For participants to acknowledge that such actions are questionable would in fact require the activation of slower, more effortful “System 2” thinking. The initial transgression may be small, but the culmination of many small transgressions can result in a set of behaviours which would normally be unacceptable becoming the norm, and an undesirable culture becoming ingrained. This is a version of the old proverb that one bad apple spoils the whole barrel. But the initial argument that it is just the case of “a few bad apples” is no longer credible. Instead it seems that there were deep rooted problems in the nature of FICC markets that resulted in practices that would be unacceptable elsewhere. As the Archbishop of Canterbury put it at a recent panel on ethics and finance at the IMF: “bad business models can corrupt good people.” Perhaps there is something also wrong with the barrel? The characteristics of the Fixed Income Currency and Commodity markets So what are the distinctive characteristics of FICC markets, and how might they have contributed to these problems? First and foremost, the FICC markets are notable for their heterogeneity. That reflects a key role of many FICC markets in providing bespoke instruments, tailored to meet the needs of investors and issuers. For example, while there are just under 2,500 publicly listed equities in the UK, there are over 11,000 different UK corporate bonds. In the US the disparity is even starker, with more than 36,000 bonds compared with just over 5,000 listed stocks.
To facilitate such heterogeneity, many FICC markets have historically been built around a “market-making” trading model, in which participants trade bilaterally with an intermediary, rather than directly with other investors. For example, in corporate bond markets a market maker will build up an inventory of different corporate bonds when there are net sales from end investors, and run it down when there are net purchases. An important advantage of the market-making system is that, when it works effectively, it provides investors with continuous two way markets. Government and corporate borrowers can generally be confident that they will be able to borrow at a time, in a currency, and for a duration that suits them. Similarly, investors can feel confident that they will be able to trade smoothly in and out of sometimes large positions without unduly affecting the market price. 1  http://www.fca.org.uk/your-fca/documents/final-notices/2014/lloyds-bank-plc-bank-of-scotland-plc.pdf  2  http://www.fsa.gov.uk/static/pubs/final/barclays-jun12.pdf  3  I am particularly grateful to Nicholas C. Barberis for this exposition. 4  Daniel Kahneman (2011), Thinking Fast and Slow, Macmillan. BIS central bankers’ speeches  3  The downside of the heterogeneity of many FICC assets is that the market in specific instruments can sometimes be thin, and hence it may be difficult to gauge what a fair price is. Publicly available quotes can be based on a limited number of small transactions, making them more vulnerable to manipulation. Another characteristic of FICC markets is that they tend to be dominated by large professional counterparties.