Special edition: Regulating Benchmarks

The Libor and Euribor scandals shook market confidence in the construction and governance of industry-set benchmarks last year. It resulted in a series of reviews as regulators worked out what happened, why it wasn’t stopped and what measures are needed to prevent banks from gaming the system again.

The scandals demonstrated the fragility of certain benchmarks, in terms of both their integrity and the continuity of provision. Regulators are keen to bring the administration and setting of benchmarks inside the regulatory parameter, starting with the most important, to close the loopholes that made the rate-setting process vulnerable to manipulation.

The UK government was the first out of the blocks with the Wheatley Review in September. Other regulators are now following suit with new rules in a manner which is “unprecedented” according to the International Organization of Securities Commissions (IOSCO).

Ongoing criminal investigations in the EU, Japan, Switzerland, UK, and the US on Euribor, Libor and Tibor could pose further challenges for banks in the medium term. Civil litigation is also on the cards. In October, some US homeowners filed a class action suit in New York against 12 major banks, claiming that Libor manipulation raised their mortgage bills.

This flux means that senior managers at participating banks must keep a close-eye on this issue, working with regulators to ensure that the right type of reforms are constructed.

Regulators take action to strengthen benchmarks

On 11 January 2013, the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) published the results of their joint work on Euribor:

In a separate development, IOSCO published a high-level consultation report on financial benchmarks (CR01/13) on 11 January 2013—which rounded-off a very busy week on the benchmarks front.

Euribor review and recommendations

The rate-setting process underpinning Euribor is fraught with problems. Those who “exercise judgement” in estimating the price at which they might have borrowed money in Europe’s opaque and illiquid inter-bank lending market have incentives to manipulate submissions to protect the image of their own creditworthiness or improve their trading positions at various times.

For a benchmark to be robust and credible it should be based on actual data collected from diverse sources based on transactions executed in a well-regulated and transparent market, supported by appropriate governance and compliance procedures and monitoring.

ESMA and the EBA support this assessment and have in turn identified “significant weaknesses and insufficiencies” in the governance of the Euribor rate-setting process following a Review in November 2012. They have proposed a series of recommendations to the Euribor-European Banking Federation (EEBF) which they want to see implemented “promptly” and “in-full” to ensure Euribor is restored as a reliable benchmark.

The Review found that Euribor’s Steering Committee, which is responsible for the governance of the rate-setting process, is not sufficiently independent because a majority of its members come from the panel banks. It wants the EEBF to diversify its membership to non-bankers and hold more regular meetings in the future.

Both regulators were unhappy that no formal requirements exist for Euribor panel banks to have adequate internal governance, a code of conduct and conflicts of interest management in relation to the submission process. The governance and code of conduct needs to be improved and reinforced, specifically with regards to the identification and management of conflicts of interest.

Streamlining Euribor rates should help reduce the opportunities for manipulation. The references for Euribor should focus on maturities with the highest usage and volume of underlying transactions. Rates should be scaled down from the current 15 maturities (1-3 weeks and 1-12 months) to no more than 7 maturities (1 and 2 weeks, 1, 3, 6, 9 and 12 months).

The Review found that EEBF, as manager and administrator, does not assume sufficient direct responsibility for, or exercise direct control over, the rate-setting process, including the calculation agent (currently Thomson Reuters). EEBF should assume direct responsibility for the quality of the data submitted by the panel banks and the subsequent collation, calculation and distribution. In this regard, it should perform internal audits as a matter of course; external audits with public disclosure of the results should follow.

EEBF should clearly define its minimum expectations regarding the internal procedures and controls being applied by the calculation agent. The calculation agent should have its own code of conduct related to reference-rate setting, perform internal audits and be subject to an annual EEBF audit.

Finally, the Review found that the definition of Euribor is not sufficiently clear because it is based on terms which create ambiguity and the rates being quoted are not assessed sufficiently against evidence from real transactions. EEBF needs to go back to the drawing board with its definition to make it clearer, i.e. by detailing definitions of prime bank and interbank transactions.

EEBF must make haste in implementing these reforms; ESMA and the EBA will assess their implementation within six months to evaluate progress.

Principles for Benchmark Setting Processes in the EU

ESMA and the EBA are also consulting on a set of Principles to address the activities of reference-rate and other benchmark providers, administrators, publishers and market participants who submit data.

The Principles provide a general framework for the setting, submitting, administration and using benchmarks and are broadly in line with the principles recommended in the Wheatley review, including:

  • Rate-setting: actual market transactions should be used as a basis for a benchmark where appropriate. The methodologies for the calculation of a benchmark should be documented and be subject to regular scrutiny and controls to verify their reliability.
  • Submission: banks should have in place internal policies covering the submission process, governance, systems, training, record keeping, compliance, internal controls, audit and disciplinary procedures, including complaints management and escalation processes.
  • Administration: the benchmark administrator should ensure the existence of robust methodologies for calculating the benchmark, appropriately oversee its operations and ensure that the market gets an appropriate level of transparency regarding the rules of the benchmark.
  • Calculating agents: the benchmark calculation agent should ensure a robust calculation of the benchmark and the existence of appropriate internal controls over the benchmark calculations it makes.
  • Users: benchmark users should regularly assess the benchmarks they use for financial products or transactions, and verify that the benchmark used is appropriate, suitable and relevant for the targeted market.
  • Continuity: benchmark administrators and users should put in place robust contingency provisions for a drying-up of market liquidity, a lack of transactions or quotes or the unavailability of the benchmark, respectively.

These Principles are a first step towards a potential formal regulatory and supervisory framework for benchmarks in the EU. The consultation closes on 15 February 2013.

Global standards

IOSCO’s consultation on benchmarks has a similar message. It calls on benchmarks to be regulated and stresses the need for credible governance structures to address conflict of interests in the setting process at banks as well as at administrators. The process of setting a benchmark needs to be governed by a clear and independent process in order to avoid conflicts of interest and limit its susceptibility to manipulation, discretionary decision making or price distortion.

The consultation discusses the need for increased transparency and openness in the benchmarking process (including transition between benchmarks), data sufficiency and the options for enhanced regulatory oversight.

The consultation also considers issues that market participants might confront when seeking to make the transition to a new or different benchmark. There should be sufficient data used to construct a credible benchmark. In cases where there is insufficient data, regulatory authorities should consider the possibility of transitioning away from a benchmark.

Martin Wheatley, Co-Chair of the IOSCO Board Level Task Force and Managing Director of the UK Financial Services Authority, believes that this consultation is an “important step for IOSCO in developing robust, internationally applicable principles to drive up the standards of governance, transparency and the production of benchmarks.”

Following this Consultation Report, IOSCO’s Benchmark Task Force will “articulate a framework of robust, globally consistent policy guidance and principles for financial Benchmarks and related activities”, probably sometime in the Summer. IOSCO’s consultation closes on 11 February 2013.


Benchmarks remain an important cog in the wheels of the financial system. Re-building market trust is central to this endeavour. A benchmark is a useless indicator without it. However, the ESMA/EBA work also brings home the responsibility of users of benchmarks not to take everything on faith.

The scandals in 2012 should be viewed as a wake-up call for all banks that participate in any type of benchmark setting process. They must review the robustness of their submission processes and the adequacy of their governance standards. Banks should also examine other areas which are “self-regulated” to head-off any potential enforcement actions coming down the line.

Dropping out of the benchmark-setting process may appear to be an easy way to evade those, but might also trigger regulatory response aiming at keeping benchmarks working (including mandating participation), because there is little doubt about their on-going importance for the proper functioning of capital markets.