DOJ Charges HSBC Traders with FX Front Running

In the DOJ's first charges against individuals in the FX market investigations of the last three years, HSBC's head of FX trading and a former colleague were charged with using inside information from a large forthcoming client trade to make an $8 million profit for the bank (and we assume thereby increasing their bonuses).

While many charges have been made and settled with the banks, here individuals are being charged, perhaps in response to claims that just as in the financial crisis, fines are levied but no individuals are held responsible. Earlier this week the Fed barred a UBS trader from the currency markets for life, due to participation in the FX currency benchmark rigging scandal. There may be a few more charges to come both in the US and Europe, for regulators to show that more than financial penalties against the banks will be levied in this and any future financial scandals.

UK Fraud Agency Drops FX Rigging Investigation

The Serious Fraud Office, a British government fraud agency that investigates and prosecutes complex frauds, has announced that it is dropping the FX fix manipulation investigation. While several government agencies around the world investigated and settled with banks for over $10 billion in fines (with many banks pleading guilty to felony charges), the SFO announced that it is dropping its investigation (while continuing to liase with the US Justice dept in its investigation of FX fix manipulation). It said that there was insufficient evidence to realistically gain a conviction.

The lion share of FX trading occurs in the UK. We will have to wait and see the effect of this matter on the law suits that reportedly are being considered for filing in the UK, as well as on further regulatory investigations in the US and elsewhere.

ECB to Inhibit Trading Utilizing Daily EUR Reference Rates

The ECB publishes reference rates on 30 currencies at 2:30 PM each day, based upon spot rates at 2:15 PM. The ECB wants these to be used for reference or informational purposes only, not for trading. The ECB has not said whether or not it suspects rigging of these daily rates, as existed in the WM Reuters daily fixings. As of July 1, 2016 these rates will not be published until 4:00 PM, thus seemingly reducing their usefulness as a basis for trading or for that matter, for rate-rigging by any parties interested in such behavior. The ECB said this change is a reaction to recommendations by regulators reforming global FX benchmarks.

It has been our experience that these rates are used for trading, particularly by asset managers, although not to the degree to which WM Reuters rates are used. Any such traders after July 1 will have to either utilize other means to trade or wait much longer between when positions are provided and trade rates are known. This time is at a minimum an operational delay/complication, or worse, an additional operational risk.

Dismissed Citi FX Trader Wins with "everyone else was doing it"

The former trader brought a lawsuit in front of a UK employment tribunal saying that he was unfairly terminated by Citi. He said that his conduct (sharing information in chat rooms with other FX traders, including sharing private info regarding client trades) was quite common at the time and that his managers were aware that he was on the chat rooms. In 2009 during an employment review he was told by his manager to join chat rooms to gather market information, but was not provided any guidelines on what he could post.

The tribunal found in his favor, although saying that he contributed to his dismissal. A hearing next year will determine the compensation that Citi is required to pay him.

This argument is not one that usually wins in a court ("officer, why did you stop me? Everyone else was speeding also). Although this verdict may help other former bank FX traders who are bringing suits, it does not impact anything else regarding the fixing scandals, such as guilt or fines and settlements with regulators.

Upcoming FX Settlements for Barclays and Deutsche

While FX misconduct investigations began regarding attempts to rig daily spot fixes, it has broadened to additional areas. Now the Financial Times reports that Barclays is near a settlement of over $100 million with the New York Department of Financial Services (NYDFS) regarding the misuse of the last look feature on its FX trading platform, BARX. Last look gives a bank the ability to quickly back out of a trade if there is a significant spot move against them. Those trading on a last look platform would expect to see tighter spreads in exchange for the proper usage of the last look provision.

The FT also reports on several FX investigations into Deutsche. These include the NYSDFS looking into Deutsche's trading platform, Autobahn, a report that there is evidence the bank intentionally set up algorithms to rig the currency markets,and that NYDFS, the Justice Department and other federal agencies have evidence that the bank profited by front running client FX orders. The new CEO at Deutsche may be more willing to try to settle these FX, and other investigations of past misconduct, quickly so that they can concentrate on the changing banking environment.

FSB Updates FX Benchmark Progress

The Financial Stability Board (FSB), created in 2009 by the G20 to reform international financial regulation, includes as part of its mandate a role in standard setting and in promoting members’ implementation of international standards. In September 2014 it issued a report highlighting recommended solutions to prevent a repeat of the FX benchmark scandal. Today it released an update to look at progress made since that report.

The update is fairly positive ("having moved the market in a favourable direction"), highlighting improvements, but also mentioning areas where it believes that more work needs to be done.

The points made include:
1) There have been useful reforms in the methodology used in the WM Reuters (WMR) fix but that more can do done, and mentions certain central banks adjusting their fix methodologies as well. The FSB reiterates that all fixes need to be reviewed, not just the WMR fix.

2) "Recommendations suggested to increase transparency in pricing for fix transactions have seen good implementation among the largest market participants and for the most used benchmarks, but that elsewhere there is scope for further improvement".

3) "Steps to separate dealers’ fixings business from other activities are being taken by the larger participants and in the most active markets, but again there is room for further implementation in other areas of the FX market. For the execution of benchmark transactions, industry-led initiatives to promote greater use of independent netting and execution facilities are seeing welcome progress".

4) "Work is underway to improve market conduct practices, both within individual firms and through market-wide initiatives, including the global effort underway to develop a single code of conduct for the foreign exchange market through the Bank for International Settlements (BIS) Markets Committee working group on FX markets".

5) "While many index providers and end-users have increased their focus on the due diligence around FX benchmark use, there is scope for greater follow-through on this on the part of some market participants".

All in all, it appears that while some additional fix changes may be seen, for the most part fix reform will primarily involve broadening the changes already made to cover additional fixes and additional market participants. The probable exception will be the new international code of conduct being created by the BIS. This will replace the many different codes currently in force in markets around the world and will impact bank behavior.

FX Scandal Not Blowing Away

First of all, the rest of the world is looking at the US class action suit in which over $2 billion in settlements have already been made by 9 large banks, and lawyers and investors are planning additional suits in several countries. A $1 billion suit has just been filed in Canada relating to benchmark currency fixes.

Secondly, a Citi FX trader who had been dismissed in the UK relating to his sharing of client information with FX traders from other banks on chat rooms, is fighting his dismissal. He is claiming that it was a market practice at the time to share such information, especially regarding the trading of central banks. He mentions one M&A deal in which Citi front run the client's trade and made a profit of $35 million. He states that the very top Citi FX management actually had a hand in this deal.

There are other FX traders who were dismissed relating to similar charges who are also planning on disputing their firings.

FX Investigations Widen Beyond WM Fix

When Bloomberg's initial story hit the wires in June 2013, the allegations, later confirmed to be true, were primarily limited to banks manipulating the WM benchmark rates. Since then regulators in the US, UK and Switzerland have instituted over $10 billion in fines on major banks related to FX, and in many cases, banks have acknowledged criminal wrongdoing. These fines related primarily to collusion by the banks in attempting to manipulate the fix, on the back of transcripts of chat room conversations by bank FX traders that clearly showed their collusion and attempts to profit at the expense of market participants. (For other wrongdoings acknowledged in bank settlements earlier this year, please see our blog post from June 1, 2015, FX Bank Settlements — More Misconduct than the Fix)

These regulatory and criminal matters relating to the fix are at least partially behind us now (individual traders and local emerging market fixes remain under scrutiny), although a class action civil lawsuit in the US related to these same matters is ongoing, with 9 banks having settled so far. In addition, law firms around the world are reported to be attempting to institute civil lawsuits in other jurisdictions as well, particularly in the UK. There, in the largest FX market in the world, new laws as of October 1 will allow suits similar to class action suits in the US (and will allow non-UK residents to participate). With over $2 billion in settlements to date in the US (with 7 banks remaining in the suit), there may be several billion pounds of additional settlements in the UK. Regulators in Australia, South Africa, Brazil and South Korea (and possibly others) are investigating benchmark rate rigging as well.

Banks fined by regulators and those settling the US class action have agreed to cooperate with regulators and the parties bringing the suit. Lawyers from the suit are reported to have said that evidence from the cooperation in the US points to bank manipulation of the bid-offer spread on currency trades through the rest of the day, not having to do with the fix. How this may have been done is not clear, but if true would dramatically increase the scope of bank wrongdoing. It would mean that the rates on many more trades are not entirely market driven and all such trades would have the bank gaining at client expense, while the benchmark manipulation had some clients gaining and some losing from each manipulated rate.

Until more information is released it is hard to know if there was additional rate-rigging in FX markets. Should it be shown to have occurred, a further move toward exchange-type trading should be expected, as well as further criminal prosecutions and civil suits. Bank traders and investors beware.

FX Manipulation Class Action Spreads to more Banks in US, Possibly Around the World

It is now reported by Reuters that four additional banks, HSBC, Barclays, BNP Paribas and Goldman Sachs, have agreed to settle the US FX benchmark manipulation class action suit. In addition to bank settlements announced previously, this brings total settlements over $2 billion. Individual bank settlement amounts have not yet been announced. These banks plus five banks that settled previously have all agreed to "substantial cooperation" against the remaining 7 bank defendants, including recently added defendants (Bank of Tokyo-Mitsubishi UFJ, RBC Capital Markets, Société Générale and Standard Chartered were added August 1). Counsel referred to these settlements as "just the beginning" and mentioned that they are consulting on bringing additional cases against banks in larger Asian and European markets.

Citi says FX Fines 2,500 Times the Illicit Profits

Bloomberg reports that "Jamie Forese, head of the Citigroup Inc. unit that houses trading and investment banking, said fines the firm paid for rigging foreign-exchange markets dwarfed the amount generated by the illegal conduct. Revenue from the trades amounted to about $1 million, while Citigroup paid out $2.5 billion in fines and penalties, Forese estimated Wednesday at an investor conference in New York."

Among commentators, and regulators as well, there has been a question regarding whether the size of fines in recent settlements have been painful enough to cause banks to prevent further occurrences of misconduct. Some suggest yes, many no, but without knowing the profits generated by misconduct, it is a difficult question to answer.

If this represents Citi's answer to the discussion, we suggest that it is incomplete. While the article does not mention how the 1 million dollar gain was calculated, perhaps it was strictly based upon the specific trades uncovered in the investigations, such as the trades highlighted in the CFTC - Citi settlement. However, the settlement states that "From 2009 through 2012 (“Relevant Period”), Citibank, by and through certain of its
foreign exchange (“FX”) traders, at times sought to benefit its own trading positions or those of certain FX traders at other banks by attempting to manipulate and aiding and abetting certain traders at other banks in their attempts to manipulate certain FX benchmark rates." So the plea is to misconduct at the fixes for 4 years.

In the DOJ settlement Citi pleads to having "entered into and engaged in a conspiracy to fix, stabilize, maintain, increase or decrease the price of, and rig bids and offers for, the EUR/USD currency pair exchanged in the FX Spot Market by agreeing to eliminate competition in the purchase and sale of the EUR/USD currency pair in the United States and elsewhere. The defendant, through one of its EUR/USD traders, participated in the conspiracy from at least as early as December 2007 and continuing until at least January 2013." Here the plea is to manipulating the EUR/USD pair for a period of 5 years, but not limited to only the fixing of benchmark rates.

If 5 years of misconduct in EUR/USD (DOJ) or 4 years in various currencies at benchmark fixes (CFTC) only lead to a 1 million dollar gain, it would lead one to question how Citi made about $2 billion in revenue per year in FX during this period. Thus we question not only if the fine was truly 2,500 times the size of the misbehavior, but whether such misbehavior was limited to about one-hundredth of one percent of FX revenues ($1 million / $10 billion).

Fine for the FX Banks (Pun Intended)

The 5 banks (RBS, Barclays, JPMorgan, Citi and UBS) were fined about $5.7 billion and all but UBS plead guilty to criminal charges (UBS gets off because they were the first to provide information on the scandal to regulators). Although having the banks plead guilty to criminal charges makes the regulators appear to be tough (more than just fines), the truth is that much of that is just appearances, as the SEC has already provided the banks with waivers. These waivers will allow the banks to continue in lines of business for which a felony conviction would typically bar them, such as operating as a fiduciary, including managing client assets. With so many banks pleading guilty simultaneously, the sting to any individual bank is lessened. And as the negotiations continued, the banks added to their reserves for these fines so that there will not be large one-time hits to earnings.

Of course the fines are a lot of money, but overall we have little reason to expect much negative impact to these banks from either the fines or the criminal charges. Our hope is that after these many scandals the banks, saddled with additional regulations and compliance costs, and hopefully having learned a lesson, will concentrate on their ethics. As it relates to the London Fix which was the start of all this, most banks are now earning their profits by charging customers either a fee or a bid offer spread, a much more transparent and ethical model than collusion, and hopefully a hint of a new direction.

6 Month Delay for FX Benchmark Fix Lawsuit

Reuters reported the stay in the case involving the antitrust class action against a dozen FX banks. As we reported in February, the DOJ requested a stay due to grand jury investigations ongoing in criminal cases being brought by the DOJ. The plaintiffs have gone along with the stay, however they have been granted exceptions that should allow them to continue to make their case during this period. These exceptions allow them to use discovery to access trade data (perhaps the most important item in order to estimate damages) and some ability to depose witnesses (although the limitations are unknown).

A hearing is scheduled in the case for March 26.

DOJ Trying to Delay FX Benchmark Fix Case

The court handling the FX benchmark antitrust case released a letter last week from the Department of Justice asking for a limited stay in the discovery phase of this case citing a grand jury investigation that is currently under way. After an initial six month stay the DOJ would then decide if a longer stay is required. The court gave both sides in the case until Friday to respond to the DOJ's request.

One would expect the plaintiffs view to be along the justice delayed is justice denied theme. The banks' position may not be as clear. Although delaying a case with a foreseen bad outcome may generally be preferable, they would also need to weigh how a quicker trial here might affect the DOJ's case, which apparently is against several bank employees involved with the fix. Different banks may have different views. An additional layer of complexity is due to additional reported probes by the DOJ into the FX practices of certain banks, including in FX structured products, and the affect on these from a delay.

Until discovery of bank documents and depositions of bank employees occurs, a more clear picture of the potential size of damages to the banks cannot be determined.

FX Manipulation Lawsuit Tsunami at Banks' Doorstep

First, about three weeks ago, JPMorgan settled an FX manipulation lawsuit for a reported $100 million. Now, Reuters reports that a judge allowed the investor plaintiffs' case to go forward to trial over the banks' objections. These included that there was a lack of evidence and that a prior LIBOR case alleging antitrust abuses was thrown out of court.

These two events alone should bring forth a barrage of suits as success seems more probable. In addition, now that this trial can go forward, the banks' position looks to be hurt by two factors.

First, depositions can now be taken, which may provide additional evidence of wrongdoing (several of the banks have already been fined by regulators following employee interviews). Second, a problem in suing to date has been attempting to prove wrongdoing and antitrust behavior. There is a lack of data on trades executed by banks on specific dates in specific currencies. Trade data released by banks during the discovery process may make the plaintiffs' calculation of any damages much easier, rather than relying upon models of what may have been manipulation based solely upon price movements.

While lawsuits from investors (money managers, pensions funds, etc.)and corporations are to be expected, many other groups impacted by currency rates can be expected as well. As an example,a few weeks ago we reported on British farmers that may have been affected by the conversion of subsidies from euro to British pounds.

Will the Banks be Hit by a Wave of FX Manipulation Lawsuits?

An article in yesterday's Telegraph reports that UK farmers were hurt by the FX benchmark rigging scandal, as there is a 2.6 billion pound EU subsidy that first has to be converted from euros before paid to British farmers. An unclear reference in the article cites one day's manipulation that cost the farmers 16 million pounds in one year.

Regardless of the details here, what struck us at FinancialPests, was the wide range of potential suits with which the banks could be hit. Beyond all of the financial players, who we would expect to be more likely to file suits now that JPMorgan has settled one US suit, there may be many others as well. UK farmers would not have been on our radar screen as potential litigants(although no suit was mentioned in the article). Europe is, of course, less litigious than the US, and slower to file suits, but this reinforced to us that potentially, there may be a landslide of suits filed around the world during 2015.

JPMorgan Settles FX Benchmark Manipulation Lawsuit

Reuters reports that JPMorgan settled an antitrust lawsuit which accused 12 banks of rigging the FX markets' benchmark rates. No other bank has commented or settled as of yet, and the terms of the settlement were not disclosed. Two other lawsuits remain.

This follows the fines imposed by certain regulators on several banks late last year on the same matter. Once regulators found wrongdoing, even if only poor oversight of traders, it becomes more difficult for the banks to defend themselves. The lawsuit depended on whether the banks' behavior was uncompetitive in nature. Regulator findings regarding collusive behavior among bank traders on chat room and other electronic media may have increased the pressure on banks for settlements.

It appears reasonable to expect some of the other banks to settle in the near future. Additionally, all of the US and international regulators have not yet weighed in, and criminal charges may be coming as well, although any such charges may be limited to individual bank traders rather than the banks themselves.

All Announced on One Day: Five Banks Fined for FX, One for Precious Metals and BOE Chief FX Dealer Fired

As had been rumored for a few weeks, FX settlements between multiple regulators and several FX banks were announced on the same day, today. The banks prefer not to be singled out for misconduct but just to be one of many, so that this is viewed as more of a market problem. The banks were not found to have attempted to manipulate FX rates but instead found to have had ineffective controls allowing traders to engage in manipulative behavior. However, the DOJ is still looking into criminal charges, the New York regulator would not sign on to this agreement as it was felt to be too weak and penalties against many other banks by these same and other regulators will be forthcoming.

The Swiss regulator FINMA also fined UBS for precious metals misconduct, finding "clear attempt to manipulate precious metals benchmarks", particularly in the silver market. As FINMA also fined UBS for FX market violations, UBS would certainly have wanted both announcements at once.

Then the Bank of England hopped onto the bad news train today as well. They have been quiet for several months after announcing that an unnamed employee had been suspended for misconduct regarding FX. Today they announced that the chief FX dealer had been fired yesterday, but still provided little information, other than misconduct was discovered as part of the FX manipulation probe but the behavior itself was not related to the probe.

Estimate of Regulator Fines on Banks for FX Fix Misconduct - $41 Billion

Bloomberg reported that Citibank analysts' estimate of fines relating to the FX fix could total over $40 billion between US, UK and European regulators, spread among money center banks.  The analysis excludes fine reductions or waivers for those banks cooperating with investigations.  As many banks are cooperating (some required to do so by their agreements with regulators in the LIBOR scandal) this might substantially reduce the actual fines.

As most banks have been reserving for these investigations, which started in the middle of last year, there may not be a big hit to the earnings of the banks as a whole from the eventual fines.  As to reputational hits, the fact that so many banks will be included may, in effect,  protect all of them.

Outline of FX Fix Reforms is Clearer

The recommendations of the Financial Stability Board last week regarding changes to the WM Reuters fix will be presented at the G20 meeting in November.  These include extending the fix window (they support a move from from 1 minute to 5, but want the WM Reuters company to set the period), making prices transparent and appropriate for the risk borne (meaning that banks should be paid for fix trades, unlike past practice) and codes of conduct and internal guidelines should be more explicit.

While fully agreeing with all of the above, we see the two remaining major recommendation as problematic.  First is the recommendation that "banks establish ... separate processes for handling such orders".  Handling fix trades separately from other fx trades will be costly, probably causing some smaller players to eliminate their participation in the fix.  An article from FX Week (subscription or free trial) refers to banks considering the possibility of creating sealed trading rooms, away from other fx traders and order flow.   While it is unclear how seriously this is being looked at, such a possibility appears a bit absurd to us, as enforcing more explicit codes of conduct and internal guidelines as already suggested, should improve the outcome without the costs or need for quarantined traders.

The other problematic recommendation of the FSB is "the development of industry-led initiatives to create independent netting and execution facilities for transacting fix orders". While a longer term recommendation, this continues on the path of much higher cost and uncertain outcome.  Just to mention one issue, commonsense dictates that the largest incentive for manipulating rates is when there is a large discrepancy between buy and sell orders for a currency pair.  At such times, the only way to clear these separate trades is to trade with the rest of the market, the same traders that this recommendation is trying to avoid.

All in all, we approve of the recommendations as promoting that which Financial PESTs stands for - ethics, simplicity and transparency, albeit with the two exceptions discussed which require additional scrutiny before any implementation.

Settlements Approaching on FX Benchmark Rate Investigations

Reports are becoming more frequent that a settlement is in the works between the UK Financial Conduct Authority and money center banks regarding the FX benchmark pricing scandal.  These discussions are supposed to involve a total fine of about $3 billion (at the low end of expectations) and importantly, only charge the banks with maintaining insufficient compliance procedures to catch individual traders.  It is the traders who would be seen as the true purveyors of misconduct.

UBS today reported that it is in talks with an unnamed regulator that could result in material fines for not having sufficient controls to prevent misconduct of their employees.

There is a belief that the regulators of many countries are working multilaterly, even if not exactly together.  If they all pursue a line of reasoning as discussed above, this would indicate a much lighter hit for the banks.  The fines may be less than assumed, and importantly, the banks may not have to plead guilty to criminal behavior.  With settlement talks ongoing, some are now expecting settlements before year end.