SYDNEY: 22 October 2014 – In less than a month the eyes of the world will be on Australia when Brisbane hosts the G20 Leaders Summit from 15-16 November 2014. The G20 comprises the European Union (EU) and 19 countries: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Republic of Korea, Russia, Saudi Arabia, South Africa, Turkey, United Kingdom and the United States. The G20 accounts for: 90% of global GDP; 80% of international global trade; and 64% of the world’s population.  These economic realities make the G20 an enormous influence in how the global economy is organised and structured. In 2014 the two core priorities for the G20 under the Australian Presidency are: strategies to stimulate growth, and building economic resilience. The key reform pathways that the G20 is following in 2014 to build economic resilience are: financial regulation reform; modernising the international tax system; reforming global institutions; strengthening energy market resilience; strengthening the global trading system; and addressing corruption. Several of these pathways are integral to ongoing international reform efforts regarding financial benchmarks, in particular to address the exposed corrupt manipulations of the London Interbank Offered Rate (Libor) and the still emerging collusive practices that have infested rate-setting in the multi-trillion dollar global foreign exchange (Forex) markets. This article focuses on contemporary international efforts to reform financial benchmarks in the wake of the Libor and Forex scandals, in which the G20 has been prominent through the activities of the Financial Stability Board (FSB). Under the aegis of the G20 the increasingly influential FSB evolved from the Financial Stability Forum (FSF) in April 2009, with a mandate to coordinate at the international level the work of national financial authorities and international standard setting bodies.

The aftermath and reactions to the Libor and Forex scandals have demonstrated the intrinsic difficulties associated with national and industry self-interest priorities impacting upon efforts to establish cohesive multi-lateral regulatory initiatives in international financial markets. Nevertheless, the sheer magnitude of both scandals has created a momentum for action amongst regulatory and other government actors. For example, in January 2013 former Assistant Attorney General of the US Department of Justice (DOJ) Lanny A. Breuer predicted that: ‘Libor will prove to be one of the largest, if not the largest white-collar case in history’. There have been a slew of multi-million dollar plus fines against some of the world’s largest banks. For example, following US and UK investigations of its manipulation of Libor, RBS was fined £90 million by the UK Financial Services Authority (FSA) and £300 million by the US Commodities Futures and Trading Commission ((CFTC) and the DOJ. Similarly UBS in December 2012 as part of its agreement with the DOJ agreed that UBS Japan not only had signed a plea agreement admitting its criminal conduct and would pay a fine of US$100 million, but also that two UBS former traders would face criminal charges. In addition, UBS AG (the Swiss parent company of UBS Japan), had entered into a non-prosecution agreement under which it would: admit and accept responsibility for its misconduct; pay a DOJ penalty of US$400 million; US$700 million due to CFTC action; US$259.2 million due to the FSA action; and $64.3 million due to the Swiss Financial Markets Authority (FINMA) action for a combined total of more than US$1.5 billion.

These are enormous sums, but importantly as Strimling and Tally emphasise: ‘..these regulatory actions (which are themselves still under way) may be mere initial salvos in a legal battle that has already grown in scope. Since 2012, several significant individual and class-action cases have been filed in various courts around the United States, whose plaintiffs frequently bootstrap on the trove of factual records developed and disclosed through initial governmental proceedings. The eventual toll of this private litigation is still unknown, but it is not far-fetched to speculate that the total potential exposure to private civil litigation could rival (or even dwarf) the regulatory settlements thus far announced.’  These potentially enormous private actor claims allied with the penalties handed down by state regulatory actors constitute powerful specific and general deterrent regulatory initiatives. Their likely deterrent impact is augmented by extensive reports issued in July 2014 by the International Organisation of Securities Commissions (IOSCO) into how IOSCO’s Principles for Financial Benchmarks have been implemented by administrators of Euribor, Libor and Tibor, and the FSB’s report on reforming major interest rate benchmarks.

The fact that there is so much pushback in both public and private spheres against manipulation of benchmarks such as Libor reflects the inherent public character of benchmarks and the key structural role that their capacity as a collective good plays in socio-economic infrastructures, for example their filtration effect into an extensive array of influential rates such as the setting of domestic residential mortgage rates. As Gibbons and Neale note: ‘Warren Buffet has referred to LIBOR as “the base rate for the whole world”, reflecting the fact that contracts with an estimated notional value in excess of $300 trillion use LIBOR as their benchmark.’  The structural significance of Libor is widely accepted but the collective character element of Libor and other financial benchmarks is less well understood.

Miller describes the financial benchmark as a collective good in these terms: ‘Benchmarks are collective goods since: (i) they are desirable by virtue of meeting a financial need; (ii) they are a good which is jointly produced, namely by the actions (in the case of LIBOR) of submitters, etc; (iii) they are enjoyed by multiple economic actors and, indeed, economic actors in the relevant market are entitled to access to the good.’  It is the corruption of this collective good character of financial benchmarks that has prompted such outrage amongst civic society and compelled both national and multi-lateral regulatory actors on the road to reform. That sense of outrage is compounded by the fact that many of those major banks who engaged in institutionalised corruption of Libor and other financial benchmarks, not only caused so much havoc in the Global Financial Crisis (GFC) due to their poor operational cultures and consequent business practices, but also received colossal amounts of taxpayer assistance in the aftermath of the GFC in order to ensure their financial survival. For example the UK National Audit Office estimates that in the aftermath of the GFC UK taxpayers provided peak outlay support to UK banks of £1,029 billion in guarantee commitments and £139 billion in cash outlay.

Financial benchmarks are emerging as a litmus test of the practical capacity and political will of national governments and financial regulators to bring meaningful change to the operational cultures of actors in global capital markets, but reform of financial benchmarks is only a part of the reformative mosaic. Impacting upon how financial institutions actually operate is a complex challenge and unlikely to be achieved simply by regulatory fiat. It requires buy-in from market actors to reform initiatives and that is unlikely to be achieved unless these same market actors perceive defined benefits for themselves from embracing operational and regulatory change.  This requires new perspectives to be brought to bear on the calculus of the benefits and disadvantages of regulatory compliance.

McCormick and Stears see much potential in a Conducts Costs approach being adopted by financial actors because: ‘The incompetent identification and management of operational risk of which legal and/or conduct risk form a real and significant part, and the failure to see the links between such risks and what are now, belatedly, acknowledged as failures in culture and ethics. Market participants of varying identities are implicated, from high street brokers to the financial behemoths of Wall Street and the City of London. The ongoing consequences of these flaws have threatened the survival of what we had grown used to as “traditional” bank business models. The old ways no longer seem to be sustainable.’

McCormick and Stears suggest a Conduct Costs Model which can operate as an objective indicator of a firm’s culture and which incorporates compliance costs such as the huge penalties incurred as a result of manipulation of Libor and/or other financial benchmarks. Thus under the Conduct Costs Model, the individual and collective decisions within a bank and other financial firms concerning whether and how to comply with regulatory obligations surrounding financial benchmarks for example, are absorbed into the rational actor cost benefit processes of that organisation. And they have to be absorbed into these rational actor cost benefit processes precisely because the huge fines incurred as a result of financial benchmark manipulation and other regulatory misbehaviour are increasingly contributing to: ‘..ongoing conduct cost problems (which are beginning to reach life-threatening levels) and reputational damage. Further, rising conduct costs will increase a bank’s overall operational risk profile and, consequently, its regulatory capital requirements. The “operational risk charge”, which will take account of conduct risk, takes the management of legal risk from what was perhaps considered in the past to be a “soft issue” for financial services firms, firmly onto a quantitative, bottom-line basis.’

Self-interest is a powerful force of motivation, so recalibrating the regulatory dynamics of global capital markets to generate increased synergies between the profit priorities of financial actors and the civic needs of the societies in which they function has much potential. The Conduct Costs Model suggested by McCormick and Stears is one perspective that can contribute to this realignment. Another is the approach suggested by O’Brien, Gilligan and Miller to embed restraint in financial regulatory infrastructure such as financial benchmarks in order increase levels of systemic stability in global capital markets. They argue that: ‘The most significant element in regulatory compliance is the choice by people to comply. This occurs as part of their reflexive theoretical understanding of their own personal standing within an organisation or industry, and/or in response to their own sets of normative values. This is perhaps the area of greatest potential for improving behaviour in the financial sector, impacting upon individuals within organisations and activating their own value systems to work towards crime prevention, reducing and/or eliminating bad behaviour in organisations, realigning incentive structures, improving organisational cultures, and prioritisation of the public interest.’  Thus for example, the ways in which individual firms are observed by regulators to incentivise or discourage those who work within or for them to comply with both individual and organisational compliance responsibilities should be incorporated into the regulatory calculus. This in turn will have implications through mechanisms such as licensing for the capacity and flexibility that are accorded to both individuals and organisations to operate in the financial sector. Through notions of the implied social contract between financial actors and the societies in which they operate, regulatory compliance and restraint regarding financial benchmarks and other regulatory obligations are emphasised and incentives towards systemic stability and its inherent advantages become more apparent and thus more appreciated commercially by rational cost actors.

The G20 Leaders’ Summit in Brisbane offers an opportunity to buttress the specific reform initiatives in areas such as financial benchmarks, by multi-lateral actors such as the FSB and IOSCO, with what might be termed political clout. If the necessary consensual political will is not generated in Brisbane in order to provide sufficient levels of such clout, then levels of ambiguity and ambivalence regarding financial regulatory reform are likely to rise, leading to parallel decreases in the specific and general deterrence capacity of reform measures in benchmarks and elsewhere. The different approaches discussed above are useful contributions to a regulatory discourse that seeks to increase systemic stability and highlight the linkages between collective goods such as benchmarks, increased systemic stability and self-interest, in order to create the necessary industry-oriented initiatives that are also a win for the civic societies that provide the ecosystems in which those same industry actors prosper.