— Paul Amery's Blog

Fixing Benchmarks

Regulators are angry about those abusing benchmarks.

This week the head of the International Organisation for Securities Commissions (IOSCO), David Wright, said that benchmark riggers should face tougher sanctions.

Wright’s comments come in the wake of a fine handed down by the UK securities regulator, the Financial Conduct Authority (FCA), to Barclays for lax controls in allowing a trader to influence the daily gold fix in 2012.

The trader’s motivation was to prevent his bank having to make a payout under a derivative contract called a digital option. The trader succeeded in influencing the fix to his benefit, but the client who had bought the derivative suspected manipulation and complained. Barclays, together with the FCA, unveiled the fraud.

This abuse is directly reminiscent of the LIBOR manipulations revealed in the same year, 2012. According to one hedge fund manager quoted in yesterday’s Financial Timesthe influencing by banks of  prices in the markets underlying such digital options is “routine” and the Barclays case is “the tip of the iceberg”.

The average investor can draw one obvious conclusion from the latest episode of benchmark manipulation: don’t buy a financial product from an institution with the motivation and the capacity to influence the reference price underlying the product.

The Chinese walls supposedly in place to separate the benchmark calculators and the traders within a single organisation may have ears.

That applies just as much to the market for index-tracking ETFs and ETNs, where some product issuers also design and calculate the underlying index. In the wake of the LIBOR and gold fixing scandals, such a lack of separation of duties is a warning.

The problem in regulating all of this is that some of those closely connected to current public policymaking don’t have clean hands.

Government agencies (in the form of central banks) are arguably the biggest benchmark riggers of all: think attempts to control foreign exchange and interest rates and the current policy of quantitative easing, which has driven bond yields to well below and asset prices to well above fair value.

And central banks may have been involved in worse behaviour than that. A commenter on yesterday’s Financial Times article, Julian Wiseman, former head of interest rate strategy at bank Société Générale, makes the observation that:

“The most prolific offenders at defending digital barriers (binaries, knock-ins, knock-outs) used to be the Asian central banks. Around the turn of the millennium a significant part of the FX market was knowing who wanted what. Investment banks would sell the exotic options to Asian CBs knowing that they would lose on that position, but that loss was merely the price of the information, which could itself be used profitably.”

Will IOSCO and other regulators now prosecute the central banks, Wiseman asks, rhetorically?

Uncovering this type of market abuse will be harder than hitting the banks while their reputations are at a low ebb.

But if regulators are serious about fixing the system of market benchmarks they should broaden their investigations to include the official sector.