From Enforcement to Prevention: International Cooperation and Financial Benchmark Reform

The London Interbank Offered Rate (LIBOR) and Forex scandals have shaken public trust in the global financial system. Despite the global nature of the scandals, the role of international cooperation in preventing financial benchmark manipulation has been surprisingly overlooked. Benchmark reform has tended to focus on structural changes to benchmark administration and regulation, with a particular emphasis on benchmark quality, methodology and governance. Where international cooperation has occurred, it has tended to operate ex post, in facilitating cross border investigations after crises have already been revealed. Where ex ante cooperation has occurred, it has taken the form of high-level standard-setting. Given the global nature of the manipulation, and its ongoing nature, it is clear that further cooperation is needed to prevent misconduct rather than to merely punish it. Our recently published article, which we have co-authored with André Dao, addresses the question of international cooperation in the financial benchmark context and concludes that cooperative tools such as ad hoc discussions, supervisory colleges, equivalence measures and regulatory networks have the potential to bridge the preventative gap in this regard.

Our article examines the suite of reforms led by the International Organization of Securities Commissions and the UK Wheatley Review, as well as the cross-Atlantic investigation into LIBOR and Forex manipulation – all of which reveal close working relationships between regulators in developed markets. Emerging market regulators, including those in Asia, are more often than not left to meet the standards developed by regulators in Europe, the US and Japan.

While some of the cooperative mechanisms used to date, including investigative assistance and memoranda of understanding, are better suited to ex post cooperation, there are a number of ex ante cooperative tools which are gaining prominence: namely, ad hoc discussions, supervisory colleges, equivalence measures and regulatory networks. If institutional culture at the global banks responsible for benchmark manipulation is going to change, these tools will be central to ensuring future reforms are applied consistently and effectively around the world.

The article commences by setting out the need for financial benchmark reform. It provides a brief introduction to financial benchmarks, their importance to the global economy, and the ways in which they can be manipulated. As part of this discussion it reviews the cross-Atlantic investigations of the LIBOR and Forex scandals, which highlighted the very close relationship between UK, US and EU investigators and which resulted in record-breaking fines being levied against an array of global financial institutions. It also discusses the importance of international cooperation to achieving genuine financial benchmark reform.

The article then surveys the responses by international and national bodies to the LIBOR and Forex scandals, including the standard-setting work done by the International Organization of Securities Commissions and the Financial Stability Board, and the major reforms conducted by the UK and the European Commission – all of which paid relatively little attention to issues of cooperation. It canvasses the Asia-Pacific responses to financial benchmark reform.

The article then proceeds to discussion of the cooperative mechanisms commonly used by securities regulators and their application in the financial benchmark context. It identifies the “preventative” gap between ex post cooperation and ex ante reform, and the tools available to regulators to bridge that gap. It evaluates both ex post and ex ante tools in the context of financial benchmark manipulation. It proposes a possible way forward towards increased and more effective cooperation: binding rather than merely cooperative regulatory enforcement featuring stronger regional regulatory bodies based around the supervisory college model.

Andrew Godwin is a Senior Lecturer in Banking and Finance Law at Melbourne Law School, University of Melbourne and Ian Ramsay is the Harold Ford Professor of Commercial Law at Melbourne Law School, University of Melbourne.