Scandals surrounding the setting of some of the world’s most important financial benchmarks, which influence the prices people pay for everything from oil to mortgages, have shaken confidence in vital markets.
The latest shenanigans, affecting currency markets, show how difficult restoring trust will be.
At issue is the process by which, at 4 p.m. London time every weekday, exchange rates are set for a number of the world’s most-traded currencies. Reporting by Bloomberg News suggests that traders misbehaved in two ways. First, they shared privileged information about their orders ahead of the 4 p.m. “fix,” allowing them to profit at the expense of less-informed market participants. Second, they timed and structured their trades to move the benchmarks in their favor, putting mutual funds and corporations that transact at the benchmark price at a disadvantage.
The possibility that currency benchmarks have been rigged is particularly troubling, because they meet many of the guidelines that global regulators set out after previous scandals. Unlike the London interbank offered rate, which relied on banks to estimate the interest rates at which they could borrow, the foreign-exchange benchmarks -- known as the WM/Reuters rates -- are based on observable transactions. They’re also administered by an independent party, World Markets Co., and calculated using a published methodology with various checks for accuracy.
(World Markets Co. is a unit of State Street Corp. and Thomson Reuters Corp. Bloomberg LP, the parent company of Bloomberg News, competes with Thomson Reuters and distributes the WM/Reuters rates.)
If such an apparently well-designed process can be susceptible to rigging, how can any benchmark be trusted? In the specific case of exchange rates, one modification might help. The 4 p.m. fix is an attractive target largely because so many trades cluster around the predefined 60-second period WM/Reuters uses to collect its data. Switching to a random 60 seconds near the fixing time, for example, would make manipulation much harder. Banks might charge more to trade if the fix were less predictable, but in many cases the benefit of avoiding manipulation would justify the cost.
More generally, insiders will always have a big incentive to manipulate markets and to profit on privileged information -- and regulators will always struggle to anticipate their strategies. There’s no hope of defeating those efforts if regulators aren’t on the lookout in the first place.
In the Libor case, a simple statistical analysis was all it took for journalists to see that something was wrong: The banks’ submissions during the financial crisis of 2008 were just too similar to be believed. In the case of the WM/Reuters rates, Bloomberg News found a suspicious pattern of price surges around the 4 p.m. fixing time. Screening for similar anomalies in all markets should be routine.
After detection come enforcement and deterrence. The business of buying and selling currencies for immediate delivery exists in a sort of regulatory blind spot. Authorities must make it clear that insider trading and manipulation will not be tolerated in any market -- and ensure that penalties are sufficient to make cheats think twice.
Many of the world’s financial benchmarks are long overdue for an overhaul. Regulators are right to set guidelines, and to demand more accountability and transparency. Even the best-designed set of rules, though, will be of little value unless somebody is watching.
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