The original constitution of an IBOR panel, in all jurisdictions, traditionally included banks of a similar credit rating who were deemed to be the key participants involved in local interbank money market activity. They acted in good faith without a great deal of guidance from their administrator (normally the local bankers association) or regulator to honestly contribute rates that were a fair reflection of the market they served to represent. The combination over time of the significant decrease in the volume of interbank lending, implied for submitters, a greater use of ‘expert judgement’ in the determination of their daily contribution and this coupled with the huge growth in interest rate derivative contracts settling on IBOR benchmark fixings, meant that to a very select few the opportunity to manipulate the rate for illicit gains was too tempting.
Following the fall-out of this fraudulent behaviour and subsequent regulatory investigations it must be acknowledged that there was not a great deal of enthusiasm within banks for their continued contribution to IBOR fixings. However, it naturally remained the key to a functioning market and the combination of a little coercing from regulatory authorities and submitters admirably accepting a shared responsibility, ensured the benchmarks continued to be produced. The IBOR manipulation story is of course well documented but is referenced for the sole reason that it proved to be the necessary catalyst to restore credibility to benchmark fixings and hence why we now have the introduction of EU BMR, to ensure a standardised and rigorous governance framework that needs to be implicitly followed, with full compliance no later than the strict deadline of January 2020.
Set against this back-drop the onus is then firmly with benchmark administrators to ensure that submitters to their benchmarks comply fully with an EU BMR compliant code of conduct, which it should be clearly stated from the outset is a more onerous governance framework than that of merely adopting the IOSCO Principles.
Relationship between submitter’s and benchmark administrators
Submitters were also members of their local financial association which oversaw the benchmark operations, and in many cases, they constituted the majority membership of the committees responsible for the oversight of the fixing. Clearly this presents a conflict of interest and in future, under BMR, and particularly for IBORs, this arrangement will no longer be allowed to prevail based on the logic that submitters should not be able to solely make decisions or rules about their own activities.
This creates a new dynamic for submitters to the benchmark. In the past, there was more of a collegial relationship between the administration of the benchmark and the panel banks. Under BMR, this relationship changes, as the benchmark administrators become more a quasi-regulatory body, working hand in hand with the local competent authority.
Let’s be clear, those continuing to submit inputs are the most critical component of a benchmark. Without them the fixing ceases to exist and as has been clearly demonstrated, the quality of the inputs, free from manipulation, will determine the quality of the benchmark final output. One can organise the best and most stringent governance framework, but this is merely supporting the determination process itself.
In this context, benchmark administrators need to keep submitters on board to maintain their crucial benchmark fixing. On the other hand, new rules, imposed by administrators to meet BMR and their own regulatory responsibilities introduces operational and compliance costs for submitting banks.
Whilst the inevitable cost implication is unwelcome, the good news is that once introduced, those involved in the daily rate contribution will be fully protected by this audited framework. Managing this paradox requires a great deal of skill and sensitivity in understanding the political position of the submitter community.
Changes required of submitter’s
The specifications of EUR BMR are very clearly defined, detailing over 200 requirements that submitters will need to meet for an IBOR, ranging from internal processes and procedures, staff training, internal and external audits and management oversight. Perhaps the most contentious issue is that of the stipulations involving the determination of the daily submission by the respective submitters. Emphasis is placed on the use of referencing actual transactions that match precisely the maturity of submission. However, across all currencies, to varying degrees, there is a lack of liquidity particularly in fixed-term contributions, which therefore requires the application of ‘market expertise’. EU BMR gives clarification on the use of a hierarchy or ‘waterfall’ of other market products that can be used in producing a methodology that generates a daily submission. This avoids any potential accusation of ‘guess-work’ and provides consistency on how the rate is calculated. The inputs to the prescribed hierarchy need be clearly documented on a daily basis.
The much-preferred route is to have this process automated with formal sign-off internally of the methodology used by risk management. Such a system provides certainty in the calculation of the rate produced by the respective submitter and protects the individuals involved from any accusation of manipulative behaviour. The additional important ingredient stipulated by EU BMR is the requirement to have the submitter’s rate validated by a ‘reviewer’. The procedure is known as the ‘four-eyes principle’, ensuring that two organisationally segregated individuals are involved in the determination of a submitter’s contribution further reducing the risk of error or non-compliance, but potentially doubling the resource required to prepare and submit daily inputs.
In addition to these demands on resources, amendments to internal IT systems to provide auditable compliance trails need be budgeted and scheduled into IT change programs. In this regard it is not only a cost issue, but the time required for internal decision making and the need to be compliant with the changes. Many of these decisions, once fully understood, are often taken at board level due to the reputational risks and costs that are at stake. In some countries, we have found that submitters have never had in place any form of code of conduct, and the necessary implementation of one will place more pressure on a submitter who may either choose to opt out as a consequence, or at the very least require a longer lead time to implement the necessary governance framework. It should also be noted that the required segregation of staff, to isolate individuals involved in the process from their trading colleagues, will prove difficult for smaller submitter organisations.
For benchmark administrators, this time constraint poses a significant problem in that until all submitter’s are compliant with their BMR defined code of conduct, it is highly unlikely that any competent authority will formally authorise their benchmark.
Submitter’s view of changes
Given this issue of increased cost of governance coupled with the reputational risk associated with non-compliance, it is no wonder that submitter organisations are conducting their own analysis concerning their continued involvement and with BMR there is little wriggle room for benchmark administrators to “ease” the burden for submitters.
Therefore, it is imperative that any benchmark administrator is fully engaged with the submitters to a) understand, advise and verify the varying methodologies used, on a bilateral basis and b) is taking the lead in the formation of a proactive ‘working group’ to establish the correct forum for the submitters to discuss and determine common issues, whilst respecting the confidentiality of submitter specific information. This sense of shared ownership is an important part of the ‘buy-in’ process to maintain the necessary momentum to ensure that submitting organisations move as swiftly as possible in observing the new code of conduct.
Once achieved the next stage for the benchmark administrator is to oversee the evolution of the rate produced, to enhance where possible the credibility of the input data. For this exercise the core group remain the local market practitioners to determine what is practical. With pressure on regulators to source, where possible, a risk-free-rate for benchmark use, the local administrator needs to drive this process to conduct the required research to reach the correct collegiate decisions that avoid unnecessary market disruption when agreed changes are introduced.
In conclusion, from my own personal experience of overseeing IBOR contribution data from a submitting bank, a healthy and open dialogue with the relevant administrator is crucial in correctly managing the entire process. Understanding the issues and sensitivities from a submitting bank’s perspective has helped GRSS to develop an administration template which balances the reality perspective of the administrator and the absolute need for conformity to BMR.
In broad terms the template involves engaging submitting banks in a consultative exercise whilst providing clear and consistent guidelines in the development of a BMR compliant code of conduct. Also included is the development of an automated methodology which, amongst other things, defines the use of trade data and the appropriate application of ‘expert judgement’.
Providing clarity to submission rules enables submitting banks to develop compliance frameworks to demonstrate consistent, ongoing observance of the code of conduct removing the key element of organisational and personal liability.
As financial benchmarks reform and evolve it’s is important that IBOR’s are robust and stable within the framework defined by EU BMR. Critical to that stability is the ongoing commitment of panel banks. The relationship between administrator and panel bank essentially changes when operating in a regulated environment, but that, in my view, shouldn’t stop both parties working in close collaboration for mutual benefit.
Neil Donaldson has over thirty years’ experience working in fixed income markets with Credit Lyonnais and was previously responsible was for the oversight of Credit Agricole’s daily LIBOR submission (CF40) and to act as the main intermediary for both the regulator and administrator in regard to the benchmark fixing and it’s necessary evolution.
Neil is the GRSS Business Development Manager for North America and is Chairman of the Stakeholder Working Group for the PRIBOR benchmark.
GRSS is a leading provider of services to benchmark administrators who are seeking to meet new EU benchmark regulations and operates as a benchmark administrator in Europe for the PRIBOR benchmark.