Trade associations slam UK regulator's proposals for benchmarking

The UK Financial Services Authority’s (FSA) proposals for using benchmarking for over-the-counter derivatives and structured products have been roundly criticised by the International Capital Market Association (ICMA), the International Swaps and Derivatives Association and the Bond Market Association (TBMA).

In a joint statement, the associations argue that the FSA’s proposals for benchmarking – comparing a price offered by a dealer to an accepted market valuation – are inappropriate for ensuring that retail investors obtain a fair price under best execution rules.

The associations have criticised the proposals as inconsistent with the flexible approach that the regulator has taken to the implementation of the Markets in Financial Instruments Directive (Mifid), which is designed to create a more transparent single market for financial services in Europe when it comes into force in November next year.

Benchmarking would be “expensive to implement” and threaten market liquidity, said the associations. “In the limited areas where benchmarking would in theory be feasible, prices are already visible to most dealers and professional investors," the associations said.

The industry trade bodies propose an alternative principles-based approach based on “intelligent copy-out” of the Mifid provisions on best execution, supplemented by Mifid Connect industry guidance.

“This would recognise that execution quality depends on other factors in addition to price, that the relative importance of these factors varies between clients, and that firms have some flexibility in determining their order execution policy,” the associations said.

Nick Collier, head of regulatory policy at the ICMA, told Risk News: “It seems to us that there is inconsistency between the focus on the need for price execution in the FSA’s best execution paper and the conclusion in the FSA’s feedback paper on benchmark transparency that there is no market failure.”

Steve Windsor, managing director and co-head of interest rate sales at Goldman Sachs, said the proposals on benchmarking could also leave banks at risk of revealing how pricing models work.

“It is highly unrealistic. Of course, you need full disclosure in liquid markets, but in illiquid markets it is not possible. We have mathematical models that take us many months – and sometimes years – to build. These models give us an edge over our competition and we would not want to disclose how they work."

He added: "Having a theoretical model that states what that price should be is all well and good. However, in the world of complex risk, the market often trades a long way away from theoretics. Hence, I would question the benefit of increased transparency in exotic markets.”

A spokesman for the FSA said: “We are receiving comments to the discussion paper and we will consider them when setting out our policy going forward.”

The FSA’s proposals for benchmarking appear in chapter three of the regulator’s discussion paper, DP06/3 Implementing Mifid's best execution requirements.