By John Kemp
LONDON, April 13 Observers have drawn parallels
between recent criticism of price-reporting agencies (PRAs) in
the oil market and the current investigation into the
manipulation of Libor rates by contributing banks. But the
comparison is wrong and betrays confusion about the role of the
PRAs and why it might or might not need to be reformed.
In a thoughtful article in the Financial Times on Friday,
Gillian Tett urged price reporters and regulators to heed the
lessons from the Libor scandal. "By acting now ... the
International Organisation of Securities Commissions (IOSCO)
seems to hope that it can stave off any truly big scandal," she
Tett develops a criticism made by Commissioner Scott O'Malia
of the U.S. Commodity Trading Commission (CFTC) who drew a
direct parallel between PRAs in the oil market and the role of
the British Bankers Association in maintaining Libor rates.
"There are other PRAs out there that create critical
financial benchmarks, including the most notable, the London
Interbank Offered Rate. It is estimated that $350 trillion in
financial products utilise Libor as their benchmark rate,"
according to O'Malia.
"In striking similarity to the issues raised with the energy
PRAs ... we've got seasoned market players - banks no less -
feeding information to the Libor's publisher, the British
Bankers' Association. The British Bankers' Association is not a
regulator, and the contributor banks are not under its
jurisdiction ... Clearly this is a benchmark to fix".
O'Malia expressed particular concern about the potential for
PRA benchmarks to be used to manipulate the valuation of other
on-exchange futures and off-exchange swaps contracts the CFTC
"Since PRA benchmarks are widely referenced in
over-the-counter transactions, as well as ISDA master
agreements, how do we ensure that the price discovery and
influence of the PRAs do not negatively impact our
jurisdictional markets. Contract settlement and pricing details
in a futures market contract, which references a physical or OTC
benchmark, must not be subject to manipulation or gaming."
In response, the leading agency, Platts, has said "We see no
connection whatsoever between Platts' price assessments and
recent issues concerning Libor." Of course they would say that.
But in this case Platts is right, and its critics are wrong.#
MANIPULATION AND MONOPOLY
Critics have levelled many complaints about PRAs in general,
Platts in particular. But they basically boil down to two
(1) Benchmarks can be manipulated by selective contributions
or lying among market participants, as well as the lack of
robustness, appropriate controls and governance at the PRAs.
(2) As dominant providers of benchmarks used throughout the
industry, PRAs and Platts in particular have too much power to
impose changes in the way they calculate benchmarks unilaterally
- giving them excessive power over all the other futures, swaps
and physical contracts which reference their assessments.
Regulators are more worried about the issue of manipulation.
Most criticism from within the oil markets concerns the issue of
monopoly. But it is worth examining both complaints to see if
they are valid and whether the proposed reforms represent an
Some reform of the PRA process (probably with more
accountability to regulators) appears inevitable given the
clamour for change. But if the current PRA process is not be
perfect, many of the proposed remedies will be worse.
PLATTS' WINDOW IS NOT LIBOR
The basic criticism of Libor is that it is based on
submitted quotes by a panel of banks about rates at which they
claimed they could borrow, rather than actual transactions, and
that some contributors were colluding and making the numbers up,
with no one querying or testing them. The market was wholly
theoretical - and became fictitious, when it suited some banks
to misreport their likely borrowing costs.
In contrast, the main benchmarks assessed by Platts and the
other PRAs are based on actual trades, where possible,
supplemented by reported quotes and a bit of editorial judgement
where markets are thinly traded.
To the extent they rely on actual trades, rather than
quotes, the PRAs are superior to Libor. Problems arise in
thinner markets, where the PRAs rely more heavily on quotes and
judgement, but it is not clear how this could be remedied.
Some refined product markets for which the PRAs assess
prices do not really exist in any meaningful, continuous sense,
since the commodity in question rarely trades in the assessed
grade, location and form. It is not the prices but the market
itself which is notional.
These tend to be minor, specialist refined product markets,
however. If both buyers and sellers choose to incorporate
notional prices for a notional market assessed by a PRA into
their physical contracts it is not obvious that regulators
should be concerned.
In particular, there is no evidence PRAs are systemically
biased in favour of buyers or sellers. Unlike credit rating
agencies, which derived all their income from the sell-side, and
ended up being captured by it, PRAs have customers on both buy
and sell sides of the market.
If benchmarks are manipulated by false or selective
provision of information by market participants, the appropriate
remedy is to mandate reporting and punish participants who
provide incomplete or inaccurate data. But that is what the CFTC
and other regulators like the U.S. Federal Energy Regulatory
Commission (FERC) are already doing.
Some reformers have suggested assessments should be overseen
by a panel of experts drawn from within the industry. But panels
would almost certainly be dominated by those with a vested
interest in the outcome.
Panelists might be asked to recuse themselves where their
interests are directly concerned and give an undertaking to
deliver impartial decisions as "arbitrators." But credibility
problems would be enormous.
The International Swaps and Derivatives Association (ISDA)
already has a similar approach for deciding on credit events in
credit default swaps which has attracted severe criticism.
The current process has been criticised for lack of
accountability. "There is limited external scrutiny, let alone
regulatory oversight ... because reporting activities have been
defined as a journalistic activity and are shielded by free
speech rules," according to Tett. But who would you trust more
to provide an accurate and impartial price assessment - a
journalist or a group of oil producers, refiners and energy
MONOPOLY OVER BENCHMARKS
The second criticism is that PRAs have too much power to
alter benchmarks unilaterally, and should be forced to consult
more with the industry, and possibly a committee of industry
experts, before making changes.
Criticism of the PRAs has intensified following Platt's
decision last year to alter its calculation of physical Brent
prices, a move which forced the futures exchanges to alter their
own contracts, and which was fiercely opposed by many players in
Platts acted in response to widespread (and justified)
criticism that the benchmark was becoming illiquid and
increasingly prone to manipulation because of falling oil output
in the North Sea and the declining number of cargoes on which
the assessment was based.
In fact, Platts was arguably too slow to change its
benchmark, and should have moved more quickly, as recurrent
squeezes in the Brent market demonstrated its increasing
vulnerability. The industry itself denied there was any problem
and wanted no change at all.
The danger of having benchmarks overseen by groups of
experts is that it will institutionalise vested interests.
Expert groups will be populated by those who have the most
direct interest in the outcome. No one can be confident a group
of experts will act in the wider public interest rather than the
narrow interest of the small circle of firms that employ them.
If Platts and other PRAs are indeed abusing a dominant
position, the appropriate response is to subject them to an
antitrust investigation. In contrast, institutionalising
benchmarks by handing control to self-selected industry groups,
will lessen competition even further.
Thomson Reuters competes with Platts, owned by McGraw Hill,
in providing information to commodity markets.