Rajit Punshi provides perspective on "Libor Rigging" Regulatory Intelligence

Libor rigging shows banks' failure to understand employees’ behaviour outside formal structures

Aug 10 2015 | Patricia Lee, Regulatory Intelligence

The sentencing of rates trader Tom Hayes shows banks need to understand how their employees behave and carry out business outside the formal structures that have been put in place, officials said. Hayes' case also demonstrates that the three lines of defence at those banks embroiled in the Libor-rigging scandals had failed in this instance, they said.

RajitPunshi, founder of The Operational Risk Practice in Singapore, said Hayes' case was revealing and showed there had been little appreciation in the banking industry of the need to understand how people behave and operate outside the policies and procedures and internal controls that have been put in place.

"Banks need to do more work to understand how people behave outside this formal setting and to really understand the impact that will be created when people in the business operate outside the formal structure and also in how they conduct themselves. This is something that must be clearly factored into the way the three lines of defence operates going forward, particularly the first line," he said.

The link between conduct and reputation

Punshi also pointed out the need for the second line of defence - the risk and compliance functions - to collaborate more effectively to ensure the right degree of oversight and control over the critical business activities. This would require banks to understand the linkages between conduct and reputation as part of the broader effort in ensuring that risk and compliance functions were effectively carried out across the firm, he said.

"Banks are still struggling with the whole issue of conduct and reputation risk. Banks need to review how the tone from the top is embedded and reflected in the way risk is being undertaken at banks and in the way business is being conducted," he said.

Punshi said banks need to review their approach to assurance. The Libor-rigging incidents highlighted the weaknesses and narrow focus of assurance in a number of institutions.

Hayes' case has also raised the question of why the senior managers at the banks where he used to work - UBS and Citibank - were not held responsible. An industry official in Hong Kong said it would be difficult to prove a case against the senior management unless Hayes was able to prove that they had instructed him to manipulate the rates.

"In most cases there would be a clear discussion that management may have known indirectly about it, or at least not ask the difficult questions. However, to prove such negative action is nigh on impossible," the official said.

Blame it on a rogue trader

A source who was close to some of the traders involved in influencing the financial benchmarks in Singapore, said it is unlikely the senior managers of those banks involved in manipulating Libor had no inkling of their traders' misconduct. He said senior managers' emphasis on generating revenue for the banks might have explained why traders' misconduct was not seriously looked into.

"Some banks managed to convince the regulators that it was a rogue trader situation. Employers do a very good job of shrugging the management off responsibility. It's always easy to put it on a rogue trader," the source said.

Punshi said the benchmark rigging incidents also showed that the senior managers at those banks involved had failed to understand the importance of process of setting financial benchmarks. Libor and other similar benchmarks are relied upon by the financial industry for pricing contracts, mortgage and consumer loans. Those senior managers also failed to provide adequate assurance that controls were in place and being complied with and the conduct of the traders involved in manipulating the Libor was consistent with expectations, he said.

"While recent thematic reviews by regulators showed that progress has been made, more needs to be done. One of the biggest challenges faced by banks today is translating the various tones from the top and integrating those requirements into the way risk is taken and business is conducted. There is a need to review not just the regulatory compliance requirements but also the softer side — the behaviour of people across the whole organisation — and that is an ongoing challenge for banks," he said.

Compliance is no panacea

Punshi said the excessive focus on compliance did not give the assurance that the underlying risk was managed within the risk appetite. "We have to move away from this notion that compliance is a panacea for everything. The reality is that regulations exist because they are risks that are being run and stakeholders interests need to be secured," he said.

Daniel Chia, director at Morgan Lewis Stamford LLC in Singapore, said the benchmark manipulation incidents in Singapore and London not only demonstrated the dearth of compliance professionals but also the fact that compliance officers lacked understanding of the business.

"An ongoing question is whether in all these Libor-rigging scandals, the compliance people understood what the traders were doing. You really need compliance persons to understand the business, otherwise they can't provide the oversight. If compliance people understand the business, they can offer proper guidance [to the traders]. Otherwise traders or those people in the business will lose faith in the entire process of reporting to the compliance people," Chia said.

Patricia Lee is South-East Asia editor at Thomson Reuters Regulatory Intelligence in Singapore. She also has responsibility for covering wider G20 regulatory policy initiatives as they affect Asia.

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