Regulators Opening New Major Front With Banks on Foreign Exchange Trading Probe

The Financial Times story revealing that regulators in Switzerland, Hong Kong, the UK and US have starting probing foreign exchange markets, based on evidence that currency traders were rigging markets, is thin on details because the inquiries are still underway. Nevertheless, these investigations have the potential to unearth a Libor-level scandal. The allegations started with Barclays but appear to engulf many of the major players in the foreign exchange market.

Some details:

Barclays has suspended six traders as part of its internal inquiry into alleged rigging of the foreign exchange market, including its chief currency trader in London, in the latest rate-manipulation scandal to hit the bank…

Authorities around the world – including those in Switzerland, the UK and the US Department of Justice – have opened preliminary investigations into whether some of the biggest banks in the world rigged the $5.3tn currency market.

Citigroup and JPMorgan on Friday became the latest banks to confirm they were working with regulators on investigations into foreign exchange trading. UBS, and Deutsche Bank have previously disclosed that regulators have asked them for information and Royal Bank of Scotland, which previously handed over instant-message chats to regulators, has suspended two traders in connection with the inquiry.

The probe originated with Swiss regulators and as this video indicates, the allegations appear to involve rate rigging in relationship to derivatives prices as well as separate allegations that traders were front-running customer orders.

This is the nub of the matter, in a separate FT story:

Crucial benchmark rates in the mostly unregulated market are set based on transactions made during short windows of 60 seconds for the largest currencies. Regulators are investigating if traders colluded to move these benchmarks, although none have been formally accused of wrongdoing.

I’m hoping readers can clarify the relationship of spot FX pricing to derivatives pricing (as in how prices are specified in the contract in relationship to spot pricing or benchmarks, I infer that prices of some widely-used instruments are set in relationship to indexes). I did a Treasury study in the days of abacuses, in London for Citibank in 1984, which included spending a lot of time sitting with the interbank currency dealers and salesmen. The “rates are set every 60 seconds” or half hour isn’t a spot market concept.

Note that foreign exchange is an unregulated market. Nevertheless, price collusion, which appears to be the behavior alleged with the derivatives price fixing, is a straight-up antitrust violation, and in the US, is subject to criminal charges. And because these markets are massive, if the banks are found to have manipulated particular indexes, the amount of transactions affected have the potential to be very large, which in turn has the potential to produce lots of big-ticket customer lawsuits.

As Lambert likes to say, pass the popcorn.

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  1. Schofield

    Perhaps one day it might dawn on a majority of human beings that it’s not recognising our ambivalent human nature and planning accordingly that creates playgrounds for sociopaths.

  2. Aaron

    Pass the popcorn indeed. I think it’s safe to say that we should just assume every market the banking cartel touches is being manipulated and gamed for profit. The only question is what, if anything will be done about it?

    1. Yves Smith Post author

      The reason I ask about mechanisms is the FX market is so liquid it should be well nigh impossible to fix (at least in the very big currency crosses, like dollar/euro, dollar/yen, dollar/pound). So while I generally don’t underestimate the ability of bankers to cheat, I’m curious as to how the prices for the indexes are set so they can pull it off.

      The other interesting bit is that this investigation originates with Switzerland. Even though Switzerland is very pro-banking in some ways (crimes against banks, like saying bad things about them, will get you in jail; one of my buddies who is a well-known tax expert won’t travel there for that reason), they’ve been way way tougher than anyone in terms of bringing their banks to heel (they forced UBS to do a huge independent investigation of why it needed an investigation and required it to publish the results; it also imposed a 20% capital requirement its big banks, UBS and Credit Suisse, which is an unheard-of level anywhere else). So I wonder if the Swiss are prepared to embarrass the other regulators into doing real investigations or not. Given how big the FX markets are, the liability could be huge.

      1. vlade

        I suspect some of the swiss angle might be coming from their EUR put. A currency manipulation could be a direct threat to that (and there were, a year ago IIRC, reports of trades below the put), thus SNB would stamp on it very hard.
        Not that I know how currency manipulation per se would work, but while cash is very liquid, futures are less so (especially in more obscure pairs than say EUR/USD). You could probably get away with selling a bunch of futures (and thus force the other side to provide the cash on the FX as they hedge) at the right moment. Say near EUR/USD futures have a depth of about 28/20 at bid/ask right now, so that’s a piddly 20/30m cash on each side. All you need then is that you know some algos try to arb futures/FX and know how MMs will hedge and I’m sure you can move the market by a a tenth of percent easily.

        More blantant is when you have pairs that are liquid only at certain times of the day (or much more so) – I saw a (IIRC) CZK/USD drop of about 10% once overnight, on one trade, which was, at the time, rumored to be caused by a certain IB to knock-out their derivative contract on which they were deeply out of money.

  3. down2long

    This past week it was also reported Citi and Chase had both “suspeneded” thre top traders each in London.. In Citi’s case their top guy has been sitting at home for two weeks.

    This seems to me based on the fact the banks are reacting with any such vigor [to my knowledge it took years if ever, for any fraudclosure miscreants to be sent home. Ditto Libor.

    The “victims” in these cases are big multinational concerns with deep pockets. As the jobless in America know, it is at your deep peril to screw with their money making no matter how small – and by my reading this rigging is huge and cost the multis big billions ever time.

    They will also move their money pronto, so the banks have to look responsive

  4. James Cole

    Generally if the trading is for hedging purposes, for example, you’re a dollar-based investor just trying to eliminate exposure to EUR while actively trading European equities, and you’re not trying to generate profit from the fx activity itself, you might agree with a bank to use one of the fixings for the USD/EUR currency pair, say, the “London 4pm” fixing, and that would be the price for your hedge. However if you’re an FX trader and FX is how you make your profit, you would be trading swaps and forwards in the swap market with multiple individual fx desks at banks as your trading counterparties, and you would not use a fixing for that because it would be like trying to day trade stocks but only using the market-close prices–i.e., it wouldn’t make sense. There is no other public market or exchange for FX, but there are dark pools and intermediated “FX prime brokerage” services out there that provide market-like fearures such as actionable quotes from multiple dealers, and matching services.
    This will all change if/when the CFTC includes FX in its swap clearing mandate at which point a lot of the fx swap activity will be moved to the clearinghouses and swap execution facilities but no one knows when that will actually happen, not likely before Q1 2014, and there is a fair amount of confusion in the market about how much of FX activity was exempted from clearing by the Treasury.

  5. Generalfeldmarschall von Hindenburg

    If the amply demonstrated mathematical genius that goes into gaming these largely pointless casino style markets were used in the service of something actually useful or practical, we’d have all those space colonies, hyperdrives, robots, &c that were promised us already.

    Species have a strong tendency to find an ecological niche and just burrow deep. Is ours getting stuck in a rut with this bourgeois capitalism thing?

  6. BondsOfSteel

    Maybe I’m cynical, but I’ve come to believe that Market == Rigging. Believing in the idea of an Efficient Market is like believing in unicorns.

    If a market seems like it’s fair… it’s only because the banks haven’t been caught yet.

    1. Doug Terpstra

      Cynical, yes, but probably not cynical enough. This is finally dawning on more people, that a deregulated market is anything but free; it is highly rigged by the greatest powers, who have finally acheived their avaristic dreams of power-lust thru the Obama regime — the fusion of finance and government.

      This is ultimately fatal to free enterprise of course, but it is beyond saving from within. I wonder if the Swiss have sufficient leverage to save capitalism from itself. Who knows, maybe the Swiss franc is destined to be the world’s reserve currency.

      1. down2long

        Wasn’t it no other than “Fab Fab” Tourre who said that if the markets were efficient with market price discovery he would be out of job. Course he is at least temporarily.

  7. susan the other

    Faux capitalism rules. So has currency fixing been going on as long as the Libor fixing scam? Do traders need to fix both? Seems like they would be at odds. Clearly they need to fix something. Would all this be necessary if derivatives were made illegal and existing ones declared to be null?

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