Through its thematic review into financial benchmarks published in July 2015 (TR15/11), the FCA has highlighted that firms have not imposed satisfactory systems and controls to avoid the risk of manipulation of benchmark rates and that firms need to carry out further work to establish satisfactory governance and control processes around their benchmark activities.

As thematic reviews are often a precursor to FCA enforcement action, firms should carefully bear in mind the findings of the thematic review and the key issues set out below.   Tracey McDermott, the FCA director of Supervision, Investment, Wholesale and Specialists made clear during her speech to the British Bankers Association (the text of which was published on 24 July 2015) that benchmark manipulation remains a key focus for the FCA.

FCA’s regulation of key UK-based benchmarks

Following the financial crisis and the discovery of manipulation of LIBOR, FX and other key benchmark rates, the FCA introduced new requirements on benchmark submitters and benchmark administrators, set out in Chapter 8 of the Code of Market Conduct (MAR).  These requirements originally applied to LIBOR, but from 1 April 2015, as a result of the Fair and Effective Markets Review, the FCA’s requirements apply to 7 other key UK-based benchmarks (including the WM/Reuters London 4pm Closing Spot Rate, the Ice Brent Index, the Ice Swap Rate).

Through the thematic review, FCA appears to be sending a clear message that the FCA’s focus is not only on the 8 benchmarks which fall within its regulatory regime set out in MAR.  The FCA is making clear that it is focused on all the hundreds of thousands of benchmarks used in financial markets and it requires firms to conduct their benchmark activities with due skill care and diligence and take reasonable care to organise and control their benchmark activities responsibly and effectively, with adequate risk management systems, in compliance with the FCA’s Principles.

Where they find that firms fail to comply with their obligations in respect of financial benchmarks, we can expect the FCA to take action for breaches of their Principles.

What is a benchmark?

In conducting its thematic review, the FCA has investigated the way in which firms manage conduct risk associated with benchmarks and for this purpose the FCA uses the definition of benchmark as defined by the International Organization of Securities Commissions (IOSCO), which produced its Principles for Financial Benchmarks in July 2013.  Importantly, the definition of benchmark used by IOSCO is very broad and includes any prices, estimates or rates which may be used to determine rates due under agreements or prices at which financial instruments may be bought or sold.  It is notable that the definition of what constitutes a benchmark under the IOSCO principles is broader than that contained within the proposed Benchmark Regulation, which the European Commission is seeking to implement to regulate the way in which benchmarks are used within the European Union.

Key messages from the thematic review

From the thematic review, which was carried out between August 2014 and June 2015, it is clear that the FCA expects firms to have learned the lessons from the notices which the FCA issued in relation to the manipulation of LIBOR, FX and other benchmarks.  Specifically, the FCA also requires senior management to be actively involved in controls around potential benchmark manipulation.

Through its thematic review, the FCA found that all firms reviewed still had work to do in changing their approach to benchmark activities.  The FCA identified the following messages:

  1. Firms need to ensure that they identify all activities which concern benchmarks, or which could affect a benchmark price.   In particular, the FCA identified that firms interpreted the meaning of benchmark too narrowly and that firms should use the IOSCO definition for the purposes of managing their activities concerning benchmarks.
  2. Senior management need to act quickly to improve any outstanding gaps in their approaches to benchmark activity.  The FCA made clear that firms need to ensure that the lessons learned from previous benchmark failures are applied consistently across all business lines engaged in benchmark activities.
  3. Firms need to strengthen their governance and oversight of benchmark activities.  Whilst the FCA found that some firms had put in place adequate controls around how benchmark submission was to take place, there was inadequate governance and oversight of activities concerning benchmarks.
  4. Firms need to continue to identify, raise awareness of, and manage conflicts of interest in relation to benchmark activities.  The FCA expects careful analysis of how conflicts of interest might arise and requires firms regularly to keep this issue under review.  In particular, the FCA found that good practice would include where firms had formalised conflict of interest policies and created logs recording conflicts of interest by benchmark and by asset class.
  5. Firms should ensure they establish robust controls and oversight for any in-house benchmarks being used.  The FCA is clearly underlining that firms need to consider how their internal indices are used, and whether they constitute benchmarks.
  6. When exiting benchmark activities, it is essential that firms give due consideration to the wider impact this may have.  The FCA expects firms which are ceasing to contribute to a benchmark price to consider how their exit might be undertaken in an orderly manner.

The FCA found that firms were not taking forward their policies and procedures around benchmark manipulation with sufficient urgency and the FCA explained that it encouraged firms to set more ambitious deadlines and implement their controls more rapidly.

As part of good governance practice, the FCA praised firms which had established a governance committee structure to oversee firms’ benchmark activities.  The FCA approved of firms which sought to monitor benchmark risk by introducing a global benchmark policy, as the FCA found that this assisted firms with properly considering conduct risk around benchmark manipulation.

With regard to controls, the FCA approved of policies where firms required attestation around contributions made by submitters or to confirm adherence to the firm policies.  The FCA noted that this appeared to raise awareness and accountability from a controls perspective.

The FCA makes clear that all regulated firms involved in benchmark activities should carefully consider the thematic review and that firms’ senior management should satisfy themselves that their current approaches are co-ordinated, in line with regulatory requirements and take into account industry best practices described by IOSCO.

In her speech to the BBA referred to above, Tracey McDermott made clear that a unprecedented amount of resources had been put into trying “to put things right”, following the LIBOR and FX benchmark manipulation actions.  She stated: “very significant progress has been made but unless we, collectively, remain focussed on the end outcome we risk throwing away those billions of hours and pounds of effort and allowing ourselves to slip back to a place we do not want to return to.”

It is clear that the potential manipulation of all benchmarks remains at the very forefront of the FCA’s focus.  Firms should ensure they have adequate systems and controls in place around all benchmarks used in their businesses.  Where there are failings, we can expect the FCA to commence enforcement actions on the basis of potential breaches of its Principles.