Two Years after LIBOR Scandal: What Is State of Financial Benchmark Reform?

In 2012, a global investigation into the manipulation of the London Interbank Offered Rate (LIBOR) revealed widespread rate-rigging by multiple banks. As a result of these scandals, regulators globally are working to establish principles or regulatory frameworks for the production and use of financial benchmarks in an effort to restore trust in global financial markets. The need for meaningful reform was underscored recently when six large banks were fined following a global probe into the rigging of key foreign-exchange benchmarks.

Rate-Rigging Reform Timeline: Key Developments

• In summer 2014, the European Union passed into law a revised legislative package on market abuse, which brings manipulation of benchmarks into the scope of criminal sanctions regimes.
• The UK “Wheatley Review,” published in September 2012, called for banks’ LIBOR submissions to be corroborated by transaction data, along with a new code of conduct over submissions to establish standards over the rate-setting process. The Wheatley reforms are now part of UK legislation. UK authorities are currently carrying out a “fair and effective markets” review that examines wholesale market conduct.
• In September 2013, the European Commission published a proposal covering a broad variety of benchmarks; EU draft regulation is currently under political negotiation. Key issues include the scope of the regulation (whether and how it should apply to different types of benchmarks), authorisation and supervision of benchmark administrators, and the application of the regulatory framework to non-EU benchmark administrators.
• The International Organization of Securities Commissions (IOSCO) task force on financial benchmarks published a final report on principles for financial benchmarks in July 2013. IOSCO has since conducted a review of the extent of compliance with its principles.
• In 2014, the Financial Stability Board also published a report on reforming major interest rate benchmarks.
• According to a July 2014 Nikkei Asian Review article, India is set to become the “first country to have both foreign exchange and interbank lending rates set by a neutral administrator.”
• The Monetary Authority of Singapore has proposed a new regulatory framework for financial benchmarks.

Investor Perspectives on Benchmark Reform

To inform regulatory reform initiatives associated with benchmarks and indices, CFA Institute has surveyed its global membership, submitted comment letters to regulatory authorities, and engaged in regulatory outreach with European and international regulators. We believe the following reform principles are critical to strengthening financial market integrity and to restore public confidence:

• Transparency over Benchmark-Setting Processes: CFA Institute believes that greater transparency over the calculation and production of benchmarks and indices in general, particularly where indices are based on subjective or judgmental inputs, is a key element to uphold integrity. Actual transaction data should be used in the compilation of benchmarks (where relevant) to the fullest extent possible. Producers of benchmarks should provide sufficient transparency for users to be able to clearly understand and evaluate the methodology used to compile the benchmark.
• Governance, Administration, and Management of Conflicts of Interest: The following measures should be put in place: Effective controls and separation of benchmark data submitters from trading desks; management and supervision of relevant personnel along with a credible whistle-blowing policy and complaints procedure; appropriate reporting and cooperation with relevant authorities; monitoring, reviews, and audits of submissions processes; appropriate documentation and record-keeping; and transparency through reporting to the public, to the market, and to regulators. Benchmark administrators and submitters should adhere to a code of conduct, and be subject to regulatory oversight where relevant.
• Regulation: Benchmarks that are systemically relevant (i.e., are widely used or followed among different stakeholders or across markets or countries), that are based on subjective inputs (i.e., nontransaction data), and that are not adequately covered under existing financial market regulations (such as trade reporting and market abuse regulations under existing securities and derivatives markets legislation) should be the main candidates for additional regulatory oversight. Regulators should have powers to pursue criminal sanctions in cases of manipulation of interest rate benchmarks such as LIBOR and EURIBOR. Regulators should limit themselves to the regulation of index production (where appropriate as outlined above) and not step into invasive regulation of index choice or limit index use.

As policymakers work through the implementation of the various reform efforts, calibrating the regulatory requirements will be essential to ensure that appropriate and effective measures are put into place for the wide variety of benchmarks potentially falling within the regulatory perimeter.

Above all, the continued slew of unfavourable news headlines over market conduct serves as a stark reminder that behaviour among financial firms continues to fall short of the highest standards of ethics and professionalism that clients must demand. To tackle public confidence, regulatory reform — and in particular, strong enforcement — is the inevitable consequence.

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