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Benchmark Regulation
Gina-Gail S. Fletcher*
ABSTRACT: Benchmarks are metrics that are deeply embedded in the
financial markets. They are essential to the efficient functioning of the
markets and are used in a wide variety of ways—from pricing oil to setting
interest rates for consumer lending to valuing complex financial instruments.
In recent years, benchmarks have also been at the epicenter of numerous,
multi-year market manipulation scandals. Oil traders, for example,
deliberately execute trades to drive benchmarks lower artificially, allowing the
traders to capitalize on the manipulated benchmarks. This ensures that later
trades relying on the benchmarks will be more profitable than they otherwise
would have been. Such manipulative practices have far-reaching and, in
some instances, destabilizing effects on the financial markets.
In responding to these benchmark manipulation scandals, regulators have
relied on the existing anti-manipulation framework, which is based solely on
ex post prosecution of wrongdoers. The current framework treats benchmark
manipulation as just another form of market manipulation. But, as more
benchmark manipulation schemes come to light, they cast doubt on the
effectiveness of this traditional approach to curbing a modern-day form of
manipulation.
This Article provides the first in-depth analysis of the differences between
benchmark manipulation and traditional forms of market manipulation.
This analysis demonstrates that regulators cannot adequately address
benchmark manipulation through ex post enforcement actions alone. In
failing to recognize how benchmark manipulation differs from traditional
manipulation, regulators miss a prime opportunity to oversee a key facet of
the financial markets and safeguard market integrity. By focusing on the
unique attributes of benchmarks that make them susceptible to manipulation,
*
Associate Professor of Law, Indiana University Maurer School of Law. J.D., Cornell Law
School. For their helpful comments on this project, many thanks to William Bratton, Brian
Broughman, Guy-Uriel Charles, John C. Coates, James D. Cox, Christopher Drahozal, Joan
Hemingway, Timothy Holbrook, Kristen Johnson, Patricia M. McCoy, Ajay Mehrotra, Donna
Nagy, Aviva Orenstein, Veronica Root, and Hilary Sale. I am also grateful to the participants at
the 2015 Duke University School of Law Culp Colloquium, SEALS 2015 Annual Meeting,
National Business Law Scholars 2015 Annual Meeting, and the Midwestern Law and Economics
2015 Annual Meeting. Finally, I am grateful to Lauren Fletcher, Erin Buerger, and Antoni’A
White for their invaluable research assistance. All errors and omissions are my own.
1930 IOWA LAW REVIEW [Vol. 102:1929
this Article puts forward a comprehensive prescriptive regulatory framework
aimed at detecting and minimizing benchmark manipulation, rather than
merely punishing wrongdoers after the fact.
I. INTRODUCTION ........................................................................... 1930
II. MARKET MANIPULATION AND EX POST REGULATION ................ 1936
A. EX POST REGULATION OF MARKET MANIPULATION ................ 1937
B. THE LIMITS OF “TRADITIONAL” MARKET MANIPULATION ...... 1940
C. BENCHMARKS IN THE FINANCIAL MARKETS ............................ 1943
1. Uses of Benchmarks .................................................... 1943
2. Benchmark Industry ................................................... 1945
III. BENCHMARK MANIPULATION ...................................................... 1947
A. INTEREST RATE ..................................................................... 1948
B. FOREIGN EXCHANGE .............................................................. 1953
C. CRUDE OIL ............................................................................ 1956
IV. BENCHMARK REGULATION .......................................................... 1962
A. IN FAVOR OF EX ANTE REGULATION ....................................... 1963
B. THE BENEFITS OF SELF-REGULATION ...................................... 1967
C. THE PROPOSED FRAMEWORK ................................................. 1969
1. Regulated Entities ....................................................... 1970
i. Benchmark Administrators ....................................... 1971
ii. Data Contributors .................................................... 1972
2. Detecting Benchmark Manipulation ......................... 1973
3. Conflicts of Interest ..................................................... 1973
4. Enforcement Mechanisms .......................................... 1975
5. Government Oversight ............................................... 1978
V. OBJECTIONS AND RESPONSES ...................................................... 1979
VI. CONCLUSION .............................................................................. 1981
I. INTRODUCTION
Benchmarks have quietly become a ubiquitous feature of the financial
markets.1 A benchmark aggregates market information into a single metric
that is used as the basis for pricing or valuing financial contracts or
obligations. More specifically, a benchmark is a price, rate, or index that
1. DAVID HOU & DAVID SKEIE, LIBOR: ORIGINS, ECONOMICS, CRISIS, SCANDAL, AND REFORM
2–3 (2014), https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr667.
pdf (discussing the use of LIBOR as a common benchmark for the health of financial markets).
2017] BENCHMARK REGULATION 1931
measures one or more underlying assets, prices, or other data based on a
formula, value assessment, or market survey.2 Benchmarks are embedded into
a wide variety of financial contracts—from consumer loans to long-term
commodity contracts to complex financial derivatives.3 For example,
derivatives based on the leading interest rate benchmark—the London
Interbank Offered Rate (“LIBOR”)—have an estimated outstanding notional
value of $220 trillion.4 Yet many outside the financial markets were unaware
of benchmarks until the revelation of the LIBOR scandal in 2012.
When a company or consumer is interested in obtaining a loan, LIBOR
is one of the primary benchmarks banks and other lenders utilize to set
interest rates.5 Although it began as a way to estimate borrowing costs among
banks, non-banks and other market actors have adopted LIBOR extensively
throughout the financial markets.6 LIBOR is widely referenced in pricing
derivatives and numerous complex financial instruments, and it impacts
interest rates applicable to everyday consumer loans—such as student loans,
auto loans, and mortgages.7 Given that LIBOR undergirds trillions of dollars
of financial obligations, the presumption is that a central bank or other type
of governmental agency oversees this benchmark, but this is not the case for
LIBOR nor most other benchmarks.8
LIBOR is calculated from the submissions of leading banks estimating
the rate at which they could borrow funds from other banks.9 But, dating back
to (at least) 2007, banks such as JPMorgan, Barclays, and UBS—known as
panel banks—began to exploit their role as input providers to profit from
derivatives that referenced the benchmark.10 To manipulate the benchmark,
2. ONNIG H. DOMBALAGIAN, CHASING THE TAPE: INFORMATION LAW AND POLICY IN CAPITAL
MARKETS 89 (2015); INT’L ORG. OF SEC. COMM’NS, FINANCIAL BENCHMARKS: CONSULTATION REPORT
48 (2013), https://www.iosco.org/library/pubdocs/pdf/IOSCOPD399.pdf. While the term
“benchmark” covers a broad range of m etrics, it is important to specify the scope of this A rticle. First,
the benchmarks analyzed herein exclude those created for public policy purposes such as consumer-
price indices or inflation indices. Second, benchmarks that reflect the value of an investment
portfolio, such as the Standard & Poor’s (“S&P”) 500, are also outside this Article’s scope.
3. See FIN. STABILITY BD., REFORMING MAJOR INTEREST RATE BENCHMARKS 6 (2014),
http://www.financialstabilityboard.org/wp-content/uploads/r_140722.pdf; HOU & SKEIE, supra note
1, at 2–3.
4. FIN. STABILITY BD., supra note 3, at 6.
5. Behind the Libor Scandal, N.Y. TIMES: DEALBOOK (July 10, 2012), http://www.nytimes.com/
interactive/2012/07/10/business/dealbook/behind-the-libor-scandal.html.
6. See Michael J. De La Merced, Q. and A.: Understanding Libor, N.Y. TIMES: DEALBOOK (July 10,
2012, 10:38 PM), https://dealbook.nytimes.com/2012/07/10/q-and-a-understanding-libor.
7. Id.
8. See infra Part II.C.
9. De La Merced, supra note 6.
10. See Understanding the Rate-Fixing Inquiry: The Banks: Global Financial Firms Reach Settlements, N.Y.
TIMES: DEALBOOK (July 28, 2014), http://www.nytimes.com/interactive/2012/07/16/business/
dealbook/20120716-libor-interactive.html?_r=0#/#banks.