WILL TOUGHER CRIMINAL sentences on proscribed market behaviour and greater preparedness by regulators to use the dark overhang of prison time as a supervisory compliance tool lead to better market outcomes?
This issue was front-of-mind this past week for two reasons. Morgan Stanley’s last-minute decision to walk away from the up-to-US$400m Hong Kong listing of Shandong Weigao Orthopaedic Device a day after the company passed a stock exchange hearing caught my eye. As did the final recommendations of the UK’s Fair and Effective Markets Review, set up to reinforce confidence in FICC markets. Two very disparate events for sure but with one binding theme.
It appears Morgan Stanley was not comfortable with a pre-IPO investment into the spin-off made by a senior manager at the parent company. My IFR colleagues said this highlighted the sensitivities facing IPO arrangers in a city where sponsors are held criminally liable for misleading investors.
The result was that the company had to postpone its IPO and it will now be somewhat tainted when it returns to market. That’s not a good outcome and one that ultimately damages the economic well-being that corporate event activity tends to promise and which politicians and regulators say is at the heart of their endeavours.
Broadly incorporating criminality and expanding its sinister tentacles into the fabric of the capital markets is not the way forward, in my view. Markets will not benefit from a negative culture of deterrence and the threats that underlie it. For financial markets to function properly, professionals need to take risk. That risk needs to be captured in a regulated control environment but at the end of the day banking and trading are about risk transfer and risk is a vital foundation of economic growth.
If efficient risk transfer starts to be undermined by behaviours unleashed by the threat of criminal sanctions, I’m not sure that’s how it’s supposed to work. I shudder to think what the end-game will be.
The burden of proof as to whether deception is intentional or unintentional in a criminal court can be dangerously nuanced. The threat of such serious sanctions will do little for the fabric of the financial community or the key role that financial intermediaries play in the efficient allocation of capital.
For financial markets to function properly, professionals need to take risk
WHILE I WAS pondering this, it struck me that the FEMR (an umbrella of the UK Treasury, Bank of England and Financial Conduct Authority under orders from the UK finance minister) was similarly hot for broader criminal sanctions and a knot of regulation that leads to a culture of assumed guilt in the financial sector.
It wants the UK framework for market abuse for individuals and firms to be extended to a wider range of FICC instruments (ie, all of those covered under the Market Abuse Regulation). They want the maximum sentence for criminal market abuse to be lengthened to 10 years in prison from seven; as well as a new statutory civil and criminal market abuse regime for spot FX.
They also want senior bank managers’ bonuses to be deferred for up to seven years from the current three to five; they’re asking for variable remuneration clawback and a deepening of the Senior Managers and Certification Regimes that will hold specific individuals directly accountable for failures in their areas of responsibility. (Who’d want to work under such a burden?)
Now don’t get me wrong. I’m all for dealing with knowingly criminal behaviour with the full force of the law but there need to be limits. The Libor and FX manipulation scandals were disgraceful examples of illegal market collusion and it’s right and proper that authorities are going after the criminals implicated in it. I fear we’re going too far with all of this and fear for the huge latitude for seriously unintended consequences.
The FEMR came out with some pretty obvious recommendations (although some of its comments were decidedly wonky). Pointing in a wonderfully understated way to the “ethical drift” FICC markets succumbed to, the report calls for clear, transparent, proportionate and consistently applied standards of market practice; open and meritocratic competition facilitating open price discovery; a body of participants behaving with integrity; and robust market architecture.
DESPITE TIGHTER REGULATORY scrutiny coming out of MAR, EMIR, MiFID 2 and Dodd-Frank, the report fears gaps still remain in regulatory coverage. The report similarly pointed to better internal governance at banks but cautioned that the professionalism and accountability of individuals in FICC markets was still too low and variable.
To promote effective mechanisms for common FICC market practice standards, they’ve proposed the creation of an industry-led FICC Market Standards Board that will have a number of functions. The world does NOT need yet another trade organisation. We’re already awash with them. I hope this is a non-starter.
FEMR is hot on cross-border collaboration but calling for international action to raise standards in global markets is getting old. And it’s such a pipedream that I wonder why they bothered. They also want a single global FX code. Good luck.
As for wonky, the UK authorities want greater standardisation of corporate bonds to increase secondary market liquidity even though it admitted that corporate issuers are “strongly opposed to centrally mandated standardisation of bond terms”, noting that borrowers want to “retain the right to choose how and when to issue debt in order to match their cashflows and the needs of investors”.
Corporate bonds are not and will never be equities, no matter how much regulators wish they were. Pointing, as they did, to CDS standardisation as a relevant comparator so egregiously misses the point of how the bond market works that it’s hard to know how to respond. And at the risk of repeating it for the thousandth time, illiquidity in corporate bonds is not a function of non-standardisation; it’s down to the dumb-ass capital and liquidity rules the same regulators introduced to save us from ourselves.
