WM/Reuters service.
Data from Thomson Reuters systems are a primary source of the exchange rates used to calculate the benchmarks. World Markets applies its methodology and calculates the benchmark.