Understanding and Regulating Benchmark-Linked Markets after the Libor, WTI and Nickel Dislocations

Abstract

A financial market benchmark is a measure of performance. Prominent examples include the settlement prices of widely used futures contracts and measures which abstract away from a group of transactions or other information from a cash market and produce a reference price or rate, such as interest rate benchmarks. Benchmarks mediate a connection between a cash market – which, being concerned with real assets, is often complex – and an ‘abstract’ or benchmark-linked market. The relationship between these markets is often sustained by arbitrage: it may also be grounded in physical settlement. This setting is analysed, and it is found that market participants often rely on the stability of the connection between the two markets. However, connections like this can break down, as consideration of the Libor scandal, the negative settlement price on the benchmark U.S. crude oil futures contract, WTI, and the recent dislocation in the Nickel futures market demonstrates. The first of these episodes stimulated regulatory action on financial market benchmarks: the paper discusses why it was unable to prevent the latter two stresses, and what these episodes reveal about the utility created by successful financial market benchmarks, the status of abstract markets, and the proper aims of benchmark policy.

Keywords: Benchmark Manipulation, Benchmark Regulation, Financial Market Benchmark, Hedging, Libor Reform, Libor Scandal, Nickel Market Crisis, WTI Market Crisis