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Forex and other benchmarks

By Vivienne Tanchel, barrister specialising in fraud and financial services regulation. She practices from leading criminal set 2 Hare Court


 “Benchmarks are at the heart of the financial system: they are critical for our markets as well as the mortgages and savings of millions of our citizens, yet until now they have been largely unregulated and unsupervised. Market confidence has been undermined by scandals and allegations of benchmark manipulation.”


Thus wrote Michel Barnier, Internal Market Commissioner at the European Commission, in a September 2013 Press Release announcing proposed draft legislation to help restore confidence in the integrity of financial benchmarks.


So… benchmarks: largely unregulated, largely unsupervised and, until recently, largely unknown to most people outside of the financial services industry. But with recent scandals such as LIBOR, and now the increasing awareness of investigations into alleged manipulation of Foreign Exchange financial benchmarks now represent big business for lawyers as well as bankers.  But what are benchmarks, why are they important, and why in particular is forex being reported as the scandal which looks like it will eclipse them all?


What is a benchmark?

A benchmark is a statistical measure, calculated from a representative set of underlying data that is used as a reference price for financial instruments and performance of an investment fund.  The prices of financial instruments worth trillions of dollars are dependent on them, and millions of retail products such as mortgages and credit cards are linked to them. Thus, benchmark manipulation can cause significant losses to consumers and investors, distorting the real economy and undermining market confidence.  They have a statutory definition, too, which can be found at Section 22(6) of the Financial Services and Markets Act 2000.


Trading in the financial services industry may be roughly divided into the following types of assets: equities (shares); interest rate products (bonds); foreign exchange; commodities (gold and other metals); and energy (crude oil).  Each of these asset types has a benchmark linked to it which is relied upon by market professionals to manage and quantify their market risk, and to asses their market performance.



The most famous of the benchmarks, though by no means the most significant, is the London Interbank Offered Rate.  LIBOR is a rate calculated from an average of estimates provided by a panel of more than 20 leading banks (including names such as Barclays, UBS and others) who have special authorisation to carry out this function.  It is, in the simplest of terms, an estimated rate at which a panel bank could borrow funds from another bank.


Why, then, is an estimated rate, restricted to inter-bank borrowing and lending, of any relevance to anyone other than City traders?  Because as with other benchmarks many financial institutions, including mortgage providers and credit card companies refer to it when setting the rate for their own products. 


General interest in benchmarks began when the story of LIBOR manipulation broke.  The UK Government immediately set up a review which identified a number of failings which had allowed the system to be exploited.  Uproar followed, new criminal offences were introduced under the Financial Services Act 2012, and that, the regulator perhaps thought, was that.


Notwithstanding those new criminal offences (which along with other legislation make much specific mention of LIBOR), what the Parliamentary Draftsmen seemed to forget is that LIBOR is only one benchmark on which financial market professionals rely.


Foreign Exchange Benchmarks

The WM/Reuters foreign exchange rate benchmark was introduced in 1994. It is based on trading data collected from across the market, and the rates are published hourly for over a hundred different currencies, and half hourly with a closing “fix” at 4:00pm London time for the 21 major currencies including the British Pound.  By concentrating orders in the moments before or after the one-minute window surrounding publication of rates during the trading day, the rate may be influenced up or down by traders. 


The forex market is estimated to turn over US$5.3 trillion a day.  Allegations have emerged that forex traders at some of the world’s biggest banks have, on a daily basis and for over a decade, been intentionally manipulating the rates used as benchmarks. Further, allegations are circulating that currency traders used their advanced knowledge of customer orders to push through trades before and during the window when the benchmark rates are set. There are also allegations that currency traders colluded with their counterparties at other banks to increase the opportunity of moving the rates.


The important difference from LIBOR is that the forex fix is based on actual trades, rather than on a theoretical judgment of where the banks could trade if they needed to. The Final Notice issued against Barclays Bank in respect of the manipulation of LIBOR make it plain that the evidence relied upon by the FCA included evidence that those who submitted allegedly incorrect rates for the setting of LIBOR were able to do so in the safe knowledge that they would not be called upon to enter into transactions at the submitted prices. The WM/ Reuters fix, however is derived from real transactions.


The Current Investigation

Currently, some 20 foreign exchange traders across the globe have been suspended or removed from their positions, including an employee of the Bank of England who also now seems to be in embroiled in the scandal, allegedly for having been aware as early as April 2012 that traders in various banks were sharing information of clients’ orders in the forex market with each other.  The Bank of England has appointed law firm Travers Smith to conduct an investigation into the conduct of its employees, and the results will be made public in due course.


As is apparent from the LIBOR investigation, one of the biggest concerns for many of the institutions and people alleged to be involved, is this multi-jurisdictional nature of the enquiries from regulators. A number of firms have been faced with investigations into their practices by both the US and the UK regulators. This is very expensive, not only for the regulators, but also for those under investigation.


What next?

Although the new Financial Services Act currently covers only LIBOR, other benchmarks can, of course, be added by way of statutory instrument.  It is very likely this will happen as more allegations of market manipulation emerge.  Further, it seems likely that the administration of (and submission to) benchmarks other than LIBOR will be added to the list of regulated activities. 


Those advising financial services professionals would be well served to ensure they are familiar with the other benchmarks commonly used to value traded assets.  In addition, they may well think it worthwhile having a white collar crime specialist on speed dial…


Vivienne Tanchel is a barrister specialising in fraud and financial services regulation.  She practises from leading criminal set 2 Hare Court.  Prior to her call to the Bar she was a derivatives trader in the City of London and other international markets for over fifteen years.  She regularly advises authorised professionals as well as financial institutions, on financial crime and financial regulation proceedings.  She also lectures extensively and provides training courses on related topics.   



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