My colleague Paul King, who leads the new regulatory practice within Global Business Consulting, has been discussing a new approach for banks to manage a critical part of regulatory compliance. In the last two years, several banks have received some of the largest fines ever issued by regulators as a result of manipulating Systemically Important Interest Benchmarks (SIIB) — e.g., LIBOR and EURIBOR. Many commentators say the LIBOR scandal is the biggest “conduct risk” issue to have ever arisen within the banking sector, damaging consumer confidence at an already difficult time.
The “fix” for SIIB manipulation must be made quickly and decisively. Banks stand to benefit not just from an improved image and a better relationship with regulators — the very system used to prevent manipulation can also reduce costs.
Investigations have shown that the controls surrounding banks’ SIIB submissions were often inadequate. There is an urgent need for SIIB contributing banks to prove that they have robust controls in place now to prevent them from manipulating or distorting these benchmarks. More broadly, banks need to be able to demonstrate to regulators how they ensure that the contributions they are making to SIIBs are valid and appropriate.
A fundamental element of the control process is the ability to swiftly identify “outlier” or unusual submissions, supported by an appropriate governance structure and escalation and resolution mechanism. Using analytics to compare a bank’s own submission to historical submissions, market benchmarks and the submissions made by peers is an important part of a risk-based assessment of unsecured funding costs. These analytics can flag outlier submissions, thus allowing control teams to focus their investigations on submissions deemed the highest risk. At the same time, this management information can be used by senior management — for example, within the Treasury Front Office (e.g. Head of Funding) — to systematically challenge the economics and underlying assumptions driving individual trader SIIB submissions.
Whilst exception analytics play a key role in establishing a robust SIIB control infrastructure, it is vital that these techniques are embedded seamlessly in the governance structure surrounding banks’ submissions towards SIIBs, as this is ultimately what regulators will be assessing. Roles and responsibilities in the governance arrangements need to be clearly documented, understood and acted upon. For example, the Front Office may employ a “four-eye” principle check of all high-risk submissions, and the bank needs to have the policies, procedures and systems to verify and record that these checks have been executed.
Adopting this kind of system will help restore the trust of consumers and regulators, and ensure an efficiently run banking system that benefits all players. But it will also have the ancillary benefit of giving banks extremely useful and detailed management information around their relative unsecured funding costs (by tenor, by currency, by broker and versus peers), thus leading to the possibility of reduced unsecured funding costs. It’s a fix that makes sense.