Market misconduct, fraud, and malpractice are as old as markets themselves.
Over the centuries, financial markets have grown, adapted and become infinitely more complex and sophisticated, but the main ways of committing misconduct have remained largely the same.
In the past 200 years, governments around the world have passed numerous laws to try to stamp out market malpractice.
But incidents of market malpractice and manipulation have if anything grown in scale and frequency.
What became all too clear in the aftermath of the financial crisis is that conduct risk is now systemic risk. In the past five years, banks globally have paid more than $375bn in conduct fines – capital that could have been used better to support $5 trillion in bank lending.
The Libor and foreign exchange trading scandals severely dented confidence in financial markets, and it became clear that regulators and market practitioners needed to adopt a new approach to break out of this cycle.
Thus the FICC Markets Standards Board (FMSB) – the body that I chair – was born.
The FMSB was created by a powerful group of leading wholesale banks, asset managers, and market participants following a core recommendation in the Fair and Effective Markets Review in 2015.
Our task is, put simply, to improve standards of conduct and behaviour in today’s financial markets. Regulators tend to set out broad principles, alongside vast bewildering rulebooks. They hardly ever help a market trader or broker answer the simple question: “can I do this deal?”. It is our job to tell them when they can – and when they should not.
Last week, we published our first full annual report. I am pleased to say it has been a busy and successful year. We have published a series of new standards covering a broad range of trading practices.
Our membership base has grown from 30 organisations to 50, and between them they now undertake over 80 per cent of all wholesale market activity and control more than $10 trillion in assets under management.
With this membership, the FMSB has real global clout and the authority to ensure that its trading standards become the reference point in our markets.
A prerequisite of managing conduct risk is understanding the various abuses that occur. As part of the annual report, we have gone back through history to see how markets are gamed and manipulated.
We reviewed over 400 cases from 19 countries over the past 200-years – the first time anyone has done this analysis.
What we found is that the same 26 types of market abuse happen time and time again. They may be called different things and occur in different markets, but they are essentially the same device.
As to the patterns, some are more common, others more intermittent. One of the most common and is wash trading, the simple practice of buying and selling the same security at the same time to create an illusion of market price and activity.
The history of wash trades in the twentieth century starts with the boom in railroad stocks in the US in 1908, but they have also been used to manipulate government bonds, floating rate notes, oil, and even sunflower seed futures. We also found them used more recently in connection with Libor.
The fact that misconduct tends to repeat itself makes the FMSB’s work easier, since we can write codes to prevent the abuses.
The FMSB’s work has started – and we plan to agree 10 standards this year alone, but there is a lot to do. We have already identified the need for over 70 statements in all, and more will emerge as we work through them. But at the end we will have created a lexicon of the type of behaviour that is and isn’t allowed on trading floors across the globe.
It is a cause for optimism that this is a City-led initiative, whose influence is spreading worldwide. Our members are global and are keen that our standards become world standards. Central banks around the world are now taking a keen and supportive interest in our work, since they understand the benefits it will bring to everyone. I think it is fair to say that no other financial centre on earth could have brought together so many powerful institutions to agree common global standards in the way we are.
We have a long way to go and are only at the beginning of what we want to achieve. However, this is a real step towards stopping the repeat patterns of behaviour which have existed for more than four centuries and are costing the global economy ever more in fines and trust from society.