Reports of FX Traders Colluding on NonBenchmark Trades

Many of the charges in the FX manipulation  media reports are possibly explicable as banks carrying on risk management before and during benchmark fixings.  Without further details we do not know if there has been misconduct.  However, the reports of collusion between major banks in the time period when London Close FX rates are established certainly means that, if true, the banks were involved in misconduct.

Now Reuters reports that the British regulator, the Financial Conduct Authority, has chat room transcripts of top traders from three large banks in London discussing the spreads to be put on specific, apparently large non-benchmark trades.   If true, then collusion extended beyond benchmark trades to the general FX market as well.  As allegations continue to come out from the FX and other markets, conspirators who have long alleged that banks controlled "the markets" are looking less and less crazy and leading some to wonder just how pervasive was misconduct.  As reported here last week, estimates of regulator FX fines to come for banks are as high as $35 billion.  Such magnitude is apparently effecting banks and recent reports have mentioned that banks are moving to further increase their proportion of electronic trading as there is less regulatory risk and less chance of misconduct on the part of traders.

DOJ probes bank sales practices in forex market

Bloomberg reports:

"Former employees interviewed by Bloomberg News said sales teams at Zurich-based UBS AG (UBSN) and London-based Barclays Plc (BARC) were aware of which companies were considered unsophisticated about currency trades and charged them more."

According to Bloomberg even investment banks like Goldman Sachs are now being caught up in these investigations.

A bank client would surely find these types of actions, if true, to be outrageous. But is it illegal for a bank to charge an unsophisticated corporate client more for the same service?  Banks do it to people.  For example, most unsophisticated consumers (and presumably ones most needing protection) are the ones most reliant on predatory bank products like payday loans or subprime mortgages. As Mitt Romney said, "corporations are people too, my friend," don't unsophisticated corporations have the right to be ripped off just like flesh and blood people?  

Report that DOJ is Investigating FX for being ... an OTC Market

Bloomberg reports today that people with knowledge of the matter say that the Department of Justice is looking into the practice by banks of charging different size markups to different clients, based upon how closely they watch market rates.  The DOJ is looking into whether not disclosing this practice represents fraudulent behavior.

FX, as an OTC market, does not charge commissions but instead banks earn profits by charging a markup on the rate to clients.  References in the article are to bankers executing trades that are sent to them via email, and then waiting some time to see if the later currency rate allows them to charge a worse rate to the client (this is similar to the fact pattern in the standing instructions lawsuits ongoing against several custodial banks).  In fact, all FX OTC trades, however initiated, include varying markups, based upon client relationship and client credit among other factors, including how closely the client watches market rates.

Buyer beware, whether buying FX or going to the store to buy milk, should be the underlying principle that protects buyers from unscrupulous sellers (and sellers from an overreaching government).  If the longstanding implications of the OTC market (unequal pricing) are no longer acceptable, what are the alternatives?  The least intrusive might include a warning notice about the OTC FX market, provided when opening an FX account (this account may be hazardous to your financial health).  The most would be to change the regulatory regime and create an exchange traded spot and derivative FX market, potentially to the detriment of the majority of market participants who benefit from a low cost, highly liquid market.

Regardless, the FX custodial lawsuits were followed by FX benchmark suits, and this leads me to suspect that there will be another wave coming.

Goldman and Bain settle antitrust suit against private equity

NYT Dealbook reports that Bain Capital and Goldman's private equity division have settled an antitrust suit, breaking ranks with the other private equity defendants. The allegations involve PE firms essentially colluding on the price they were willing to pay for target companies, thereby denying shareholders of potentially higher takeover bids.

I haven't heard much about this suit before the settlement. Have any incriminating documents come to light to trigger the settlement?  Where is the DOJ?  

International Financial Law Review on ISDAfix

For those who can't get enough of ISDAfix, he IFLR just published The ISDAfix Scandal: Injured Investors. There is still surprisingly little information about the ISDAfix scandal. I haven't seen any banks enter into a settlement with regulatory authorities where they reveal how ISDAfix was manipulated and, just as importantly, the duration and the degree of any manipulation if it occurred.  Until that data become available, there's not much more to discuss. 

One Estimate of FX Benchmark Fines for Banks - $35 Billion

Reuters discusses the research report issued this week by an independent research firm, Autonomous Research.  Led by a former minister in a Labor government and a former head of equity research at Merrill Lynch, the report attempts to determine the size of government fines around the world to be assessed upon money center banks for the FX benchmark rate manipulation scandal.

While they admit that they are speculating, they use the theory that repeated wrong-doing will attract much larger fines and thus use the total $6 billion in fines from LIBOR as a base.  Their assumption is that total fines among banks will be a minimum of $12B (but capped for individual banks at a level equal to annual profits) but could rise as high as $35B in total.  Individual bank fine estimates in the report are $8B for UBS, $4.4B for Deutsche and $4.3B for Citi.

While we find it difficult to comment on what the fines may ultimately total between all of the regulators involved, a number somewhat higher than twice LIBOR  may be more reasonable.  In addition, banks will most likely need to acknowledge wrongdoing, rather than being able to deny such as in the past.  Some of the reasons we tend toward lower estimates is that regulators will still be able to herald record fines and that the additional sources of fines and litigation costs screaming toward banks' balance sheets and earnings from other scandals (including mortgages, other market manipulations, US sanction/embargo evasion and numerous others) are already going to strain the ability of many banks to meet more stringent capital requirements going forward.  The answer will not be known most likely until sometime next year.

Something Funny Happened on the Way to Court

News about the alleged forex manipulation has sucked most of the media's attention and focus away from the Libor and ISDAfix scandals.  I just saw, however, this recent piece from Global Insurance Intelligence discussing the potential payouts on the ISDAfix scandals. The article suggests that the payouts for ISDAfix could dwarf the costs of Libor and forex but does not share any analysis as to how they got to that conclusion. I don't have a crystal ball telling me whether there will in fact be any payouts on ISDAfix and if so what they will be, but this is a welcome distraction of the steady drumbeat of news about forex traders at big banks being suspended or fired. 

Forex rigging investigation expands to taint more banks

The media have reported that German regulators are expanding their investigation of forex rate manipulation beyond the small handful of banks known to be targets. According to Reuters, "all German banks with forex trading activities have been asked to conduct internal probes and to submit their findings" to the regulators.  In fact, even banks with a minor market share in the forex market, such as Commerzbank, is suspending their forex traders due to alleged attempted manipulation.

Does anyone out there wonder whether this controversy will reach beyond the money center banks and start touching the investment banks? 

GARP: Barclays Fined $44 Million by U.K. FCA for Gold-Fix Failings

Here's a great article from GARP reporting on the $44mm fine Barclays received from the UK's FCA for alleged manipulation of gold prices.  What's next?   

Growing trends: increased regulation of forex trading

The Sydney Morning Herald reports that Australian government "may be forced to beef up forex regulations." This follows reports that the UK's Chancellor Osborne is also targeting forex manipulation. That is no surprise. What remains to be seen is exactly how regulators can "beef up" the forex market to prevent the types of manipulative practices reported in the media.  And while they're at it, don't forget about ISDAfix, LIBOR, gold, and other metals trading too.

FT: Deutsche Bank warns of material damage for forex probes

Defendants of lawsuits generally refrain from discussing potential damages lest they show their hand to the plaintiffs. But the Financial Times reports that Deutsche Bank has warned of material impact from the forex probes. Obviously Deutsche is taking a different tactic.

Bloomberg Business Week: Bank of Canada Conducting Survey as Part of Currency Review

Bloomberg Business Week reports that the Bank of Canada is conducting a survey as as to the usage of forex rates as part of its review of potential manipulation.  You can view the press release here and take the survey here. 

Credit Suisse Estimates US Fines and Other Litigation Costs of $104 Billion

FT Alphaville reports the doubling of Credit Suisse's estimate for US litigation costs from last year to this, from $58B to $104B.  Of this, only $69B has been reserved to date.  US regulators are looking for substantially higher penalties for misconduct on the part of banks than in the past, and many European banks are expected to be severely penalized for many actions. Credit Suisse breaks down its reserves into seven areas, as can be seen in the article.

The WSJ reports that litigation costs have been a part of US bank stress testing but have not been captured in European stress tests.  That is now changing as the European Central Bank and European Banking Authority are both concerned with the potential scope of the costs.  The EBA has asked individual countries to look at "conduct risk" as part of their stress testing.  The ECB takes over the role of European banking supervisor on November 4 from national regulators.  Based upon CS's litigation costs equaling about half of the losses from the financial crisis, the ECB will be kept quite busy in its new role.

Sovereign Suitability?

Bloomberg reports:  "Goldman Gets Ecuador Gold ...."

    Oh my gosh, this story looks familiar!  Channeling Mark Twain, History Rhymes.  This brief story has few details, so we'll need to make a few assumptions and guesses.  The deal between Ecuador, a sovereign entity that embraces the US dollar as its currency, and Goldman Sachs appears to be "gold lending" for a 3-year term in the amount of $580 million.  Just like "securities lending," Ecuador is entitled to receive cash as collateral.  The best interpretation is that Ecuador will use the cash to buy liquid USD securities from (surprise!) Goldman.

    The first alarming aspect is the statement of the Ecuadorean Central Bank that the gold "now becomes a productive asset that will generate profits."  Here we find the rhyme with the famous cases from the 1990's that created suitability laws!  The Treasury department at Procter & Gamble sought to become a profit center for the company - just like Ecuador's current Central Bank.

    A better analogy to Ecuador (a sovereign) is Hammersmith & Fulham London Borough Council (a UK municipality).  See this legal synopsis of the court judgment repudiating Hammersmith & Fulham derivative contracts as ultra vires.

    On its face, this Ecuadorean gold lending arrangement appears unsuitable for the sovereign.  We reach this view by noting that the central bank is pleased that it "will generate profits" of roughly 1% per year.  How does this happen?  It's leverage!!  It appears Ecuador will take the yield spread of the liquid securities as its profit.  But Ecuador will have, then, both the credit and market risk of the securities AND the market risk of the gold it has lent to Goldman.  Just like securities lending, this is the risk - the lender increases assets through leverage.

    For sophisticated investors with risk expertise, such leverage can be acceptable if fully disclosed.  But sovereigns don't fit this description.  How many central banks are there that gain leverage through off-balance sheet transactions?

    Good question!  Greece comes to mind!  See the February 2010 article "Wall Street Helped Greece to Mask Debt Fueling Europe's Crisis."  We don't recall anybody citing "suitability" concerns for these Greek derivative transactions, but that's how we see the story.  The Greek people were not well served by the delayed reckoning provided by the highly sophisticated Wall Street counterparties.

    Sovereigns and, really, all parties to financial transactions should keep their activities as simple as possible.  Ecuador would be better served simply by selling its gold if it needs the USD cash and near-cash instruments.  Why own gold anyway?  (The Fed itself owns essentially no gold.)  As a USD-based country, Ecuador should simply match the risks of its assets and liabilities.  Having a large, long gold position does not help such risk matching.

UK to Increase FX Oversight

Bloomberg reports that the UK will announce new regulations for the FX market as a response to the stories of WM Reuters benchmark rate manipulation at the London close.  Chancellor of the Exchequer Osborne may announce these rules at his annual address to be held next week.  While details are slim at this point, it is expected that they may include making the manipulation of benchmarks a crime, as well as mandating additional oversight of bank employees involved in benchmark rate setting, by their employers.

Clearly some change is required following the news reports, suspension of traders by banks and the first hints by some regulators that misconduct has been found in FX.  However, maintaining the liquidity of the FX markets should be paramount.  The information regarding potential manipulation has already started many market participants to review how they can improve their use of, or whether they should use, FX benchmarks.

Banks Seek Dismissal of FX Fix Rate Manipulation Class Action Lawsuit

Reuters reports that the 12 banks included in the WM Reuters manipulation class action suit are requesting that the case be dismissed.  This would seem to be a standard legal maneuver but we will need to wait to see the judge's ruling.

The banks state that no specific instances of manipulation are mentioned in the suit, nor is there any specific instance of harm brought forth in the suit.  The plaintiffs apparently are waiting for internal bank or regulatory investigations to provide them with some specifics.  The banks are hoping for dismissal before this occurs and to avoid the discovery process if the case is allowed to continue.