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The UK’s asset management sector is a classic case of market failure. Its services are allocated in a sub-optimal way, while clients are not shifting their resources to achieve better outcomes.

The Financial Conduct Authority’s (FCA’s) interim report on asset management, released earlier today, demonstrates the lack of effective competition via a couple of charts.

The average ongoing charges for actively managed funds have remained static during the last decade, while those for passive (index-tracking) funds have been declining.

active

passive

How is this possible? After all, it’s passive that has been taking a steadily rising share of the funds market. Assets in index-tracking funds have risen fivefold in the last decade and they now represent 23 percent of the overall market, says the FCA.

On the basis of the increasing competition from the passive sector, you’d expect the active fund operators to be cutting fees to compete. That they haven’t done so at all is an indictment of their business model. And it’s a very short-sighted one, suggestive of senior executives angling for a last fat bonus before the tide turns, and reminiscent of the well-publicised excesses in the banking sector.

The FCA cites a number of reasons why active managers may have been so immune to competition.

First, there are too many intermediaries between savers and fund managers, and many of those advising on the selection of active managers—whether pension fund consultants, fund ratings services or fund supermarkets—overemphasise the importance of past performance. This facilitates a merry-go-round of managers, lucrative for the intermediaries but detrimental for the clients.

The success of consultants’ own manager recommendations may be poorly monitored, while the consultants increasingly risk conflicts of interest, such as when providing fiduciary management services—getting involved in asset allocation, portfolio construction and risk management, traditionally the asset managers’ domain.

Meanwhile, retail clients may either be woefully misinformed about the costs of the products they invest in—according to the FCA, about half of retail investors don’t know they are paying a fee at all—or may be restricted from accessing the lowest-priced funds, either because their financial advisers don’t suggest them, or because their fund supermarkets don’t have them on the menu.

If it may be uncomfortable reading for many active asset managers, the FCA’s report threatens even worse news for the consultants and supermarkets, whose business models are now under close regulatory scrutiny.

But while the FCA report provides substantial evidence that there is cartel-like behaviour amongst active managers, it’s striking how competitive the passive funds business has become (see the sharply falling ongoing charges figure in the second chart above).

We’ve witnessed a wave of competition amongst ETF providers in the last few years, with firms forced to cut fees to compete with the likes of Vanguard, which prices its funds at cost.

There’s also been a substantial automation of passive fund management, with firms seeking to cut out expensive human intermediation and improve their operational efficiency.

The FCA’s survey reminds us of some basic human psychology. Every basis point in fees matters if you’re trying to track an index, while if you’re sold on high future performance you may turn a blind eye to what you pay. This is despite the overwhelming evidence that the costs you incur are the best indicator of what you’ll end up with.

So there will always be some demand for high-octane versions of fund management, with the associated high fees. But for the bulk of the active funds industry, there’s now a version of passive management that threatens to eat their lunch and shave zeros off the annual bonus.

The evidence released today by the FCA suggests that smart beta funds, which aim to deliver better risk-adjusted returns than conventional index trackers by using alternative weightings, are likely to take substantially more market share.

(Disclosure – I’ve done paid writing work in the last year for firms that provide smart beta and index products) 

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The widely used distinction between passively and actively managed funds dates to the introduction of index funds in the 1970s. Similarly, finance courses teach students that investment portfolios can be separated into beta and alpha components.

Beta is the return you get through systematic exposure to an asset class as a whole. It’s accessible by purchasing an index fund or ETF based on the capitalisation-weighted index. Alpha is then the excess return targeted by active managers. It’s long been standard practice among professional investors to use this mental shortcut and allocate assets accordingly when designing portfolios.

But these simple categorisations don’t help us when it comes to smart beta, the label commonly attached to rules-based investment strategies.

If you want an equity strategy focused on US value stocks, high-momentum shares or quality Japanese companies, there’s a range of smart beta indices available for purchase off the shelf. Many ETF issuers include index-tracking smart beta funds of this type in their product ranges.

For example, iShares’ European ETF range includes funds focused on size, momentum, quality and value factors, all tracking indices from MSCI. Lyxor offers smart beta ETFs targeting quality income, minimum variance, value beta and a number of market factors, based on indices from Société Générale, FTSE Russell and JP Morgan.

So why, when launching a range of similar strategies as ETFs this morning, has Vanguard decided to sidestep the index part of the strategy altogether?

Vanguard’s new ETFs—global liquidity factor, global minimum volatility, global momentum factor and global value factor—are instead labelled as active.

Although these funds offer exposure to essentially the same strategies as index-based ETFs from other providers, Vanguard says its new ETFs will not track an index and there’s no mention of smart beta in the firm’s marketing literature.

Instead, the new Vanguard ETFs use the (cap-weighted) market index as a reference benchmark, while the fund manager’s investment objective is long-term capital appreciation, rather than tracking or relative outperformance.

Vanguard’s approach is consistent with a research paper it published this summer, in which it suggested that smart beta indices should be labelled as rules-based active strategies. The firm has long argued that index-based investing should involve cap-weighted benchmarks and nothing else.

Are these semantic differences important? Perhaps not. But I take Vanguard’s move as a sign of an intensifying turf war between asset managers and index firms over smart beta.

Index firms argue that their smart beta strategies operate on the basis of transparent index rules, providing reassurance to investors that a tracker fund is not going to diverge hugely in performance from what the index does. There are plenty of examples of quantitative investment managers getting their models wrong and blowing up.

Asset managers can claim that they have the quantitative investment expertise to produce smart beta in-house, and that by managing the money themselves they are freed from the obligation to rebalance their portfolios according to a set schedule, something that exposes index-based funds to front-running. And avoiding the use of an index in a smart beta strategy means saving on the licensing fees paid to the index provider.

In Vanguard’s case, the firm is clearly betting that its own name carries more weight amongst potential fund purchasers than the name of an index firm attached to the product.

Regulators may yet become more involved in the competitive battle between fund and index firms. There’s long been a legal loophole by means of which asset managers are prohibited from advertising products that use back-tested performance data, whereas index firms—since they are not treated as product promoters—may do so when describing how indices work.

If you think smart beta is a good thing, rather than a marketing gimmick, this turf war is good news, since fees are coming down. Vanguard’s new factor ETFs cost 0.22 percent a year, undercutting similar strategy ETFs from other providers. But the increasing confusion over terminology means navigating your way around competing investment products isn’t getting any easier.

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Today the main US-listed high yield bond ETFs, BlackRock/iShares’ HYG and State Street’s JNK, are trading at levels unseen for over two years. At the time of writing, HYG is at 88.10, down nearly seven points in price from an interim peak of 95 in late October.

Junk bond indices have been hit by the sharp post-summer decline in oil prices and fears of broader deflation: according to Dave Nadig of ETF.com, 15% of the index underlying HYG is in bonds issued by energy companies; for JNK’s index it’s 17%.

Here’s a three-year chart of HYG, JNK and Invesco Powershares’ BKLN, another high yield ETF, this time investing in senior bank loans from sub-investment grade companies. The three ETFs’ prices are rebased to 100 at the end of 2011.

hyg jnk bkln

Source: Google Finance

Over recent days many analysts have been pointing out the divergence between the weakness in the junk bond market and the relative strength of US equities. In the past such divergences have hinted at equity market falls to come, since the credit market tends to act as a leading indicator.

Unlike during previous bouts of market nervousness, the price declines in the high yield market haven’t so far been met with large-scale ETF redemptions. During the first half of 2013, the last significant sell-off, HYG and JNK lost up to 20% of their net assets, a collective outflow of $5 billion. This time round things have so far been different: Nadig noted earlier this week that the two funds have pulled in almost $3 billion in new assets so far in the fourth quarter. Of the three ETFs in the chart above, only BKLN has seen net redemptions for the quarter to date.

Here are the Q4 fund flows for the three ETFs, courtesy of ETF.com.

HYG flows Q4 JNK flows Q4BKLN flows Q4

That’s what’s concerning about recent price weakness in the sector. During previous market downturns (notably in June last year) the redemption mechanism of high yield ETFs has been put under strain. Meanwhile, by many accounts, the underlying liquidity of the corporate bond markets has worsened further.

What if the sell-off in junk bonds hasn’t even really started?

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Take two exchange-traded funds (ETFs), both on sale to retail investors, both investing in dollar-denominated high yield bonds. The funds are run by the same asset management firm, both track an index from the same benchmark provider and both promise their authorised participants (APs) the ability to create and redeem fund units daily on the basis of the underlying net asset value (NAV).

APs are the entities that transact in wholesale lots with an ETF fund issuer, an interaction that dictates how the fund is priced in the secondary market, where most of us buy and sell it.

Yet in one prospectus we read that the ability of investors to exit the fund may be curtailed in a number of circumstances. The ability of APs to redeem their fund units, says the prospectus, may be suspended if any of the principal underlying markets are closed or if the fund’s directors decide it’s difficult to determine the NAV.

More broadly, redemptions can be halted if the directors decide a suspension of dealing is in the interests of the fund, its shareholders or the investment company (an “umbrella” structure under which tens of ETFs are issued).

And even if none of these things occur, the fund may limit redemptions to 10% of the fund’s assets a day, meaning that large withdrawals may be scaled down and that those heading for the exits may have to wait.

Under any of these circumstances you could expect secondary market trading in the ETF to come to an effective halt.

In the other prospectus—remember, for a fund sold by the same firm, tracking an index in exactly the same asset class—there’s no mention of a possible suspension of redemptions.

All we read is that “if particular investments are difficult to purchase or sell, this can reduce the fund’s returns because the fund may be unable to transact at advantageous times or prices” and that, if it’s difficult to obtain reliable quotations for securities held by the fund, its manager may use a so-called “fair value” approximation of the securities’ worth in order to calculate the NAV.

Why the difference in language? The first fund operates in Europe and in compliance with the region’s UCITS rules. The second is a US ETF, operating according to the 1940 Investment Company Act, the governing regulation for US mutual funds.

A central principle of the 1940 Act is that investors should be able to redeem their fund units on demand. Unlike in Europe, where local regulators accept the possibility that redemptions may be suspended or “gated”, the US mutual fund rules dictate that fund inflows and outflows should continue even when the liquidity of underlying markets is compromised. There are very narrow exceptions to this principle, mainly relating to the closure of local (US) equity markets.

Does this difference in regional approaches matter?

In its March 2013 principles for the management of liquidity risk in collective investment schemes, IOSCO, the international coordinating body for securities regulators, accepted that liquidity crises in funds are less likely to cause systemic confidence problems than when the same occurs in the banking sector. Investors know they can lose money when buying a fund, or they should do.

But IOSCO’s principles are very high-level and non-prescriptive, no doubt as a result of the transatlantic differences in fund frameworks. In 2012 the regulatory body skirted around the fundamental gap in mutual fund rules by saying that the suspension of redemptions by a mutual fund may be justified only if permitted by (local) law.

IOSCO—whose principles are non-binding—has advised fund managers that they should not promise more frequent liquidity to investors than is appropriate for the underlying asset class and that liquidity risk and a fund’s liquidity risk management process should be effectively disclosed to prospective investors.

Again, this is subject to very wide interpretation in practice. Mutual funds promising daily redemptions (and, in the case of ETFs, instantaneous dealing), now invest on a large scale in a variety of asset classes that have been prone to liquidity crises in the past, from high yield bonds, to emerging markets equity and debt and even senior bank loans.

BlackRock, the asset manager responsible for the two ETFs I mentioned earlier (Europe-listed SHYU and US-listed HYG), has recently called for globally consistent best practices for fund structures, liquidity risk management and investor disclosure.

This is a hot topic, with those charged with ensuring the stability of the financial system now taking a much closer look at whether mutual fund run risk could cause wider contagion. IOSCO and the G-20 Financial Stability Board are due to issue a new consultation on systemically important non-bank financial institutions by the end of the month.

If a fund issuer gates redemptions in one jurisdiction, could there be a run from its funds elsewhere? I don’t know. But while local rules continue to differ so markedly, it’s hard to see how US investors are getting the same message on fund liquidity risk as those in Europe.

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The column inches devoted to castigating bankers for benchmark abuse pile up. But the clients who gave banks the fixing orders in the first place bear some responsibility too.

There’s a common theme running through the benchmark abuse cases: Libor and FX. Banks were given orders to execute client trades at levels that referenced these market benchmarks, while also contributing to the benchmark-setting process.

Clearly, banks should not have been using advance knowledge of clients’ orders to push fixing levels one way or another: this kind of behaviour happened on a large scale, involving collusion between traders at multiple banks.

But what of the clients who gave the order to “trade at the fix” in FX? Were they innocent victims?

If a large corporation or fund manager wants to (say) sell a billion dollars for euro he can trade it in the market in a single order, split it into smaller orders or use an electronic algorithm. All these methods threaten a degree of market impact; in other words, the FX rate moving against the manager as a result of the size of the order.

But (in the past, at least) the fund manager could also hand the order to a bank and instruct it to conduct the whole deal at the day’s 4pm fixing rate.

Although the fixing rate had a bid-offer spread to compensate the market maker for making the trade, the spread was always the same, regardless of the size of the client order and the state of the markets.

There’s a good reason why a fund manager might want to trade at the exact fixing price in a market like FX (or, for example, at the closing index price in an equity market). The fund manager is incentivised (often, formally, via his contract with a client) to minimise tracking error against his own performance benchmark.

Trading at the fix (or at the equity market close) is therefore safer for the fund manager, since it reduces the risk of an unwelcome divergence in performance between fund and benchmark. In some cases clients appear willing to trade at a specific point in time even if this costs money.

It’s unsurprising and no secret that the more money following a particular index or market benchmark, the greater the likelihood of distortions in the index’s or benchmark’s price behaviour.

Fund managers, and other users of the FX fixing, had a right to expect that information regarding their orders would not be abused by the banks.

But the existence of a set spread for “fixing” trades should have raised suspicions that the banks were making money on the side from client orders.

And, unfortunately, by the very act of requiring the banks to commit to execute orders at an (as-yet unknown) fixing rate, irrespective of size, clients acted as the enablers of abusive behaviour.

While the banks are rightfully being brought to task for their role in benchmark abuse, those who “fed” the fix should also recognise they got things wrong.

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Could the post-LIBOR regulatory crackdown on banks exacerbate price movements when indices are rebalanced?

Late afternoon on Friday shares in Dutch bank ING jumped nearly 5% in heavy trading on the Euronext Amsterdam exchange.

ING Price Spike

ING

Source: Yahoo Finance

The price spike has now been fully reversed. A 5.75% increase in ING’s share price on Friday has been followed by a 4.69% decline yesterday and a further 1.23% fall so far on Tuesday morning.

ING’s late-Friday price move seems related to the reconstitution of equity indices. Friday’s market close set the price at which ING’s shares entered two indices from STOXX—the Euro STOXX banks index and the STOXX Europe 600 Banks. The latter index is a popular one: it underlies several European equity sector ETFs and is reportedly used in many bilateral swap agreements.

Both STOXX and ING declined to comment on Friday’s share price movements.

Price movements in shares entering and exiting benchmarks are a well-known phenomenon, and an unsurprising one. Index changes mean unavoidable cash flows in a whole range of tracker products, including futures, swaps, ETFs and index funds, which other market traders can try to exploit.

STOXX announced the September constituent changes for its indices on August 26 and between August 25 and September 18 ING shares had already risen 8.43%, a not-uncommon price rise between the announcement date for an index addition and the date on which the addition becomes effective.

So why the unusual late-Friday action?

According to one trader I’ve spoken to, post-LIBOR restrictions by banks’ compliance departments on their traders’ index-related deals may be having the effect of forcing market participants into the end-of-day auctions on stock exchanges, which are used to set closing prices.

Previously, said the trader, bank dealers could pre-position their trading books for index changes. Now, he argued, after the LIBOR revelations banks are scared of being seen to exploit benchmark-related trading flows. Instead, he told me, they are now taking the most conservative option: trading at the actual price point at which the index change occurs, even if this leads to a less efficient execution.

Managers of index-tracking funds and financial products face a similar dilemma: place a trade in the closing auction and risk losing money (as anyone buying ING at Friday’s close would have done by Monday morning) or attempt to trade either pre- or post-close. Shunning the closing exchange auction may mean you avoid involvement in a crowded trade, but fund managers will incur tracking error if the fund’s execution price is significantly different from the price used by the benchmark calculator.

Rebalancing-related share price movements may be exacerbated by another factor, the trader told me: the widespread use of volume-weighted average price (VWAP) algorithms. VWAP algos automatically seek to trade when volumes are highest.

“The more volume in the closing auction, the more the VWAP will seek to execute there, leading to more volume in the auction, more VWAP execution….in other words, a feedback loop,” the trader told me.

Not everyone I’ve spoken to agrees with this explanation. The ING price spike could have been caused by someone realising late in the day that they were incorrectly positioned for the index change, or even by a mistake, other traders suggested.

As the volumes of money in tracker products increase, there’s more at stake when indices rebalance. It’s clear that these events involve a trade-off between transparency and making it difficult for those seeking to game index changes. But it would be ironic if, by making trades more crowded, measures taken to clean up the benchmark business had a detrimental effect on the efficiency of indices.

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Active fund managers may offer poor value for money. But some index fund costs are hidden too.

Professor David Blake of Cass Business School has just released a paper in which he argues for better disclosure of the costs of active management.

Between 50-85% of the costs of active management fall outside the headline “ongoing charges” figure that every European retail fund has to display, estimates Blake.

Commissions and taxes paid on securities trades undertaken by the fund manager are excluded from ongoing charges, for a start.

Other, harder-to-measure “invisible” costs, as Blake calls them, include the bid-offer spreads payable on trades in securities, transaction costs in any underlying funds, hidden revenue earned by the fund manager from stock lending or interest, market impact costs and market timing costs.

The high undisclosed costs of active fund management are often used by advocates of passive funds as an extra justification for indexing.

Unfortunately, some of the arguments being made in favour of indexing are fallacious.

In another study published this month, Blake and co-authors Tristan Caulfield, Christos Ioannidis and Ian Tonk argue that active management is not worth paying for.

Having measured the performance of 561 domestic UK equity funds against the FTSE All-Share index over 10 years, Blake, Caulfield, Ioannidis and Tonk conclude that “the average mutual fund manager cannot ‘beat the market’ (i.e., cannot beat a buy-and-hold strategy invested in the market index), once all costs and fees have been taken into account.”

There’s a major problem with this argument. Tracker funds don’t match the market index, as Blake appears to assume as a matter of fact: they underperform as well.

Clearly, you should expect any index-tracking fund or ETF to lag its index by the annual ongoing charges, which are admittedly smaller on average than those of active funds.

But in harder-to-track equity markets the underperformance of the average index fund/ETF may be greater than the headline fee would imply. This occurs as the result of extra, frictional costs that closely resemble the hidden charges Blake talks about in the context of active management.

For an example of this effect, note that most trackers of the MSCI Emerging Markets index underperform it by more than their ongoing charges (see this recent Lyxor publication for evidence).

This additional performance lag occurs as a result of access costs: you pay more in the form of bid-offer spreads, taxes and commissions when buying stocks in smaller and less developed equity markets. Index funds have lower turnover, on average, than active funds, but they do trade.

[Disclosure—I’ve recently done writing work for Lyxor]

Index fund managers can, however, mask their funds’ underperformance in ways that are even less transparent than some of the below-the-surface active fund costs described by Blake.

One way to do this is to include extra costs in the index (whether as an index fee or, more cleverly, by depressing the assumed post-tax dividend rate in a total return index to make the fund’s performance look better).

If the index fund manager also gets to produce the index, a practice that the US regulator now appears to be condoning, then there’s even more scope and incentive to embed additional costs, to the investor’s detriment.

Another way of hiding index fund costs is to include collateral in a derivatives-based fund that is of lower quality (from the perspective of the repo market) than the quality of the securities basket represented by the index. This generates extra income for the counterparties to the repo trade, who can pocket the revenue with the average investor none the wiser that he’s losing out at all.

The equivalent practice in a physically replicated tracker fund is to exchange the index securities via a securities loan for lower-quality collateral, again resulting in extra income, a large portion of which has historically been retained by the fund issuer or its affiliate.

There’s a little more transparency regarding these practices than there used to be, and more of this hidden income is now being credited to fund investors than before. But securities lending and repo market trades are also much more characteristic of index-tracking than active funds, meriting extra scrutiny when indexing is involved.

It’s worth reiterating that if you buy an index fund assuming that you’ll get the index’s return, you are making a mistake. And if you compare index funds on the basis of their headline fees only, you are ignoring potentially substantial hidden costs.

I’m a fan of ETFs and am all for criticising active fund managers if they are providing poor value for money. But we shouldn’t give indexing a free ride as a result.

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Manipulating interest rate, currency and commodity benchmarks will soon be a criminal offence in the UK, carrying the threat of a seven-year jail sentence, according to press reports.

Meanwhile, evidence mounts of an epidemic of benchmark-rigging.

The 2012 LIBOR scandal has been followed by other alleged cases of price-fixing, involving gold and foreign exchange.

Traders have gone on the record to describe traders’ attempts to skew survey-based energy benchmarks by submitting unrealistic prices that suited their trading positions—just as occurred with LIBOR.

Other types of market manipulation appear to have taken place in the financial instruments used by indices underlying tracker products.

In 2009 I published an article describing how investors in oil ETFs were being hit by apparent front-running in the futures contracts being used by the trackers as reference prices.

Unsurprisingly, the business of producing indices and benchmarks is now under intensive regulatory scrutiny.

Those compiling benchmarks have to comply with IOSCO’s 2013 principles for financial benchmarks, which set new governance and transparency requirements, by next month. The European Commission has its own draft benchmark regulation on the table.

Some of the firms involved in benchmark-setting are deciding it’s not worth the hassle—or the increasing potential legal liability—to continue. Deutsche Bank recently resigned from the daily London gold and silver fixes, having failed to find a buyer for its seat on the fixing panel.

Requiring greater transparency in benchmark-setting, introducing new sanctions and bringing about a greater separation between those calculating benchmarks and those involved in trading should help to counter the worst abuses.

But none of these things will make benchmarks immune from attempted manipulation.

Even share indices, which, unlike oil, FX and interest rate benchmarks, are calculated using prices from relatively transparent public markets, are not fool-proof.

All indices undergo periodic rebalancing. When index providers announce details of the stocks due to enter and exit their benchmarks some traders seek to profit from the information during the period between the announcement and the date of the index change itself.

Index firms can change the benchmark rules to try and counter attempted front-running, for example by randomising the dates on which the rebalancing occurs within that time-frame. This may deter manipulators, but it also detracts from the index’s transparency. A benchmark using opaque construction rules wouldn’t work as a benchmark at all.

There’s no perfect solution here. The most popular benchmarks are used in financial products because they have gained widespread acceptance and met a market need. $350 trillion of derivative products were reportedly linked to LIBOR, which was originally seen as a superior, market-based alternative to official central bank interest rates. But such volumes of traffic attract those seeking to influence prices or flows.

The more accepted an index or benchmark becomes, the greater the inefficiencies it may generate.

Heavier fines and jail sentences may deter the worst cases of benchmark-fixing. But some attempts at market manipulation are an inevitable result of the use of indices and benchmarks as reference prices in financial products.

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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.

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