HKMA and RBA voice fears over Iosco benchmark proposals

Responses to Iosco's Principles for Financial Benchmarks reveal concerns that many markets will not be able to support transactions-based rates; RBA questions 'lexicographic hierarchy'

The Hong Kong Monetary Authority (HKMA) and the Reserve Bank of Australia (RBA) have both raised concerns over a consultation paper published by the International Organization of Securities Commissions (Iosco), aiming to clean up the governance of scandal-hit benchmark rates such as Libor and Euribor.

The Principles for Financial Benchmarks, a consultation paper published by Iosco in April, set out nine principles seeking to make benchmarks a more reliable indicator of actual market conditions by reducing errors, eliminating the scope for manipulation, and using data on transactions as a basis for setting the benchmark, rather than submissions by banks.

While Iosco maintained that transactions data should form the basis of each benchmark rate, it added that this "does not prohibit the use of non-transactional data such as bids and offers, or adjustments based on expert judgement, as an adjunct or supplement".

Earlier this week, Iosco published responses to the consultation, spanning central banks, commercial banks and the rate-setters themselves. A key concern that many raised was whether a process based on transactions data would yield a benchmark that actually reflected market conditions, particularly in markets where the volume of transactions is very low.

The RBA said the volume of trading activity required to make transaction-based benchmarks credible was "too high a hurdle" for most markets. Furthermore, the central bank warned that where trading was "sporadic", reliance on transactional data could even increase the opportunities for manipulation.

"A single low-volume trade is a less reliable indicator of pricing in the market than firm bids and offers provided by multiple market-makers on a continuous basis over the same time interval," the RBA said.

By contrast, the HKMA said the rate-setting process should be "anchored" by observable transactions. However, the central bank added, "expert judgement is still crucial for filtering unrepresentative market volatility and outlier transactions that may creep into transaction data'.

The HKMA raised further concerns, about attempts to avoid a conflict of interest by removing the rate-setting process from the ‘front office'. The HKMA pointed out that the front office was the most likely to make accurate submissions, so forcing middle- or back-office functions to make the submissions "could adversely impact the quality of data used in the benchmark fixing process".

The HKMA did note that conflicts of interest were still an issue if front-office submissions continued, but said the "stringent" controls set out in other Iosco principles should be sufficient to ensure "proper and ethical behaviour".