n Benchmarks
CAN A
LEOPARD
CHANGE
ITS SPOTS?
Image: Shutterstock
As the dust begins to settle on the
benchmark manipulation scandals that have
rocked the financial services sector in recent
years, Nicola Tavendale asks what has
changed?
n THE TRADE n ISSUE 48 n SUMMER 2016 n www.thetradenews.com 65
n Benchmarks
T
he administration
and calculation of
certain financial benchmarks were once so deeply
flawed it made them vulnerable to manipulation
for years. It took the most
serious financial scandals
of modern times to act as a
catalyst for change.
In July 2016 it will be
a full four years since the
full extent of the London
Interbank Offered Rate
(Libor) scandal became
public knowledge.
Following the findings
of the Wheatley Review, the
UK created the world’s first
benchmark regulation for
eight critically important
rates. This summer will
also see the release of an
updated FX Global Code
of Conduct by the Bank for
International Settlements
(BIS), the Financial Stability
Board (FSB) will report on
the progress of reforms to
Libor, Euribor and Tibor
(the Ibors), while the Bank of
England continues to develop
an alternative near risk-free
interest rate benchmark.
independent Oversight
Committees, are the most
significant and have clearly
given market users of
benchmarks confidence in
their integrity.”
The governance and
oversight arrangements
also focus strongly on the
surveillance of benchmark
submission and calculation, Clark adds, claiming
that this has dramatically
reduced the opportunities
for manipulation.
Arguably the most
extensive of reforms implemented to date are the
n “The changes in governance … have clearly
given market users of benchmarks confidence
in their integrity.”
David Clark, chairman of the Wholesale Markets Brokers’ Association
Far-reaching change
According to David
Clark, chairman of the
Wholesale Markets Brokers’
Association, the success
of benchmark reform in
the UK since 2012 can
be measured by the “significant changes that have
been made in benchmark
governance and the introduction of extended Market
Abuse Regulation.
“The changes in governance, especially the introduction of comprehensive
Then there were additional investigations into
the manipulation of other
global benchmarks such as
the WM/Reuters London
FX rate (the Fix) and
LMBA Gold.
They sparked an unprecedented process of reform
in the setting and governance of these rates.
66 n THE TRADE n ISSUE 48 n SUMMER 2016 n www.thetradenews.com
changes, both planned and
already implemented, by
the new administrator of
Libor, the ICE Benchmark
Administration (IBA).
The new surveillance
IBA is completely bespoke
and represents a significant
investment for the group.
Finbarr Hutcheson,
president of the IBA, says:
“Nothing was available at
the time so we built it ourselves, which I think was far
more successful – specific to
Libor – and we have since
n Benchmarks
been able to adapt that for
the other benchmarks we
produce for swaps and gold.
“If I distil the Wheatley
report to a single message
it is this: there was a significant conflict of interest
amongst the banks and the
British Bankers’ Association
(BBA),” Hutcheson adds.
Understandably the BBA,
Libor’s former administrator, was run as an industry
organisation rather than as
a professional benchmark
business, he explains.
While this made sense in
the past, at some point the
benchmark grew too big and
the inherent conflict of interest needed to be addressed.
“We have learnt that
lesson with a vengeance,”
Hutcheson adds. In addition to Libor, the IBA has
also taken over the governance of LBMA Gold,
ISDAFIX (now the ICE
Swap) and will be launching a further product in
the summer summer called
ISDA SIMM (Standard
Initial Margin Model),
which is part of the calculation for collateralising
uncleared derivatives.
“We continue to fulfil the
function of an independent,
conflict free administrator that can bring together
and provide value to the
market where they need an
n “If I distil the
Wheatley report
to a single
message it is this:
there was a
significant conflict
of interest
amongst the banks
and the British
Bankers’
Association.”
Finbarr Hutcheson,
president of the IBA
independent organisation
Sproehnle, head of benchto produce data or informa- mark services at Thomson
tion,” Hutcheson adds.
Reuters. “Benchmark reform
has helped to build confiAdditional change
dence in the industry where
In April, the governance of it had fallen away,” he adds.
a further critically impor“It has ensured that the
tant benchmark, the WM/ benchmarks meeting the
Reuters FX rate, also nota- emerging global standards
bly changed after Thomson are more reliable and more
Reuters acquired the busi- accurate than ever before.
ness from State Street
“We are still in the early
Corporation.
stages of a long process –
Thomson Reuters has
only one market so far has
been working with the
fully regulated benchmarks,
regulators, central banks and there is more work to be
supranational organisations done – but pioneering work
such as the FSB and Iosco
by Iosco and the FCA is
on financial benchmark
leading the way.”
reform from the very beginPrior to this change of
ning, according to Tobias
governance, the calculation
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n Benchmarks
of the Fix had already
been changed to extend its
benchmark window from
one minute to five, which
does appear to have been
effective in reducing volatility around the Fix, claims
Jim Foster, deputy head of
eFX at State Street.
“At the same time, the
proportion of benchmark
flow which is executed electronically has dramatically
increased,” he adds. “This
brings increased internalisation of risk by the e-trading
desks and more even execution throughout the window, which has helped to
reduce volatility further.”
recommendations, many
banks used manual processes to dealing with benchmark orders, which lacked
the necessary controls and
were more prone to errors.
“What we have in place
now is more automated
electronic management,
specifically designed for
School of Business, New
York University. “But
everything has costs and
benefits and ultimately the
benefits from enhanced
regulatory oversight of
benchmarks to date have
out-weighed the costs to
a large extent,” she adds.
“Namely, the elimination
of conflicts of interest by
administrators, higher
n “The proportion of
benchmark flow which is
executed electronically has
dramatically increased.”
Jim Foster, deputy head of eFX at State Street
Regulatory vs. market
reform
Yet while there has been
good progress made in
implementing reforms to
benchmarks, in particular
to the Fix, there is definitely
scope for further improvements on other fixings,
argues Bujar Bivolaku, head
of regulation, Barracuda FX.
“I think the market in
general has reacted positively
to the reforms and it feels
like confidence is being slowly restored in the FX market,”
he explains. “This is only a
start of financial benchmarks
reforms but it’s a good start.”
He adds that prior
to the FSB reform
68 n THE TRADE n ISSUE 48 managing benchmark
orders,” Bivolaku adds.
While radical reform to
the benchmarks was necessary at a governance level,
the intervention of regulators in the reform process
also needs to be carefully
balanced against the potential for too much oversight
which may actually harm
the market, warns Dr Rosa
Abrantes-Metz, managing director for antitrust,
securities and financial
regulation practices, Global
Economics Group, and
Adjunct Professor, Stern
n SUMMER 2016 n www.thetradenews.com
transparency and changes
in calculations that make
manipulation harder.”
Instead of governmental
bodies taking control of
benchmarks, she argues
instead for private benchmark administrators to take
a key role.
Private benchmark
administrators free of conflicts of interest will have a
reputational and business
stake in the success of their
benchmarks, she explains,
and therefore have the
incentive to ensure they are
credible and robust. “But
it is critical that conflicts
of interest are not present,”
she adds.
n Benchmarks
Libor reforms
Benchmark regulation ultimately benefited from the
global acceptance of the 19
Iosco principles for financial benchmarks which has
become the template for
governance and a framework for their management
and use going forward,
explains Clark.
He believes that the evolution of Libor, which is still a
work in progress, is founded
on compliance with these
new regulations and the spirit of the Iosco principles.
He adds: “It has also
been widely consulted
on with the industry and
will emerge as an evolved
benchmark curve with wide
stakeholder support.”
In March, the IBA
released its plans for the
further reform of Libor.
Following the first six
months of putting surveillance in place, testing and
ensuring it could “cover business as usual”, Hutcheson
says that the last 18 months
“have been spent looking at
how to evolve it strategically
for the long term.”
This has included developing resilient and robust
technology alongside very
secure data integrity, he adds.
“It has frankly moved the
banks from having ten or
15 minutes to check their
submission to 40 minutes,
which means there is less risk
of making an error and being
accused of wrongdoing,” says
Hutcheson. “That’s reassuring and helpful to them.”
Looking ahead, the IBA
has designed a so-called
waterfall of submission
methodologies to ensure that
Libor panel banks use funding transactions where available in a bid to anchor the
rate to true transactions, as
well as reflecting significant
changes in banks’ funding
models. The first phase of
this implementation will be
introduced during the summer and is due to complete
by the end of 2016, with
banks continuing to send
IBA their data every day but
how they determine these
submissions is now uniformly prescribed by IBA. In
addition, IBA is conducting a
feasibility study to determine
if it can move to using an
internal algorithm instead.
This would effectively entail
that the banks’ responsibility is purely to report their
transactions to IBA, significantly reducing the cost and
risk for submitting banks.
Buy-side appetite
The demand for benchmarks may remain undiminished, particularly
from the buy-side, but the
reasons behind this demand
can also be called into
n “Benchmark reform has
helped to build
confidence in the industry
where it had fallen away.”
Tobias Sproehnle,
head of benchmark services at Thomson Reuters
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n Benchmarks
question. The motivation
to move or manipulate the
benchmarks is too large,
according to Abrantes-Metz,
but benchmarks are important for pricing and therefore need to be believable.
“But in my view, they
may not be necessary for
all the functions in which
they are currently used,” she
adds. Buy-side demand for
market, asset managers are
becoming more sophisticated with their FX execution
and no longer rely solely on
trading at the benchmark
fix,” Bivolaku says.
“Asset managers these
days are embracing multiple
trading strategies, for example algo trading giving them
tighter pricing and the
advent of transaction cost
analysis (TCA) gives them
further tools to drill down
into the quality of their FX
execution.”
a competitive marketplace
at a clear price, he adds,
which ultimately attracts
both users and providers of
these services.
Risk of repetition
But Abrantes-Metz argues
that there are many areas
where work may still need
to be done to prevent the
potential for manipulation
of key benchmarks. “Many
leading commodity futures
contracts – which include
traditional commodities
n “What we have in place now is more
automated electronic management, specifically
designed for managing benchmark orders.”
Bujar Bivolaku, head of regulation, Barracuda FX
Regulators are also
steadily moving towards
putting in place a global
regime, argues Sproehnle.
“This means that participants in every market can
be assured that their local
benchmarks are operated
and governed to the highest
standards in a manner consistent around the world,”
he adds. Foster agrees that
the reforms “appear to have
worked as intended, producing a market which is
both fair and efficient”.
This ensures clients
have access to benchmarkbased execution services in
the FX Fix is particularly
note-worthy. Traditionally,
buy-side institutions used
the Fix to manage currency
exposure of their multiasset portfolios (usually
equity and bond portfolios)
according to Bivolaku.
It was a way to ensure
they were obtaining comparable FX pricing and execution from their bank and
the standard market benchmark fix provided transparency around the pricing, he
explains. “But with the latest
structural changes in the FX
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such as gold, silver, as well as
treasuries and FX – are still
settled in very narrow windows of time (of 30 seconds
or one minute),” she says.
The reality is that it is
much easier to manipulate prices that are set in
30 seconds or one minute
than prices that are set
over a five- or ten-minute
interval, Abrantes Metz
argues, adding that she
is “surprised that to date
that no reforms have taken
place in these futures settlement processes in order
to implement wider calculation windows.”
n Benchmarks
n “Everything has costs and
benefits and ultimately
the benefits from enhanced
regulatory oversight of
benchmarks to date have
out-weighed the costs to a
large extent”
Dr Rosa Abrantes-Metz, managing director for antitrust,
securities and financial regulation practices, Global
Economics Group, and Adjunct Professor, Stern School
of Business, New York University
In addition, she also
does not favour the continued calculation of the gold
and silver fixings through
auctions rather than by all
market trades in a wider
time window.
“These processes have
been reformed and are now
more transparent, and the
benchmark administrators
are no longer the banks
themselves but independent parties,” she explains.
“These are liquid enough
markets to allow such
benchmark settings.”
However, IBA counters
that the auction to determine the LBMA Gold Price
concentrates liquidity at that
moment in time, each morning and each afternoon.
It adds: “All liquidity
transacted in the auction
results in bona fide trades,
meaning that the benchmark
is based on a significant
volume of traded spot gold.”
Hutcheson adds that the
bank CEO’s are very wary of
the potential for manipulation and the impact on their
reputation. “The fact that we
have trebled the participation in [the gold rate], which
in fact has the biggest retail
participation, is a demonstration of their greater confidence,” he says.
Learning lessons
Indeed, the fact that Libor
continues to be “the most
widely used benchmark on
the planet”, according to
a senior market source, is
perhaps an indication that it
was not the calculation of the
rates that was the main concern but rather the potential
for manipulation and subsequent reputational damage.
The work of global bodies such as ISDA or the FSB
have also already proved
n THE TRADE n ISSUE 48 n SUMMER 2016 useful and effective, according to Foster, especially in
setting out expectations of
behaviour and pushing for
netting initiatives.
“There should now be
a much lower variation of
behaviour across banks,
which creates a more level
playing field for those participants, as well as encouraging higher standards in
general,” he argues. But the
market cannot be complacent, warns Abrantes-Metz,
and it needs to learn the
lessons from benchmarks
and proactively reform
other market structures
to pre-empt and prevent
potential further abuse.
“It was clear that some
of these structures were
highly defective with large
gains from potential manipulation, very low probability of detection, and hence,
highly susceptive for abuse:
means, the motive and the
opportunity,” she explains.
Yet, abuse went on for
many years with very little
awareness by authorities
of the likelihood of such
conduct. Abrantes-Metz
adds that perhaps the
market should not be waiting for the next scandal to
be uncovered, but should
instead “roll up its sleeves
and reform deficient structures now.” n
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