Global FX Scandal

The thought for this post was triggered by the Foreign Exchange Committee sponsored by the Federal Reserve Bank of New York.

The Committee has recently observed in its 2014 March 26th meeting that order handling, hedging, disclosure policies and use of social media in the Foreign Exchange industry merit further serious deliberations and discussions. The minutes of this meeting were recently released.

Authorities around the world are investigating whether traders at some of the largest banks sought to manipulate the WM/Reuters foreign-exchange rates in their favor by pushing through trades before and during the 60-second windows when the benchmarks are set. Regulators are examining whether bank traders communicated with dealers at other firms and timed trades to influence benchmarks and maximize profits.

The WM/Reuters service is a joint venture between The WM Company and Thomson Reuters. The WM/Reuters Closing Spot Rate Service was launched in 1994 to provide a better standard for the valuation of global portfolios. This need was a direct consequence of the globalization of trade and investments which took place in the early 1990’s.

The closing currency “fix” refers to benchmark foreign exchange rates that are set in London at 4 p.m. daily. Known as the WM/Reuters benchmark rates, they are determined on the basis of actual buy and sell transactions conducted by forex traders in the inter bank market during a 60-second window (30 seconds either side of 4 p.m.). The benchmark rates for 21 major currencies are based on the median level of all trades that go through in this one-minute period.

The importance of the WM/Reuters benchmark rates lies in the fact that they are used to value trillions of dollars in investments held by pension funds and money managers globally, including more than $3.5 trillion of index funds. Collusion between forex traders to set these rates at artificial levels means that the profits they earn through their actions ultimately comes directly out of investors’ pockets

The traders are alleged to have colluded by sharing confidential information on pending client orders ahead of the 4 p.m. fix. This information sharing was allegedly done through social media instant-messaging groups that were accessible only to a few senior traders at banks who are the most active in the forex market.

Banging the close refers to aggressive buying or selling of currencies in the 60-second “fix” window, using client orders stockpiled by traders in the period leading up to 4 p.m.

These practices are analogous to front running and high closing in stock markets, which attract stiff penalties if a market participant is caught in the act. This is not the case in the largely unregulated forex market, especially the $ 5.35 trillion per day spot forex market. Buying and selling of currencies for immediate delivery is not considered an investment product, and therefore is not subject to the rules and regulations that govern most financial products.

This scandal in which the world’s largest currency trading banks colluded for a long time (at least a decade) to manipulate and rig the daily foreign exchange rates is aptly called as Global Forex Scandal.

This forex scandal coming as it does just a couple of years after the colossal LIBOR fixing scandal, has led to heightened concern that regulatory authorities have been caught unaware.

The forex benchmark rate scandal came to light in June 2013 when Bloomberg News reported suspicious activities and price surges around the 4 p.m. fix. The Bloomberg journalists analysed data over a two year period and discovered that on the last trading day of the month, a sudden surge occurred before 4 p.m. followed by quick reversal.

While this phenomenon was noticed for fourteen currency pairs, the anomaly occurred mainly for the common currency pairs like Euro/Dollar.

The month end exchange rates are significant because they form the basis for determining the month end net asset values for funds and other financial assets.

Almost all the major regulators – UK’s Financial Conduct Authority, European Union, US Department of Justice and Swiss Competition Commission – are investigating these allegations of forex trader’s collusion to manipulate exchange rates.

Already, more than 30 traders have been fired, suspended or put on leave by banks including Deutsche Bank, Citigroup, Royal Bank of Scotland Group, Barclays, HSBC, Goldman Sachs, JPMC and UBS.

At the centre of the investigation are the transcripts of electronic chat room discussions in which senior currency traders shared with their competitors at other banks the types and volumes of the trades they planned to place. The discussions in these chat rooms were interspersed with jokes about manipulating the forex market and repeated references to alcohol, drugs and women.

The size of global foreign exchange market dwarfs the size of other markets, with an estimated daily turn over of US$5.35 trillion (BIS Triennial Survey 2013). Speculative trading dominates commercial transactions in the forex market, as the frequent fluctuation of currency rates makes it an ideal venue for institutional players with deep pockets – such as large banks and hedge funds – to generate profits through speculative currency trading.

Unfortunately the rate manipulation scandal highlights the fact that despite its size and importance, the forex market remains the least regulated and most opaque of all financial markets.

This forex scandal calls into question the practice of allowing rates that influence the value of trillions of dollars of assets and investments to be set by a few greedy, unscrupulous individuals in the garb of traders as it has shaken the investors’ confidence in fair and transparent markets.

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