IOSCO says that Libor-like manipulation possible for many financial benchmarks

Bloomberg reports that according to a confidential discussion paper by the International Organization of Securities Commissions many of the benchmarks used by the financial industry are not based on actual transactions and as a result are subject to Libor-like manipulation.

Regular readers are not surprised by this finding as they know that the global financial regulators failed to focus on ensuring transparency in the financial markets.  As a result, financial firms that stood to benefit introduced opaque benchmarks that they could easily manipulate.

The same lack of oversight that enabled traders to manipulate the London interbank offered rate plagues other benchmarks around the globe, according to a group of international securities regulators. 

Fewer than half of the benchmark interest rates surveyed in the U.S., Europe and Asia were based on actual transactions, according to a confidential International Organization of Securities Commissions discussion paper obtained by Bloomberg News. 

Instead, the rates were calculated by methodologies that were unclear, not transparent and only rarely subject to specific regulatory standards or obligations, the group said....

The solution for restoring confidence in the benchmarking activities globally is to base all of the benchmarks off of actual transactions.

For interest rate benchmarks, these transactions should be disclosed as part of banks providing ultra transparency and reporting on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

According to the discussion paper, about 80 percent of benchmarks were either compiled by associations or private entities. For survey-based benchmarks like Libor, the criteria for submitting data was not always objective and called for judgments about rates and prices, according to the discussion paper. Even in benchmarks that are based on actual transaction data, the compiling bodies retain discretion in producing the actual rates or prices. 

As part of my recommendation, I recommended that all the data should be collected, standardized and disseminated by a data warehouse that was overseen by a firm with no conflicts of interest.

It is only by eliminating conflicts of interest in the oversight and operation of the data warehouse that market participants can trust the data.

“The risk of manipulation will be greater where participants in the process have both incentive and opportunity to submit inaccurate data or apply a methodology inaccurately,” the authors said in the paper. “Furthermore, where judgment is required in determining the data to be submitted, the problem is particularly acute.”.... 

The advantage of setting up a data warehouse and basing financial benchmarks off of actual trades is that it eliminates these types of problems.

While these characteristics make a range of benchmarks susceptible to manipulation, many regulators have limited authority to take enforcement action against traders or entities that tamper with the process since they are generally unregulated activities, according to the paper....

“Presently, there is little evidence that the current scope and severity of global sanctions regimes provides effective deterrence,” the authors said in the paper.

Since sanctions don't act as an effective deterrent, it is better to bring in transparency and prevent manipulation in the first place.