Behavioural Consequences – The UK Bond Market Rigging Scandal

Health Warning: The UK Bond Market rigging issue is all behaviourally driven. We express a personal opinion in this post and do not endorse or condone breaking any jurisdiction’s sovereign laws.

We would like to contribute a very short thought piece on this issue. Our premise basically goes like this and is grounded in behavioural theory:

2012 Behaviour Matrix copy
2012 Behaviour Matrix copy (Photo credit: Robin Hutton)

Take away any sensible incentive (by over regulating the market participants) and you create the disincentive for cheating behaviour to manifest. Simple.

It is a natural competitive behaviour to ‘cheat’ or try to cheat a system that becomes ‘badly’ designed, as in the case of the highly over regulated bond market and an environment of very low yields.

We find is amazing that the popular press only tend to focus on one side of the equation and distort the real issue and underlying drivers that lead tot cheating behaviour.

Illustration for Cheating Français : Illustrat...
Illustration for Cheating Français : Illustration d’une antisèche Español: Ilustración de una chuleta Deutsch: Illustration zum Schummeln (Photo credit: Wikipedia)

The rule of law should be the overriding guiding principle and helping to design markets and market participant behaviours based on properly incentivised interactions is part of any regulatory system. In the recent past, we have forgotten to bear this in mind…

…and then we act surprised when market actors (participants) misbehave?

theMarketSoul ©2013

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Commentary on newly proposed UK Financial Regulation

 

The news headline: Osborne gives Bank of England top regulatory role

 

Our response:

Firstly, we are relieved to see no sweeping statements such as abolishing ‘boom and bust’, which by inference must mean that the ‘normal’ business cycles will from now on resume business as usual, albeit with slightly more volatile amplitudes?

The statement regarding more tools is interesting, because as far as we are aware there are two, maybe three specific tools available in the toolbox at the moment. Fiscal policy and monetary policy and the third one possibly being risk management. Therefore, as with the debate currently evolving between Efficient Market Hypothesis and the behaviourally focussed irrationality school of (economic) thought, that there is no unifying theory yet offered to explain market events, we are still searching for the ‘unifying toolbox’ or rather the Swiss army knife of financial stability and regulation?

“Huntsman” - Victorinox Swiss army knife with ...
Image via Wikipedia

So we can read into the statement that we will add more tools, rather than take tools out of the box never to be returned, such as the retention of Sterling and thus monetary policy.

Therefore, the one important tool at the moment that requires sharpening is the regulatory framework and structures that support both regulation, monitoring, enforcement and dare we say it ‘rehabilitation’, because just like of criminal justice system, even though we have both the laws and enforcement framework, we will always have the offenders and ultimately it is the ‘how to rehabilitate and re-integrate’ them issue that we have to deal with. If moral hazard has now been replaced by having to swallow ‘TARP’-entine (poetic licence evoked) and senior investment grade civil servants (RBS and the half of Lloyds they own), then the compensation schemes being touted and created via banking levies, is the wrong approach and signal to send to the market participants.

The G20 seems to be driving the urgency of the regulatory reform agenda, timeframe and tripartite of Financial Regulatory Standards, capital adequacy and strengthening Corporate Governance regimes as outlined by the Bank for International Settlements. However, some framework agreements have been in place for some time, such as the Norwalk Agreement between the IASB & FASB. Thus, it is not a case of the lack of effort and focus, but rather a lack of urgency and clear objectives in creating a global regulatory and governance framework.

As the BP debacle has illustrated, it does take some time to formulate a coherent response and action plan and if the Global Regulatory Framework is not given sufficient debate, design and implementation time (due to political expediencies), all we will do is sow the seeds of the next crisis, which, as stated before is definitely on the billing in a country near you very soon.

 

theMarketSoul ©2010