MELBOURNE: 1 December 2014 – On the morning of 19 November 2014 I attended Allen & Overy’s Sydney offices and I had the privilege of participating in the workshop Fixing the Fix: Benchmark Reform and the Future of Financial Regulation.  The workshop was hosted by Allen & Overy in conjunction with the Centre for Law Markets and Regulation at UNSW and received research support from the Australian Research Council and the Centre for International Finance and Regulation.  My fellow speakers included; Cathie Armour, Commissioner of the Australian Securities and Investments Commission (ASIC); Guy Debelle, Assistant Governor (Financial Markets) at the Reserve Bank of Australia; David Lynch, Executive Director of the Australian Financial Markets Association (AFMA); and leading practitioners and academics from Australia and the US.  The focus of the workshop was on the implications of growing national and international investigations into manipulation of financial benchmarks and emerging reform efforts to ensure that such benchmarks are more transparent and effective in the future.  The timeliness of focusing on these issues was further highlighted on that very same day by a media release from ANZ, one of Australia’s Big Four banks.   In that media release, ANZ confirmed that as part of its ongoing cooperation with an investigation by ASIC into historic trading practices in the Australian interbank market known as the Bank Bill Swap Rate (BBSW) market it was: “…taking the precaution of having seven staff involved in markets trading step down pending completion of the investigation into practices to 2013.’

ASIC is investigating potential misconduct regarding the BBSW for the period 2007-2013 and this pretty dramatic step by the ANZ is unlikely to be the only instance in which an Australian financial institution’s trading practices regarding the BBSW are seen in an unfavourable public light.  As a result of the ASIC investigation of their problematic BBSW trading three foreign banks who operated in the Australian BBSW market already have entered into enforceable undertakings with ASIC and made voluntary contributions to independent financial literacy projects in Australia: UBS $1 million; BNP Paribas $1 million; and Royal Bank of Scotland plc and the Royal Bank of Scotland N.V. (RBS) $1.6 million.  The BBSW rate setting panel was disbanded in March 2013 and the rate has become based on actual market trades. It would be naive to think that there will be no other financial institutions whose trading behaviours fall foul of ASIC’s investigations.  Other members of that panel are presumably, like ANZ, cooperating with ASIC in their investigations and undoubtedly will be nervous about the outcomes of those investigations.  Those institutions are: Citibank NA (Australian Branch); Commonwealth Bank of Australia; Deutsche Bank AG (Australian Branch); HSBC Bank Australia; JPMorgan Chase Bank (Australian Branch); Lloyds TSB Bank (Australian Branch); Macquarie Bank; National Australia Bank; Royal Bank of Canada (Australian Branch); Suncorp-Metway; and Westpac Banking Corporation.

The BBSW scandal is unlikely to result in the huge fines totalling billions of dollars regarding the London Interbank Offer Rate (Libor) and the still-burgeoning rigging of foreign exchange rate debacles.  However, the BBSW is an Australian element of the global story of financial benchmark manipulation that has been exposed in recent times around the world.  The sense of outrage regarding financial benchmark manipulation is testimony to the intrinsic public good character of these benchmarks and is recognition of the key strategic role that they perform in national and international economies.  Public anger is intensified because several of the financial institutions responsible for the institutionalised corruption of Libor and other financial benchmarks, were not only central villains in the Global Financial Crisis (GFC) due to their poor operational cultures and associated business practices, but also received huge taxpayer assistance in the aftermath of the GFC to ensure their 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.

It is this seething anger and resentment that has fuelled high levels of public mistrust of finance professionals and finance organisations in many countries around the word, as well prompting frustration and annoyance amongst very senior national and international regulators.  For example, the criticism of prevailing operational cultures in the finance sector by Mark Carney, Governor of the Bank of England and Chair of the Financial Stability Board (FSB), when delivering the 2014 Monetary Authority of Singapore Lecture on 17 November 2014:

‘Last week, the UK’s Financial Conduct Authority, US CFTC and Swiss FINMA fined six banks $3.3bn for misconduct in FX markets: misconduct that went on long after banks had already been fined for abusing interbank interest rate benchmarks.  The repeated nature of these fines demonstrates that financial penalties alone are not sufficient to address the issues raised.  Fundamental change is needed to institutional culture, to compensation arrangements and to markets….the succession of scandals mean it is simply untenable now to argue that the problem is one of a few bad apples. The issue is with the barrels in which they are stored.  Leaders and senior managers must be personally responsible for setting the cultural norms of their institutions. But in some parts of the financial sector the link between seniority and accountability had become blurred and, in some cases, severed.  The public were rightly angered that so many of the leaders and senior managers who were responsible for sowing the seeds of the crisis and for allowing cultures to develop in which gross misconduct took place have walked away from their actions or inactions.’

Even only ten years ago such a stinging reproach of the finance sector by the Governor of the Bank of England would have been almost unthinkable.  The GFC and the financial benchmark scandals that have emerged in its aftermath have been financial regulation game changers.  Similar frustration, disappointment and annoyance have been expressed by Christine Lagarde, Managing Director of the International Monetary Fund (IMF):

‘Trust is the lifeblood of the modern business economy. Yet, in a world that is more networked than ever, trust is harder to earn and easier to lose….In this age of diminished trust, it is the financial sector that takes last place in opinion surveys. ..As many have pointed out, the very word credit derives from the Latin word for trust.  We are all familiar with the factors behind the crisis—a financial sector that nearly collapsed because of excess. A sector that, like Icarus, in its hubris flew too close to the sun, and then fell back to earth—taking the global economy down with it.’

In their public speeches and no doubt in their private conversations with the finance industry, Ms Lagarde and Mr Carney have stressed the nexus between incentives structures, operational cultures and networks of trust.  All business interactions are ultimately dependent upon sociologies of trust, so what can be done to restore those networks of trust that have been so damaged by manipulation of financial benchmarks, a litany of miss-selling scandals and assorted harmful behaviours by finance organisations and finance professionals?

There is an imbalance between the privileged participation and potential for rewards as licensed financial services actors that individuals and organisations receive, in comparison to the civic duties and obligations that could or should accompany that privileged status.  Balance can only be restored through normative change at individual, organisational and industry levels.  An emphasis on culture and increased professionalisation can be a fruitful pathway to reinvigorate the implied social contract between financial organisations and the financial citizenry, from whom increasing sophistication is expected by both the state and the industry, notwithstanding evidence that many citizens have substantial difficulty in understanding those risks.  The licence to operate in the finance space is a gift of the state which in recent years has been somewhat taken for granted by finance organisations and finance professionals in Australia and in other jurisdictions.  Governments, regulatory actors, consumers, the media and other interest groups should increase the expectations, accountability and transparency surrounding the granting and retention of finance sector participation licences.  The inherent flexibilities of licensing have been vastly under-utilised in terms of ensuring that licensed finance actors adhere to their implicit civic duty obligations. Initial and ongoing licensing processes and associated certainty of sanctions should be made sufficiently robust to ensure that behaviours such as financial benchmark manipulation are viewed as too great an opportunity cost by rational market actors.  Such market-aligned strategies are what will raise standards in prevailing operational cultures.

Such progress will not be an easy task.  For example, it has been reported that at the Annual General Meeting of Australia’s largest bank the Commonwealth Bank of Australia (CBA), in Melbourne on 12 November 2014, its chairman David Turner ‘…blamed the bank’s focus on survival in the financial crisis for its failure to pick up the seriousness of the financial planning debacle.’  The debacle referred to is of course Commonwealth Financial Planning Limited (CFPL).  CFPL is a wholly owned subsidiary of CBA.  CFPL operates under the business advice structure of Colonial First State (CFS) which is also part of CBA.  On 26 June 2014 then chair of the Senate Economics References Committee, Senator Mark Bishop, issued a media release accompanying the Committee’s report into the performance of ASIC which was withering in its criticism of CFPL and CBA.  It describes past practices at CFPL as ‘appalling’, and the conduct of a number of CFPL advisers as: ‘..unethical, dishonest, well below professional standards and a grievous breach of their duties…The CFPL scandal needs to stand as a lesson to the entire financial services sector.  Firms need to know that they cannot turn a blind eye to rogue employees who do whatever it takes to make profits at the expense of vulnerable investors…That a major financial institution could have tolerated for so long conduct that included apparent criminal behaviour is not easy to accept.’

So, it would seem that there is some variance between the perspectives of Mr Turner and former Senator Bishop.  We should not be surprised by this as operational cultural norms and self-interested interpretations of poor behaviour are well entrenched in a sector such as finance.  However it is crucial to bridge gaps such as these and unless the human system challenges posed by poor operational cultures, inadequate organisational accountability structures and distorted incentives regimes in Australian financial services and markets are addressed, reform efforts will falter, egregious behaviours similar to financial benchmarks manipulation will persist and the legacy effects of the current Financial System Inquiry chaired by Mr David Murray AM will be substantially diminished.  Mr Murray is reported to have handed his final report to Treasurer Joe Hockey a few days ago on 28 November 2014 and it is reportedly scheduled for release on 7 December 2014.  Despite the depressing ongoing litany of financial scandals in Australia and elsewhere, and the calls for meaningful cultural change from powerful overseas regulatory actors such as Christine Lagarde and Mark Carney, it remains to be seen how prepared Mr Murray and the Treasurer are to grasp the nettle of operational cultural reform in the Australian finance sector.

This work was funded, in part, by the Centre for International Finance and Regulation and in part by the Australian Research Council.