Workshop Series: Manipulation of LIBOR and Associated Benchmarks, 2014
CLMR ran a series of four major workshops on regulatory issues regarding the manipulation of the London Interbank Offered Rate (LIBOR) and associated benchmarks. The aim of the first workshop, held at Allens Linklaters in Sydney on 26 March, was to map the scale of the regulatory problems. The second workshop was held at Harvard University in May to evaluate divergent enforcement agendas with particular reference to the European Union Competition Directorate investigation into how traders at contributing banks operated as a cartel. The third workshop took place in Brazil in October to evaluate the degree of success that investigations and regulatory initiatives regarding currency manipulation by the International Organisation of Securities Commissions (IOSCO) and the Financial Stability Board (FSB) have had in engendering confidence and curbing malfeasance. The final and fourth workshop will return to Sydney in November concomitant with the G20 Leaders Summit. The papers from each workshop will be published in special editions of the Law and Financial Markets Review which is a highly regarded academic journal published by Hart, Oxford and edited by CLMR Director Professor Justin O’Brien.
Benchmark Governance and the Dynamics of Financial Regulation
19 November 2014, Allen and Overy, Sydney
This workshop is the fourth and final in a series funded by research provided by the Australian Research Council and the Centre for International Finance and Regulation. Staged at Allen & Overy in conjunction with the Centre for Law, Markets and Regulation, assesses the conceptual coherence of attempts, driven by the United Kingdom, but with significant support from both the Financial Stability Board and the International Monetary Fund, to create ‘fair and effective’ markets by articulating a new vision of ‘inclusive capitalism.’ Fusing national and international imperatives in benchmark governance and reform, it includes keynote presentations from Guy Debelle of the Reserve Bank of Australia, Cathie Armour of the Australian Securities and Investments Commission and David Lynch, Chief Executive of the Australian Financial Markets Association along with Peter McDonald, head of the competition practice as Allen & Overy and leading academics, Eric Talley of the University of California at Berkeley and Justin O’Brien, Director of the Centre for Law, Markets and Regulation at the University of New South Wales.
ICSA – Centre for International Finance and Regulation – IOSCO
3 October 2014, Rio de Janeiro
The aim of the Rio workshop was to drill down into three core issues highlighted by identified and ongoing problems in financial benchmark governance. The objective is threefold. It investigates deficiencies in the effectiveness of the corporate governance framework in financial firms to restrain misconduct, and investigates how these deficiencies can be remedied. To what extent does the existing paradigm have the capacity to monitor conduct the further one moves form the board of directors? Is it reasonable to assume that bad news is not filtered out as one ascends the power dynamic? It examines the benchmark reform process, and other aspects of reform, and evaluates the extent to which these reform measures will lead to a demonstrable improvement in conduct. How effective has the process been in involving and, therefore, securing the commitment of industry to substantive change? Thirdly, it takes into account technical and normative considerations in respect of both regulatory design and industry commitment as part of an integrated research agenda, to be designed and executed in consultation with IOSCO and ICSA and presented in London in 2015. The entire agenda is designed to be forward looking and ensure more effective consultation and verifiable and warranted commitments.
Institutional Corruption and the Capital Markets: Financial Benchmark and Currency Manipulation, Enforcement Strategies, and Regulatory Re-Design
23 May 2014, Harvard Law School
In the second of an international series of four major workshops, scholars, practitioners, and regulators explore the divergent enforcement agendas followed in the aftermath of the financial benchmark and broader currency manipulation scandals. The workshop builds on the pioneering work on institutional corruption at the Edmond J. Safra Center for Ethics at Harvard and the Center for Law, Markets, and Regulation at UNSW's work on the dynamics of regulatory policy. It assesses the trajectories of the investigative and enforcement process across multiple markets and fuses detailed empirical analysis with recommendations for policy reform linked to a core normative agenda: how to enhance market integrity.
The timing of the workshop is critical. The Governor of the Bank of England, Mark Carney, has stated that the currency manipulation scandals, which involved collusion among traders using electronic chat-rooms with names such as "The Pirates" and "The Cartel," could be even more significant than the corruption of the initial London Inter-bank Offered Rate (Libor). It is rendered more so because of the role that agencies such as the Bank of England play as both participants in and overseers of the multi-trillion dollar FX market.
The management of these conflicts of interest is critical to the rebuilding of trust in the capital markets. Has enforcement and regulatory reform gone too far or not far enough? Can securities regulation ever protect against systemic risk? What lessons can be learnt from attempts to deal with other manifestations of institutional corruption across the capital markets and other regulatory domains.
This workshop follows an initial scoping workshop in March in Sydney that mapped the problem. A third workshop in London in September 2014 will evaluate the progress made by IOSCO, the Financial Stability Board and national regulators in engendering confidence that institutional corruption has been curbed. The fourth workshop in Sydney coincides with the G20 Summit. Each workshop will result in papers published in Law and Financial Markets Review.
Regulating Culture and the Manipulation of Financial Benchmarks and Currency
26 March 2014, Allens, Sydney
Guiding themes for the first workshop arose from the truism that regulators tend to create new rules to rebuild trust and confidence after a crisis; yet reactive regulation that is ill-considered in design or implementation can generate high compliance costs and exacerbate adversarial tensions without necessarily reducing risk. The scandal surrounding the long-term manipulation of the LIBOR reveals that crucial yet covert obstacles to countering entrenched and deleterious elements of the global finance system may be normative as well as technical.
Thus, regulating against the harmful effects that may be nurtured by elements of the prevailing culture of the finance sector is one of the greatest challenges facing contemporary society.
Having regard to these challenges, seven expert speakers mapped the rocky terrain of the LIBOR scandal and its aftermath in the first workshop. These speakers were Mr Greg Medcraft, Chair of the Australian Securities and Investments Commission (ASIC) and IOSCO; Martin Wheatley, CEO of the UK Financial Conduct Authority (FCA); Dr Deen Sanders, CEO of the Australian Professional Standards Authority (PSA); Professor Eric Talley from the University California (Berkeley); Professor Justin O’Brien and Dr George Gilligan from CLMR UNSW Australia; and Mr John Morgan, Partner at Allens Linklaters. The audience was at full capacity with a diverse composition of bankers, regulators, lawyers, academics and journalists.
From the perspective of cultural regulation, some key challenges arise when harmful behaviour is not technically illegal. Mr Wheatley stated that the pre-2013 UK regulatory structure under the Financial Services Authority (FSA) was “ill-equipped” to deal with something of the scale and ilk of the LIBOR scandal. Specifically, he said that the scandal “erupted outside the regulatory perimeter” in the sense that the definition of market misconduct at that time did not extend to the submission of interest rates cost of borrowing. Mr Wheatley said that every regulator had a problem regarding dealing with conduct that is “obviously abuse” but not illegal such that “depending on the ethical model of the jurisdiction in question, manipulation may not technically be illegal.”
To this end Mr Wheatley stated that the new FCA which began operating on 1 April 2013 has a “completely different philosophy” to its predecessor: “the focus is now on forward-looking regulation not backward looking, on compliance models not box ticking, and on an ethics of care not an ethics of obedience.”
Importantly, this change in focus amounts to a significant philosophical and cultural change within the regulator itself. And it is clearly a harbinger of cultural change that the FCA would like to see adopted by regulatee organizations. Scandals can take a long time to come to light precisely because harmful behaviours may be viewed as acceptable and normal by market participants.
To this end, Mr Morgan’s contention that those who price risk might influence organisational behaviour is novel and powerful. The three major types of indemnity insurance are fidelity/prime cover (such as for embezzlement), professional indemnity (civil liability) and director liability (primarily criminal). Instead of focusing on moral hazard, Mr Morgan highlighted that the cost of premiums could be an under-used regulatory lever by which to improve cultural standards within capital markets actors. Mr Morgan opined that this may be a particularly useful way of influencing behaviour and culture within smaller banks.
In addition to regulating a firm’s culture via external monitors (such as insurers), individual practitioners within a firm, particularly those at the coalface, can be targeted as well as senior management or ‘the firm’ itself. Indeed, Dr Sanders promoted the professionalization of financial services as a potential puzzle piece in the broader regulation of market conduct. Specifically, he argued for the need to balance public good with economic benefit and to recognise the role and responsibility of the professional individuals (not their corporate entity) who are “sitting opposite and advising” individual consumers. However, he noted the current milieu of employer primacy, which creates regulatory gaps in professional standards.
However, as Professor O’Brien and Dr Gilligan pointed out, a principles-based approach to regulation will not have traction with market players that do not have principles. Speaking to the issue of rogue traders, rogue regulators and state actors as policy entrepreneurs, O’Brien and Gilligan argued that renewal and reform are likely to fail unless the core ethical deficit at the heart of contemporary banking is systematically addressed. On this point, employees and their firms are indistinguishable: corporate culpability for individual ethical failures is invariably and inevitably informed by the relative strength or weakness of the firms’ organizational culture. Culture and resulting behaviour are reinforced through recursivity and reciprocity between individuals within a firm, senior management of a firm, and the firm’s macroeconomic political context.
Accordingly, a clear (and largely unspoken) dilemma occurs when regulatees, whether firms or individuals, behave complicitly not just with each other but with the government regulator itself. Professor Talley, who presented the view from North America on LIBOR and the dynamic of US regulatory politics, conducted empirical research that revealed a correlation between regulator and bank behaviour at key moments in time. The clear implication from these data is that the U.S. regulator knew about the benchmark manipulation and chose to ignore it. If this was the case then should we be concerned? From a public policy perspective the answer is both yes and no. The regulator has a mandate to ensure market confidence. This can be done by punishing wrongdoers and sending a strong signal about appropriate market conduct to all market participants. Yet it can also be achieved by mitigating market hysteria in times of crisis. Ironically, any government complicity, if it existed, may have been motivated by a public welfare logic.
In conclusion, the LIBOR scandal presents a doorway through which we can glimpse the secret garden of market conduct and financial regulation: currently overgrown with weeds but with significant landscaping potential. Arguably there is no one perfect solution; yet for this very reason now is the perfect time for regulatory experimentation and pluralism. This will need to include deeper consideration of modalities for regulating culture, industry self-regulation, and inculcating an ethics of care and not obedience into both regulator and regulatee thinking and practice.
Originally Published:
01/01/2014