The FX market's entry into the Great Libor Scandal Lookalike Contest may have been a littleunderwhelming1 - Libor, a made-up number, was manipulated by making up a different number; the FX market's WM/Reuters benchmark, which was derived from actual trades, was manipulated by actually trading - but the judges deemed it adequate:
“All benchmarks share similar vulnerabilities so there is a need for a framework that applies to all benchmarks to ensure their integrity and restore market confidence,” Chantal Hughes, a spokeswoman for European Union Financial Services Commissioner Michel Barnier, said in an e-mailed statement.
Trade-based and poll-based benchmarks would actually seem to share opposite, not similar, vulnerabilities, but whatever: uniform standard-setting is vaguely afoot, and "The International Organization of Securities Commissions, a Madrid-based group known as Iosco that harmonizes market rules, may propose final guidelines improving transparency and oversight of benchmarks." I guess they'll make the poll-based benchmarks more like the trade-based benchmarks? Which were also manipulated?
The other item on the agenda is to criminalize benchmark manipulating, since manipulating benchmarks doesn't really seem to have been a crime anywhere.2 Singapore, for instance, was a hotbed of manipulation, with "20 banks at which 133 traders tried to manipulate the Singapore interbank offered rate, swap offered rates and currency benchmarks," but "no criminal offence under current Singapore law appears to have been committed."
So what to do about it now? The Monetary Authority of Singapore has a clever answer:
Twenty banks were found to have deficiencies in the governance, risk management, internal controls, and surveillance systems for their involvement in benchmark submissions. MAS has censured these banks and directed them to adopt measures to address their deficiencies. ... The banks are required to set aside additional statutory reserves with MAS at zero interest for a period of one year. The duration for which the additional statutory reserves are to be placed with MAS may be varied depending on MAS’ assessment of the adequacy of the measures put in place by each bank to address the deficiencies and risks identified.
Isn't that neat? It's sort of like a fine, in that you have to stump up some money, but you get it back if you behave yourself for a year or so. And if things go horribly pear-shaped during that year or so, I guess the money goes to your creditors. (Also of course they're going to make benchmark-manipulating criminal. In the future.)
You don't see this approach - punitive reserve requirements for semi-unrelated naughtiness - applied to big banks very often in the U.S., but it has a certain appeal. There is plentiful blather about how banks are "too big to prosecute," because criminal convictions and big fines would destabilize them and, thus, the financial system. Putting individual mid-level humans in prison for doing things that were standard practice in the industry - 20 banks! 133 traders! just in Singapore! - and approved by their bosses seems a bit harsh. Libor-related fines come out of shareholders' pockets, and anyway are pretty small relative to the amount of money at stake over years of Libor manipulation.
But "post a big honking bond to protect everyone if you blow yourself up," while not really related to Libor manipulation, has a pleasing affinity: "if you are the sort of bank that is unscrupulous enough to try to manipulate Libor and big enough to succeed," it seems to say, "you are also the sort of bank that is likely to cause expensive trouble in the future." And it's harder for the bank to fight than a fine or criminal charges: what, you're going to go to court to demand the right to be riskier?3
You could replace the reserve/bond requirements with capital requirements too: if we find you messed with Libor, or whatever, you can't do any new share buybacks until your capital ratios have increased by [X]%.4 Anat Admati and Martin Hellwig, godparents of the recent push for increased bank capital, claim that not only are higher capital requirements good for, like, the world, but they're also good for shareholders: that "the required return on equity, which includes a risk premium, must decline when more equity is used," and so the preference for highly levered banking is not a shareholder but a management preference:
Why are bankers so focused on ROE? ... Bankers may target high ROE because it is treated as a performance measure that affects their compensation. If compensation depends on ROE, bankers have direct incentives to take risks. Bank managers also have incentives to increase bank borrowing in order to increase the average ROE as well as the bank's risk.
If you believe this line of reasoning,5 then forcing naughty-but-maybe-not-criminal banks to increase capital and/or reserves has pleasing properties. Unlike fining or prosecuting them, it makes the financial system more rather than less stable. Also unlike fining them, it doesn't harm shareholders too much (as the cost of equity decreases in parallel with the decrease in ROE6), while maybe actually hitting bank managers where it hurts (in the ROE-based compensation). And unlike Brown-Vitter, it could probably be accomplished by informed regulator/bank negotiations rather than confused Congressional blunderbuss.
I suppose the downside is that this approach creates the impression that capital and reserve buffers are a punishment rather than just a sensible safeguard for the financial system. But in their hearts bankers pretty much think that already. So it can't hurt too much to make it true.
FX Rates Said to Face Global Regulation in Libor Review [Bloomberg]
Singapore Censures 20 Banks for Bids to Rig Benchmark Rates [Bloomberg]
MAS Proposes Regulatory Framework for Financial Benchmarks [MAS]
1.Matt Taibbi disagrees!
This time the rates allegedly being rigged are in the foreign-exchange or "FX" markets, meaning that if this story is true, it would almost certainly trump LIBOR for scale/horribleness.
As one friend of mine who works on Wall Street put it, "It's endless! This is the biggest market in the world."
It's funny to think about Matt Taibbi's friends who work on Wall Street. "Hey want to grab a drink after work?" "I can't, I've got plans to hang out with Matt Taibbi and talk about how all the bankster scum should be in prison." *Awkward silence*.
2.Oh I kid, I kid. Lying to anyone in the vicinity of a computer or telephone is always a crime in the U.S., if authorities want it to be. Everything is a crime in the U.S.! And the UK thinks that Libor rigging was probably a crime there too. But not in like a "Section 404: It shall be a crime to mess with Libor" kind of way. In a lying to someone near a computer kind of way.
3.It works for other vague scandals too. Did the London Whale do anything wrong? Did JPMorgan do anything wrong in responding and disclosing/not-disclosing it? Opinions vary! Court cases will be contentious! But "set aside a billion dollars of reserves just in case that happens again" seems like a compromise everyone could live with.
4.That is in fact, loosely and informally, what happened to JPMorgan after the Whale:
We would like to buy back stock, but after discussion with the Federal Reserve, we need to work with the Federal Reserve, the board has determined not to buy back stock until two things take place. Until we finish the Board review, I think it’s a logical thing, so we come to the conclusion of the Board review, and we find no other major stuff, which I don’t expect this time.
5.And there's no particular reason you should. Certainly the prevailing view is that diluting shareholders is bad for them? There are empirical examples supporting Admati & Hellwig's claim, however.
6.Whatever you think of the Admati/Hellwig math, the intuition "bank that increases capital cushion should have a lower cost of equity, while bank that pays tons of fines for misbehavior should have a higher cost of equity" seems plausible. And fines reduce ROE too you know.