What happens when financial regulators are trying to look at and regulate the wrong subject? Even more financial fraud? The point is raised by an new article on the various “benchmark manipulation” cases, such as LIBOR. The thesis is outline in an August 27, 2104 Blue Sky blog post by Andrew Verstein, and the article itself is on SSRN. The article
Manipulation is all too common in financial markets. Reports of brazen schemes have rocked the markets for gold, aluminum, foreign currency, and interest rates, to name just a few from the last twelve months. These scandals are surprising in light of substantial scholarship that has long argued that market manipulation is impossible. Perhaps you can bid up the price of an asset by buying a large amount, but the price will fall as you try to sell it. Taking into account of your trading costs, you should not even break even. Regulation of manipulation is unnecessary since it cannot be profitable.
This Article challenges orthodox understandings of manipulation, showing that they reflect an obsolete view of markets. While manipulation skeptics discuss prices, markets focus on benchmarks of price – and so do the manipulators who prey upon them. Benchmarks such as Libor or the S&P 500 summarize market prices, and they have become essential to contemporary markets. They are written directly into industrial contracts, financial derivatives, statues, and regulations, and so their accuracy affects the economy every bit as much as the prices themselves. They are also are much easier to manipulate than underlying prices, because such benchmarks are typically derived from only a small slice of the market. For example benchmarks of exchange rates – the price of Euros and Yen – reflect only trade prices in a single venue, during a two-minute period of trading. If a manipulator can strategically position trades – placing aggressive purchases on that venue and aggressive sales elsewhere – she can bias the benchmark and therefore project influence over the market as a whole.
This theory – that market manipulation is increasingly synonymous with benchmark manipulation – has many important implications. It shows that the recent push by regulators and courts to require fraud in manipulation cases is fundamentally misguided since benchmark manipulation does not depend on anyone being “defrauded.” Likewise, recent proposals to extensively regulate the creation of benchmarks are shown to misunderstand the mechanics of benchmark manipulation.”