FX Bank Settlements — More Misconduct than the Fix

Another day, another FX settlement. What’s new? Well, actually a lot. The recent settlements, when you dig into them, provide a whole new array of material. First we will explore the background, and then we’ll get you to the new…

The latest settlements between FX banks and regulators were filed on May 20. Five banks agreed to pay approximately $5.6 billion in fines to US and UK regulators relating to the rigging of FX rates, including several fix benchmark rates. JPMorgan, Citi, Barclays and RBS plead guilty to criminal charges for having “entered into and engaged in a combination and conspiracy to fix, stabilize, maintain, increase or decrease the price of, and rig bids and offers … in the foreign currency exchange spot market.” UBS avoided a guilty plea, and was only fined for breaking a prior non-prosecution agreement relating to LIBOR misconduct, as a reward for being the first to inform regulators of these FX activities.

A Bloomberg news story in June 2013 provided the initial public information that there was a potential problem with FX benchmark fixes, particularly the WM Reuters London Fix. Since then numerous news stories and the November 2014 settlements with the CFTC, OCC, FCA (UK regulator) and FINMA (Swiss regulator) have described the communications between bankers at several major banks, conniving to rig FX benchmark rates -- including their use of group chats to share information on the fix trades that they would need to execute. These traders would communicate each other’s currency positions and customer orders for the upcoming fix and then determine the means to trade off of this information so that the banks could make profits at the expense of their customers. Some of the settlements provide examples of chat room conversations in which traders from multiple banks collude to manipulate the fix.

This collusion at the London Fix is the focus of news reports and the regulators’ settlements with banks for good reason: fix trading constitutes a major portion of daily FX spot trading; fix rates are used world-wide to price many widely-held assets including mutual and pension funds; collusion is illegal and easily shown to have occurred based upon chat room communications; and the names of the chatrooms (e.g., the Cartel, the Mafia), and the lingo used within, make for entertaining media.

NEW REVELATIONS
New areas of misbehavior are revealed in the new set of settlements and pleas. There is much less awareness of these than the fix-specific misconduct, so we’d like to underscore some of this behavior.
This time around, the New York State Department of Financial Services (NY DFS) gets in on the act as well, tagging Barclays with a Consent Order. The NY DFS sheds light on some areas that are not covered in other plea agreements or settlements. For example, it stipulates that “Barclays conspired with other banks in order to coordinate trading … coordinate bid/ask spreads charged.”i
The DFS also highlights Barclays’ “misleading sales practices”ii, as well as the fact that “The misconduct described in this Order was not confined to a small group of individuals; it involved more than a dozen employees, who acted with the knowledge and oversight of some senior desk managers, and spanned geographically across numerous countries.”iii Moreover, the DoJ and DFS agreements include broader time ranges of misconduct than some of the earlier settlements, such as the CFTC’s.iv
So…what other wrongdoings were these FX trading engaged in?

MANIPULATION of SPOT MARKET to PROFIT from CLIENT ORDERS
Clients leave orders with their FX banks to execute FX spot trades, in order to manage their risks from future spot moves.
Banks have admitted to manipulating FX rates when near the order levels, in order to increase the banks’ profit at the customer’s expense. For example, banks admitted to “accepting limit orders from customers and then informing those customers that their orders could not be filled … when in fact the defendant was able to fill the order but decided not to do so because the defendant expected it would be more profitable not to do so….”v
Likewise, NY DFS notes that Barclays told “clients that their orders had been only partially filled, when in fact the FX Sales employees were holding back a portion of the fill as the market moved in Barclays’ favor….”vi

PROVIDING QUOTES with DEALER MARKUP to CLIENTS EXPECTING to HEAR “DIRECT TRADER QUOTES”
On large trades, some clients insist on hearing quotes not from their salesperson (who might add a spread to a trader quote), but directly from the bank trader over a phone line. Clients would expect these to be market-based -- and not shaded in one direction based upon the direction of the client’s intended trade. However, bank traders shaded the quotes either based upon hand signals from the salesperson indicating the direction and the size of the markup to include, or based upon earlier agreements made between the two bank employees.
On this count, banks admitted to “including sales markup, through the use of live hand signals or undisclosed prior internal arrangements or communications, to prices given to customers that communicated with sales staff on open phone lines….” vii

DISCLOSURE of CUSTOMER IDENTITIES and TRADE ACTIVITY to OTHER MARKET PARTICIPANTS
Banks provided this information to other banks and even other customers, on both large fix and non-fix trades. According to the plea agreements, the banks disclosed “non-public information regarding the identity and trading activity of the defendant’s customers to other banks or other market participants….”viii

TRADE PLATFORM PROVIDED ALTERED RATES to CERTAIN CUSTOMERS
The settlements were unclear on the relationship between the platforms and the bank, but platform rates provided to certain customers were systematically favorable to the bank versus the unaltered rates. RBS engaged in “intentionally altering the rates provided to certain of its customers transacting FX over a trading platform disclosed to the United States in order to generate rates that were systematically more favorable to the defendant and less favorable to customers….”ix

TRADING AHEAD of a CORPORATE TRANSACTION
We find a new anecdote of RBS trying to move the currency rate ahead of a corporate transaction so as to favor the bank at the client’s expense. This is commonly known as front running.
From the plea agreement: “… in connection with the FX component of a single corporate transaction, trading ahead of a client transaction so as to artificially affect the price of a currency pair and generate revenue for the defendant, and to affect or attempt to affect FX rates, and in addition misrepresenting market conditions and trading to the client….”x

MANIPULATION of EMERGING MARKETS CURRENCY PRICING
“Barclays FX traders exchanged information about customer orders with FX traders at other banks…”xi For example, “a Barclays FX trader explicitly discussed with a JP Morgan trader coordinating the prices offered for USD/South African Rand to a particular customer, stating, … ‘if you win this we should coordinate you can show a real low one and will still mark it little lower haha.’”xii

CONCLUSION
These regulatory investigations have uncovered several different means used by traders to increase bank profits to the detriment of their customers, including by “providing false and misleading information to customers and markets.”xiii
As opposed to the FX market convention of adding a spread on each trade to generate bank profit (controllable by customer scrutiny of the rates), these investigations opened the window to the various layers of deceptive practices prevalent in the FX market, and the abuse of client confidentiality and trust. While the FX market has begun adjusting to the misconduct around the 4pm WM/R London fix, it is not yet clear whether clients have yet begun reacting to the newly highlighted misbehavior.
One additional feature of these settlements is the demand by regulators for additional compliance scrutiny of FX trading which will hopefully limit potential future misconduct. At FinancialPests we expect these settlements to lead the FX market toward our goal of Promoting Ethics Simplicity and Transparency.


i NY DFS Consent Order, In the Matter of: Barclays Bank PLC, p.1
ii NY DFS Consent Order, In the Matter of: Barclays Bank PLC, p.2
iii NY DFS Consent Order, In the Matter of: Barclays Bank PLC, p.6 ¶14
iv FCA “Relevant Period”: 1/1/2008 – 10/15/2013; CFTC “Relevant Period”: 2009 – 2012; FINMA “Period under Investigation”: 1/1/2008 – 9/30/2013; OCC “Relevant Period”: 2008 – 2013; Fed “Review Period”: 2008 – 2013; DoJ: 1/1/2008 and 1/1/2009 – 5/20/2015
v See for example: Plea Agreement USA vs JPMorgan Chase & Co. p.17 ¶13
vi NY DFS Consent Order, In the Matter of: Barclays Bank PLC, p.16 ¶ 56
vii See for example: Plea Agreement USA vs Citicorp p.16 ¶13
viii See for example: Plea Agreement USA vs Barclays PLC p.18 ¶16
ix Plea Agreement USA vs The Royal Bank of Scotland PLC p.17 ¶13
x Plea Agreement USA vs The Royal Bank of Scotland PLC p.17 ¶13
xi NY DFS Consent Order, In the Matter of: Barclays Bank PLC, p.11¶33
xii NY DFS Consent Order, In the Matter of: Barclays Bank PLC, p.11 ¶34
xiii NY DFS Consent Order, In the Matter of: Barclays Bank PLC, p.2

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.

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.

Regulators/Prosecutors Moving Forward in UK and US FX Benchmark Investigations

Reuters sources  indicate that in the UK there is a push being made by the banks to come to a joint settlement with the FCA regarding the benchmark FX investigation.  A joint settlement reduces the reputational risk for each bank and would allow for the FCA to wrap up the investigation more quickly than pursuing each bank individually.  Indications are that such a settlement, if it occurs, could come as early as year end.

In the US there is a report that the DOJ has informants still working on the fx desks at several US banks. The DOJ is looking to charge individuals with crimes as an additional deterrent to the fines on the banks.  Perhaps it may also avoid a repeat of the criticism of the regulators following the LIBOR investigation that fines alone are merely a cost of doing business for the banks.

Regulatory Investigations of the FX Markets are Progressing

Bloomberg reports that the U.K.'s FCA is trying to speed up settlement talks with the banks by keeping the settlement narrowly focused.  The FCA is hoping for a settlement before year end, much earlier than previous reports.  The SFO in the UK has recently begun a criminal investigation and the director said that charges could come next year.  It is reported that the DOJ's investigation could bring charges and impose fines as early as this year.

The WSJ also reports that a number of banks are negotiating with the UK's FCA that any settlement will be announced at the same time for all of the banks.  This is an attempt to avoid the LIBOR scenario where each bank settlement was announced separately, bringing considerable bad publicity to each.  Perhaps a cross bank settlement would spread such publicity around and also draw attention to the misconduct being more of a market-wide problem rather than any bank being a bad apple.

New York's bank regulator, the Department of Financial Services, is negotiating with Barclay's and Deutsche Bank to install monitors at the two banks to investigate whether trades manipulated FX currency benchmark rates.  This was reported by the Wall Street Journal , but both banks declined comment.

All in all it sounds as if the regulators are attempting to fast track the investigations.  Earlier this year the FCA had mentioned 2015 as a goal and BAFIN in Germany had mentioned completion in 2018, hopefully. Speed will be helpful for all involved - the banks, regulators, and oh yes, market participants.  The discussions on changes to benchmarks is ongoing publicly, but no solution is perfect - longer windows of trading which seems to be a favorite, mitigates but does not eliminate the possibility of misconduct and a benchmark that is more of an average rate for the day is not what all market participants are looking for.

UK's FCA Benchmark Manipulation Investigations - Let's Hope the Tortoise Wins the Race

Reuters reports the Financial Conduct Authority's head of markets infrastructure and policy testified before a Parliment committee on their benchmark investigations.  None of his comments indicated that the investigations were moving very quickly.  

On the possibility of collusion in setting the London gold fix the FCA stated "It is possible but I have no clear evidence that that has actually happened".  The FCA fined Barclay's in May for a trader manipulating the rate in 2012 to avoid paying off on a client gold contract.  Next month the industry is to report on whether the process meets new benchmark guidelines.  

The FCA could provide the committee with no guidance as to when the FX benchmark investigation, which began a year ago, will reach a conclusion.  

A committee member claimed that it is well known by equity traders around the world that closing stock prices are also manipulated.  The comment from the FCA involved checking back to see if any action has been taken in this area.  While we are not familiar with charges of equity price manipulation either, the incentive to do so is clear, as portfolios are valued using those levels.

All in all, the FCA gives the appearance of moving deliberately, and since these are complex charges, with huge amounts of data and conversations to review, the slow pace appears inevitable. More important than the timing, at the conclusion of these benchmark investigations, market participants' faith in the markets must be restored.

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?   

German FX Investigation: "Much, Much Bigger" than LIBOR; Investigation to be Completed "Hopefully Before 2018"

Reuters reported on the annual news conference held yesterday by the German financial regulator, Bafin. The biggest news relates to progress on their foreign exchange investigation.  The regulator said that the probe was "much, much bigger" than the interest rate benchmark case.  "There were clearly attempts to manipulate prices, that's what was disturbing."  The Bafin spokesman said that these attempts involved fix rates in many different currencies, excluding the largest, such as euro vs. the dollar.  The only currency mentioned was the Mexican peso.

For the first time the regulator let it be known that all FX banks in Germany have been asked to conduct internal investigations into potential misconduct and report back to Bafin.  However, there is no need to lose sleep awaiting the final results of Bafin's probe, as the spokesman said that "we're not going to be done in 2014 ... but hopefully before 2018'".  There are no indications that the spokesman was kidding.

While most regulator comments from around the world have been indicating that they are finding some misconduct on the part of banks attempting to manipulate FX fixes, interestingly, at the end of April, the UK FCA head of enforcement and financial crime said "we are at a relatively early stage of plowing through some pretty detailed analysis of what was happening".  " We are some way away from saying there was actually misconduct at all".  Several FCA officials have stated that their probe will last until at least 2015.

FX Benchmark Investigations to Drag into 2015

An article in FX Week regarding the FCA investigation into the FX benchmark allegations quotes a defense attorney as saying that the findings would become public when the investigation nears its final stages, not before early 2015.  In the event of any disciplinary action, it is at this point that warning notices would be publicly issued.

The investigation complexity is driven by the large number of banks alleged to be involved, the wide ranging and voluminous documents expected to be handed over, and as well, the large number of people who will be interviewed.

There are investigations by several national and supranational regulators.  It is safe to assume that they will cooperate with each other and that none will be in a position to announce results in the near future.

Financial Conduct Authority says 10 Banks have Provided Evidence on the FX Benchmark Allegations; FCA Warns 2 that they will be Charged with Misconduct regarding LIBOR

The Financial Conduct Authority (FCA) announced today that 10 banks have provided evidence to the British regulator.  The head of the agency said that the investigation is unlikely to be concluded this year, and that the FX benchmark allegations are "as bad as LIBOR".
BusinessWeek

The FCA also warned 2 individuals that they intend to charge them for misconduct related to the LIBOR rate manipulation.  This is the first time that the FCA has issued such a warning since this power was granted to it in 2013.  These unnamed individuals are likely not the same ones who will face criminal charges.
DealBook NY Times