The importance and complexity of their task is illustrated by the multiple root causes of the misconduct in FICC markets. Specifically, the Review identifies:
- Market structures which presented specific opportunities for abuse, such as poor benchmark design, and which more generally were vulnerable to conflicts of interest, collusion, and thin markets;
- Standards of acceptable market practice that were usually poorly understood, often ignored and always lacked teeth;
- Firms’ systems of internal governance and control that were incapable of asserting the interests of firms – let alone the wider market – over those of close-knit trading staff;
- Individual incentives that were skewed, with pay packages stressing short-term returns over
long-term value and good conduct;
- And personal accountability that was lacking, with a culture of impunity developing in parts of the market.
All these factors contributed to an ethical drift. Unethical behaviour went unchecked, proliferated and eventually became the norm. Too many participants neither felt responsible for the system nor recognised the full impact of their actions. For too many, the City stopped at its gates, though its influence extended far beyond.
A good start has been made in addressing these deficiencies.
The design and regulation of key FICC benchmarks has been overhauled and transparency in FICC markets is being enhanced. Compensation rules have, in the main, been transformed to align better risk and reward.
From next year, senior managers of banks and insurers will be held directly accountable for failures in their areas of responsibility. And the best firms are improving the ‘tone from the top’, launching conduct training and revamping control structures.
But major gaps remain.
These are evidenced by enforcement actions which continue to appear with depressing frequency. These sanctions, while necessary, aren’t the solution, not least since the $150 billion of fines levied on global banks translates into more than $3 trillion of reduced lending capacity to the real economy.
We need a better balance between individual and firm accountability. But who should be accountable? Against which standards? And with what consequences?
In these regards, I welcome the Review’s recommendations that:
First, individuals must be held to account. Doing so requires new, common standards, cast in clear language; better training and qualifications for FICC personnel; and mechanisms to ensure that when individuals are fired, their history will be known to those who consider hiring them.
Second, firms must take greater responsibility for the system by improving the quality, clarity and market-wide understanding of FICC trading practices. I welcome the industry’s leadership in drawing up plans for a new FICC Market Standards Board. The Board’s mandate will be to establish readily understandable standards, keep them up-to-date with market developments, and promote adherence to them. Crucially, the Board will be dynamic, and will monitor and address areas of uncertainty in specific trading practices.
This is a major opportunity for the industry to establish common standards of market practice that are well understood, widely followed and, crucially, that keep pace with markets. If firms and their staff fail to take this opportunity, more restrictive regulation is inevitable.
To give these measures teeth, key elements of the Senior Managers Regime should be extended to all firms active in wholesale FICC markets, including dealers and asset managers. That means all senior managers would have clearly defined responsibilities and would be answerable for training, certifying and monitoring the material risk takers they supervise. The FCA should oversee compliance, redeploying resources to focus on Senior Persons. In turn, these individuals would be on the hook for promoting compliance within their organisations. Incentives will be aligned.
For the best in the industry, this won’t be new. This is just how you run your business. But for others, who free ride on your reputations: the Age of Irresponsibility is over.
Third, regulators should extend the coverage of market abuse regulation to include every major fixed income and currency market. And criminal sanctions should be updated, with market abuse rules similarly extended and maximum prison terms lengthened.
Finally we need global standards for global markets. I welcome the FICC Markets Standards Board’s intent to be as global as possible in its membership and influence. All major Central Banks and market participants have begun working on developing a new single Global Code for FX. I would encourage IOSCO to consider complementing these efforts with a similar initiative to cover FICC markets as a whole when they meet in
London next week. The FSB will engage with these processes and work to improve the alignment between remuneration and conduct risk across the globe.
The Bank of England’s Role
All must play a role in building real markets, including the Bank of England.
Although the Bank does not regulate conduct or markets per se, it has responsibilities for, and powers over, the stability of the UK’s financial system as a whole.
In the run-up to the crisis, the Bank’s contribution to the effectiveness of markets fell short in three respects. In all cases, the Bank is now responding.
First, the Bank’s framework for providing liquidity was shown to have lagged behind market developments. Once under pressure, the Bank could neither stabilise overnight rates nor support the banking system. Fortunately, in the jaws of the crisis, the Bank innovated rapidly and admirably to avoid a collapse of the system.
Those lessons are now embedded in a new, comprehensive framework for the Bank’s sterling market operations. We have expanded the range of eligible collateral, and will lend to many more counterparties, at much longer maturities. The Bank also stands ready to act as a market maker of last resort.
Constructive Ambiguity has been replaced by Open for Business.
Second, like many others, the Bank neither identified the scale of risks in the system nor spotted the gaps in the regulatory architecture.
Following the Chancellor’s reforms in the last Parliament, the Bank now has statutory responsibility to protect and enhance the stability of the UK’s financial system, and is working as One Bank to do so. The FPC and the PRA have catalysed a series of actions that influence market resilience including stress tests of banks and hedge funds, system-wide capital actions, and new tools like the leverage ratio and minimum repo haircuts.iii
Third, the Bank’s arcane governance blurred the Bank’s accountability and, by extension, weakened the social licence of markets.
Before my arrival, the Bank’s governance was reshaped. The Bank’s board of directors, Court, has been strengthened. Its external members now have formal powers to observe the meetings of the Bank’s policy committees and to commission reviews into the Bank’s performance.iv
I welcome the Government’s intention to introduce legislation further strengthening the governance and accountability of the Bank.
The Bank will continue to modernise its operations. Following the Grabiner report, the Bank has focused its Market Intelligence programme, strengthened procedures, improved training and overhauled compliance. And the Bank is introducing today a new code of conduct. The Bank expects its senior management to meet the highest standards of professional conduct. As one example, the Bank will apply the core principles of the Senior Managers Regimes to its own senior staff, including the Governor. This is in addition to existing obligations and scrutiny from Court, Parliament, the media and the general public.
And the Bank will continue to reinforce its commitment to openness and transparency. Minutes of Court meetings are now published with minimal delay. The Monetary Policy Committee will publish transcripts of its deliberations with an appropriate lag. Whenever there are difficult issues, outside reviews of the Bank’s performance will be conducted, publicly released and acted upon.
The Bank welcomes such scrutiny of our activities, including open debate about the cumulative impact of reform on the functioning of markets.
In particular, while the core of the system has been made more resilient, the combination of new prudential requirements on dealers and structural changes in markets has reduced market depth and increased potential volatility. This process likely has further to run, particularly as the normalisation of global monetary conditions edges closer. Firms and regulators should be alert to these developments, including their consequences for investment funds that offer daily liquidity while investing in securities that only appear liquid.
To be clear, more expensive liquidity is a price well worth paying for making the core of the system more robust. Removing public subsidies is absolutely necessary for real markets to exist. Volatility characterises such real markets and much of the pre-crisis market making capacity among dealers was ephemeral. However, the possibility of sharp, unpredictable changes in market liquidity poses a clear risk to financial stability, particularly when some market participants take liquidity for granted and crowd into trades in anticipation of central bank action.
The Bank is keenly alert to such risks. The FPC and the FSB are currently analysing these issues and welcome perspectives on whether the market, regulation or both should adjust for the good of the system.
With the main building blocks of reform in place, now is the time to take stock.
It’s vital that we – public authorities and private market participants – work together to reverse the tide of ethical drift. This cannot be a one-off exercise. We need continuous engagement so that market infrastructure keeps pace with market innovation.
That’s why the Bank is announcing that it will hold an Open Forum this Autumn which will bring together all stakeholders in FICC markets. Our goal is to discuss the prospects for market functioning, where regulations might overlap or conflict, and whether enough has been done to build the real markets the UK deserves.
To prompt an open discussion, we are publishing a detailed paper which reviews these issues and draws out such questions.v
Everyone has an interest in the future of financial markets, so I would strongly encourage you to engage with our Open Forum process online and at the conference itself. An Open and Accountable Bank welcomes your input. This time we really did mean to hit ‘Reply All’.
Our response to recent failings should be as ambitious as those of our predecessors to the Great Fire: renewed prosperity built on private markets and public market infrastructure.
Let our legacy be the earthly equivalent of Wren’s ethereal genius, real markets so that the City can do what it does best: transact and innovate for the good of the people of the United Kingdom and the world.