29 November 2017

BoE's Carney speech at the FICC Market Standard Board “Two years on from the Fair and Effective Markets Review”

In the cycle of scandal, response, integrity, drift, and renewed scandal; potential solutions have oscillated between the extremes of Self Regulation and Total Regulation.

Recent difficulties illustrate the problems with each of these approaches.

By undervaluing the importance of hard and soft infrastructure to the functioning of real markets, light touch regulation led directly to the financial crisis.

Multiple factors contributed to a tide of ethical drift in FICC markets. Market standards were poorly understood, often ignored and always lacked teeth. Too many participants neither felt responsible for the system nor recognised the full impact of their actions. Bad behaviour went unchecked, proliferated and eventually became the norm.

Given the economic and social consequences of the ensuing disaster, it is right that regulators proscribe certain behaviours and set out their high level expectations. Yet, authorities cannot regulate for every circumstance, watch every transaction, or anticipate every market innovation. Total regulation is bound to fail because it promotes a culture of complying with the letter of the law, not its spirit, and because authorities inevitably lag developments in fast-changing markets.

But it doesn’t have to be this way.

A more comprehensive and dynamic solution combines public regulation with private standards and then buttresses them with a series of hard incentives which materially increase individual understanding and accountability.

Market standards can be effective if they:

- Articulate clearly the market’s collective view of best practice, with worked practical examples to clarify grey areas;

- Are grounded in, and are reinforced by, relevant regulatory frameworks and requirements;

- Are kept current; and

- Are given teeth by incentives that foster adoption and adherence.

Will These Standards and Codes Make a Difference?

We know from history that codes are of little use if nobody reads, follows or enforces them. Why should the FMSB’s efforts be expected to help reverse the tide of ethical drift? Indeed, given the long history of misconduct, aren’t such efforts akin to King Canute rebuking the waves? I’m more optimistic that the tide will turn because the FMSB is part of a much broader effort by UK authorities and market participants. Together, we have created a comprehensive and mutually reinforcing set of measures that strengthen the hard and soft market infrastructure. The resulting incentives give FMSB standards moral force and practical consequence.

First, in the FMSB’s core work, the best in the market are taking responsibility for identifying and codifying best practice, in a way that complements and reinforces existing regulation. The FMSB now convenes senior participants from fifty global issuers, underwriters, asset managers, exchanges, custodians and investment banks. The breadth and engagement of the membership gives its standards credibility and creates peer pressure within the industry to promote adherence.

Second, peer pressure within firms should reinforce standards and, more generally, the commitment to real markets. Most banks have codes of ethics or business principles. These are necessary but not sufficient not least because it isn’t reasonable to expect every trader to absorb their meaning or to translate them readily into live situations. But it is reasonable to expect them to use FMSB guidance to help recognise the differences between a real market and a rigged one. And it is essential that business cultures encourage everyone to call out market abuse when it occurs.

Third, buyside pressure for proper behaviour is made easier by clear, practical standards. This is formalised in the example of the FX Global Code, where major central banks including the Bank of England, have confirmed that they intend to adhere to the principles of the Code, and that they also expect the same of their regular FX counterparties. Similarly, the Bank of England will adhere to the UK Money Markets Code and Precious Metals Code and will expect the same of its market counterparties.

Fourth, the combination of new arrangements for compensation, the expectations of the Senior Managers Regime (SMR), regulation and market standards are mutually reinforcing. In the UK, a significant proportion of the variable compensation of key decision-makers must now be deferred for a period of seven years to ensure it can be clawed back over the time scales it generally takes for conduct issues to come to light. [...]

The FSB’s misconduct action plan, presented to the G20 Leaders’ Summit in July 2017, includes:

(i) Developing new global standards of conduct in fixed income, commodities and currency markets, of the sort that the FMSB has championed, as well the FX global code, in which UKbased authorities and market participants played an important role;

(ii) Direct measures to strengthen financial institution governance and compensation structures to align better risk and reward, including developing governance toolkits, which will address individual accountability, firms’ risk culture, and the risk of ‘rolling bad apples’, (all of which are in place in the UK); and

(iii) Reform of major financial benchmarks arrangements to reduce the risks of their manipulation. [...]

Full speech

© Bank of England