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.
Promotion of Ethics, Simplicity and Transparency in Finance
Showing posts with label London close. Show all posts
Showing posts with label London close. Show all posts
Thursday, January 29, 2015
Wednesday, July 23, 2014
FSB Proposes FX Benchmark Changes; UK Opens Criminal FX Benchmark Investigation
The Financial Stability Board (coordinates national regulators and international standard setting bodies) published suggested changes to FX benchmark calculations in the following areas:
- The calculation methodology of the WM/Reuters (WMR) benchmark rates;
- The publication of reference rates by central banks;
- Market infrastructure in relation to the execution of fix trades;
- The behaviour of market participants around the time of the major FX benchmarks (primarily the WMR 4pm London fix);
- Recommendations from a forthcoming IOSCO review of the WMR fixes.
These are open to comments and should entail great diversity as there is much disagreement on how to reduce the possibility of rate rigging in FX markets.
In the UK, the Serious Fraud Office (SFO) has opened a criminal investigation into possible fraud occurring in benchmark rate setting. The US DOJ has been looking into criminal angles for quite some time,and last week we reported their offer of immunity to junior FX traders in exchange for information. The SFO has an ongoing investigation into LIBOR rigging as well.
Thursday, July 3, 2014
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.
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.
Thursday, May 29, 2014
Deutsche Reported to Set Aside $2.7 Billion in FX Legal Costs and Fines
Last week Deutsche announced that in total, it is facing 1,000 lawsuits with potential payouts above 100,000 euros. We reported here last week that Bafin, the German regulator, announced that the FX benchmark probe was "much, much bigger" than the LIBOR case. Now Reuters reports that sources tell it that Deutsche is setting aside $2.7 billion to cover future FX fines and settlements.
Put these together and, while it is not certain what has been found so far in the internal and various regulatory investigations, Deutsche clearly believes that there will be substantial costs going forward of at least that amount. Of course, this does not necessarily mean that Deutsche believes that they are guilty as they may feel that they are meeting accounting/legal requirements in recognizing these costs at this time. However, throw in several FX traders that Deutsche has suspended during its internal investigation, and it is difficult not to lean towards the view that where there is smoke there is fire.
Put these together and, while it is not certain what has been found so far in the internal and various regulatory investigations, Deutsche clearly believes that there will be substantial costs going forward of at least that amount. Of course, this does not necessarily mean that Deutsche believes that they are guilty as they may feel that they are meeting accounting/legal requirements in recognizing these costs at this time. However, throw in several FX traders that Deutsche has suspended during its internal investigation, and it is difficult not to lean towards the view that where there is smoke there is fire.
Thursday, May 8, 2014
Legal Theories in LIBOR and FX Lawsuits
While this article in CapLaw discusses the history of the allegations, investigations and lawsuits in the FX and LIBOR scandals, we thought it most interesting to focus on the legal theories and their current status.
In LIBOR, the US consolidated case held that there was no antitrust damage as the LIBOR rate setting process was not competitive in nature and thus there could not be anti-competitive behavior. However, "second-generation" lawsuits filed by plaintiffs claiming direct trading losses from derivatives with banks that provided benchmark LIBOR rates, are moving through the legal system. Two large plaintiffs are the FDIC, on behalf of 38 failed banks, claiming fraud and collusion were used by the LIBOR setting banks to suppress rates, and Freddie Mac and Fannie Mae, claiming that LIBOR manipulations caused them to suffer losses on mortgages and financial derivatives.
LIBOR cases in the UK have been limited, with only two cases filed, one of which was settled and the other remains with the courts.
In the FX benchmarks, the US has consolidated numerous class action suits into one. Differences between the rate setting process in FX vs. LIBOR make it unclear whether antitrust charges will hold up in the FX case. Fraud and collusion charges remain in FX as well, but the later start of FX allegations, the complexity of the cases and the continuing regulatory and internal bank investigations, means that further clarity will not be forthcoming until at least late 2014.
In LIBOR, the US consolidated case held that there was no antitrust damage as the LIBOR rate setting process was not competitive in nature and thus there could not be anti-competitive behavior. However, "second-generation" lawsuits filed by plaintiffs claiming direct trading losses from derivatives with banks that provided benchmark LIBOR rates, are moving through the legal system. Two large plaintiffs are the FDIC, on behalf of 38 failed banks, claiming fraud and collusion were used by the LIBOR setting banks to suppress rates, and Freddie Mac and Fannie Mae, claiming that LIBOR manipulations caused them to suffer losses on mortgages and financial derivatives.
LIBOR cases in the UK have been limited, with only two cases filed, one of which was settled and the other remains with the courts.
In the FX benchmarks, the US has consolidated numerous class action suits into one. Differences between the rate setting process in FX vs. LIBOR make it unclear whether antitrust charges will hold up in the FX case. Fraud and collusion charges remain in FX as well, but the later start of FX allegations, the complexity of the cases and the continuing regulatory and internal bank investigations, means that further clarity will not be forthcoming until at least late 2014.
Wednesday, April 9, 2014
If FX Benchmarks were Manipulated, How Often did it Occur?
FX Week (subscription) reports that the counsel for one of the plaintiffs in the FX benchmark class action suit says that their analysis of London Close benchmark trades for the six most liquid pairs on the last day of the month for the past 10 years shows manipulation occurred between 26% and 34% of the time. The headline of the article, however, is a bit misleading: FX benchmark manipulated more than 25% of the time, plaintiffs say.
Even if the interpretation of these results can be said to be true, this still would not mean that there was that much manipulation on all trading days. The last day of the month was most likely reviewed because most asset managers that hedge the FX in their portfolios adjust the hedges on that day, leading to particularly high volumes. These high volumes, and the tendency for these hedge adjustments to be in the same direction, would make those the days most likely for manipulation if there was any.
So even if you did accept the results, it does not answer the question of how extensive was any FX benchmark manipulation.
Even if the interpretation of these results can be said to be true, this still would not mean that there was that much manipulation on all trading days. The last day of the month was most likely reviewed because most asset managers that hedge the FX in their portfolios adjust the hedges on that day, leading to particularly high volumes. These high volumes, and the tendency for these hedge adjustments to be in the same direction, would make those the days most likely for manipulation if there was any.
So even if you did accept the results, it does not answer the question of how extensive was any FX benchmark manipulation.
Monday, April 7, 2014
Who needs Flash Trading when we have the FX London Close?!
The hotly debated, headline story of the moment is whether some HFT (high-frequency trading) firms are front-running all other U.S. equity investors by paying fees to the exchanges. Good question .... but let's look at another topic in the news: allegations of front-running and collusion in the London Close for currency trading in the WM/Reuters index.
Quoting an earlier and detailed Financial Pests account:
Instead of several MILLISECONDS of potential front-running, the London Close provides ONE HOUR of potential front-running!
Focusing on the London Close, what strikes us is that there's an easy answer. First and foremost, it's a risk management issue. Banks and dealers should not "guarantee to trade for [clients] at the London Close rates." It's simply not possible to achieve the last price whereas giving a "guarantee" of last price is a difficult-to-quantify risk exposure. With both this quantification difficulty and the appearance of manipulating markets that arises from trading as much as possible in the final minute, prudent risk management dictates "don't offer the London Close guarantee trade to clients."
As an alternative to banning the London Close trade, permit the pairing of such trades for clients on opposite sides. Prior to close, the client may commit itself to executing a stated maximum notional at the fix price subject only to the dealer finding a client for the other side. If confirmed prior to the market close, this trade execution can be posted to the exchange for all participants to see. If no client materializes for all or part of the stated notional, then the original client order is not completely filled.
Quoting an earlier and detailed Financial Pests account:
"Many banks provide a
service to their customers where they guarantee to trade for them at the London
Close rates. Customers provide the trade amounts to their banks within the one
hour prior to the London Close, also known as “the fix”. Those banks that have agreed to make
transactions for funds at the London Close need to push through the bulk of
their trades during this window where possible to minimize losses from market
movements."
Instead of several MILLISECONDS of potential front-running, the London Close provides ONE HOUR of potential front-running!
Focusing on the London Close, what strikes us is that there's an easy answer. First and foremost, it's a risk management issue. Banks and dealers should not "guarantee to trade for [clients] at the London Close rates." It's simply not possible to achieve the last price whereas giving a "guarantee" of last price is a difficult-to-quantify risk exposure. With both this quantification difficulty and the appearance of manipulating markets that arises from trading as much as possible in the final minute, prudent risk management dictates "don't offer the London Close guarantee trade to clients."
As an alternative to banning the London Close trade, permit the pairing of such trades for clients on opposite sides. Prior to close, the client may commit itself to executing a stated maximum notional at the fix price subject only to the dealer finding a client for the other side. If confirmed prior to the market close, this trade execution can be posted to the exchange for all participants to see. If no client materializes for all or part of the stated notional, then the original client order is not completely filled.
Class Action FX Benchmark Lawsuit Filed
A dozen individual lawsuits alleging antitrust and anti-competitive behavior on the part of the 12 largest FX trading banks, based upon their behavior at the WM Reuters London Close FX fix, were consolidated and filed as a class action last week. The plaintiffs and defendants are listed below.
The allegations are similar to those aired in the press over the last nine months or so. This suit has updated some of the individual suits based upon recent information from the Bank of England and recently fired or suspended bank traders and include some examples of how FX rates were allegedly manipulated. While for bank customers and those interested in the integrity of markets, the issue is simply whether or not the allegations are true, for the success of the suit, antitrust and anti-competitive behaviors must be shown. Thus much of the suit contains the plaintiffs' building of such a case. Similar issues drove the LIBOR case.
Much of the information for the case and press stories, relates to banks' internal investigations and their cooperation with regulators. As highlighted in the suit, DOJ LIBOR non-prosecution and deferred prosecution agreements require many banks to provide information relating to benchmark manipulation, including manipulation of FX benchmark rates.
The class has been defined as those trading FX at or around the London Close since at least June 1, 2003. Included are those not trading the fix but trading at around that time of day and those trading forwards and swaps as well as spot.
No attempt is made to quantify damages or who are the members of the class. Reference is made that records should exist, which we can only assume would be held by the banks.
Plaintiffs Defendants
Aureus Currency Fund Bank of America
City of Philadelphia, Board of Pensions and Retirement Barclays
Employees’ Retirement System of the Government of BNP Paribas
the Virgin Islands Citigroup
Employees’ Retirement System of Puerto Rico Electric Credit Suisse
Power Authority Deutsche Bank
Fresno County Employees’ Retirement Association Goldman Sachs
Haverhill Retirement System HSBC
Oklahoma Firefighters Pension and Retirement System JP Morgan
State-Boston Retirement System Morgan Stanley
Syena Global Emerging Markets Fund RBS
Tiberius OC Fund UBS
Value Recovery Fund
United Food and Commercial Workers Union and
Participating Food Industry Employers Tri-State
Pension Fund
The allegations are similar to those aired in the press over the last nine months or so. This suit has updated some of the individual suits based upon recent information from the Bank of England and recently fired or suspended bank traders and include some examples of how FX rates were allegedly manipulated. While for bank customers and those interested in the integrity of markets, the issue is simply whether or not the allegations are true, for the success of the suit, antitrust and anti-competitive behaviors must be shown. Thus much of the suit contains the plaintiffs' building of such a case. Similar issues drove the LIBOR case.
Much of the information for the case and press stories, relates to banks' internal investigations and their cooperation with regulators. As highlighted in the suit, DOJ LIBOR non-prosecution and deferred prosecution agreements require many banks to provide information relating to benchmark manipulation, including manipulation of FX benchmark rates.
The class has been defined as those trading FX at or around the London Close since at least June 1, 2003. Included are those not trading the fix but trading at around that time of day and those trading forwards and swaps as well as spot.
No attempt is made to quantify damages or who are the members of the class. Reference is made that records should exist, which we can only assume would be held by the banks.
Plaintiffs Defendants
Aureus Currency Fund Bank of America
City of Philadelphia, Board of Pensions and Retirement Barclays
Employees’ Retirement System of the Government of BNP Paribas
the Virgin Islands Citigroup
Employees’ Retirement System of Puerto Rico Electric Credit Suisse
Power Authority Deutsche Bank
Fresno County Employees’ Retirement Association Goldman Sachs
Haverhill Retirement System HSBC
Oklahoma Firefighters Pension and Retirement System JP Morgan
State-Boston Retirement System Morgan Stanley
Syena Global Emerging Markets Fund RBS
Tiberius OC Fund UBS
Value Recovery Fund
United Food and Commercial Workers Union and
Participating Food Industry Employers Tri-State
Pension Fund
Monday, March 10, 2014
BOE Governor Testifies Tomorrow; Will need to Defend the Bank's Integrity Regarding the FX Fix
The BOE Governor will testify before the UK Parliment's Treasury Committee tomorrow to defend the BOE in the wake of meeting minutes showing that there was knowledge within the BOE as early as 2006 of unusual trading around the 4PM London fix for foreign currencies. At this point the BOE says that it is unaware of any collusion between traders and BOE staff, however, there are many questions regarding specifically what the BOE was told and why this information was not passed up the chain of command.
Assuming that lack of collusion holds up under internal BOE investigation, the most likely explanation of why no action was taken may have to do with the age old problem of coziness between the regulator and the regulated. Examples have repeatedly come to light among utilities (gas, electric and pipelines), banks, insurance companies and when closely regulated in the US many years ago, the trucking and airline industries.
Assuming that lack of collusion holds up under internal BOE investigation, the most likely explanation of why no action was taken may have to do with the age old problem of coziness between the regulator and the regulated. Examples have repeatedly come to light among utilities (gas, electric and pipelines), banks, insurance companies and when closely regulated in the US many years ago, the trucking and airline industries.
Friday, February 21, 2014
EURIBOR Benchmark Reforms
The EURIBOR European Banking Federation (EURIBOR-EBF) manages short term interbank interest rate benchmarks within the EU. The European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) released a report reviewing changes made by the EURIBOR-EBF, noting the progress made in "raising the transparency of the benchmark setting process, enhancing the governance and control mechanisms of the benchmark, thereby improving the quality and reliability of the resulting index".
Just as interest rate benchmark process changes have been and continue to be made, changes in FX benchmarks are on the way as well. We reported earlier this week that Singapore has stopped publishing FX benchmarks for certain SE Asian currencies used for non-deliverable forwards (Singapore Ends FX Benchmark for Indonesian Currency). It is unlikely that WM Reuters or other benchmark setters will wait for the results of investigations before changing their processes as press reports have raised market concerns which will need to be addressed as soon as practical.
EURIBOR-EBF
Just as interest rate benchmark process changes have been and continue to be made, changes in FX benchmarks are on the way as well. We reported earlier this week that Singapore has stopped publishing FX benchmarks for certain SE Asian currencies used for non-deliverable forwards (Singapore Ends FX Benchmark for Indonesian Currency). It is unlikely that WM Reuters or other benchmark setters will wait for the results of investigations before changing their processes as press reports have raised market concerns which will need to be addressed as soon as practical.
EURIBOR-EBF
Thursday, February 20, 2014
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.
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.
Thursday, January 30, 2014
A Third WM Reuters Fix Class Action Suit Filed; Deutsche Suspends Head of Emerging Markets FX Trader in NY
It was also reported today that Deutsche suspended this senior trader in mid-December.
The stories continue, but at this point neither of these sheds any more light on what actually happened. The filing of lawsuits is understandable, and possibly encouraged by the banks continued suspension and firing of employees related to internal bank investigations of the fix allegations.
Friday, January 24, 2014
WSJ - BOE Governor Carney: Regulators Must Fix Mechanics of Libor, Forex Benchmarks
"The" quote from the article: "While regulators will fix the mechanics of benchmarks in markets ranging from LIBOR to foreign exchange, only private individuals and institutions can reform the behavior that has made such changes necessary," Mr. Carney said.
This quote confirms our belief in additional regulation to come. The article infers that this quote only refers to banks and traders, but we suggest that in the case of FX, it should also include asset managers who were requesting execution of their trades with no profit for the banks, at a benchmark rate to be determined. Such a situation is fraught with peril.
http://online.wsj.com/news/articles/SB10001424052702303448204579340354242747762?mg=reno64-wsj&url=http%3A%2F%2Fonline.wsj.com%2Farticle%2FSB10001424052702303448204579340354242747762.html
This quote confirms our belief in additional regulation to come. The article infers that this quote only refers to banks and traders, but we suggest that in the case of FX, it should also include asset managers who were requesting execution of their trades with no profit for the banks, at a benchmark rate to be determined. Such a situation is fraught with peril.
http://online.wsj.com/news/articles/SB10001424052702303448204579340354242747762?mg=reno64-wsj&url=http%3A%2F%2Fonline.wsj.com%2Farticle%2FSB10001424052702303448204579340354242747762.html
Tuesday, January 21, 2014
Rate Manipulation News May Shake Investor Confidence in Markets
The
news stream on alleged benchmark manipulations in different markets continues,
including commodities, interest rates and FX. While banks have only admitted
wrongdoing in the LIBOR scandal, the news in just the past week has been
widespread and includes:
1)
Reports of firings and suspensions have been increasing in frequency, to include 2 employees suspended at each Citi and
HSBC just this past Friday.
2)
Deutsche Bank is withdrawing from the London Gold fix.
3)
German regulator Bafin says that the alleged gold and FX manipulations are
worse than the LIBOR scandal as they
would include actual trades rather than reported rates.
4)
A new mechanism and administrator for the LIBOR fix (ICE) has been announced
5)
New regulators, now the Federal Reserve and the Monetary Authority of
Singapore, are joining the FX benchmark investigation.
The
connection in all of these alleged scandals is that a limited
number of large market participants are colluding to set benchmark prices that bring
greater profits to themselves at the expense of their clients and other
investors. Large notional amounts of executed
financial transactions are directly impacted by being priced at allegedly
rigged rates. All of the holdings of
investors in funds whose assets are marked to market at manipulated rates are
indirectly impacted when shares are purchased or sold. If true, the scope is
such that large swaths of the investment landscape may have been affected by
one or more of these collusions.
Banks
have admitted wrongdoing in the LIBOR scandal and have paid $6 billion in fines
to date. Investigations continue in the
ISDAfix, FX WM Reuters London Close, the London Gold fix, oil and other
commodities as well. It can be inferred
from the banks’ personnel actions, that they too see improper activity by
traders. In fact, these reports have
come up so quickly, in so many markets, that all benchmarks may very well now
be suspect in the eyes of investors.
What
is most important is that regulators thoroughly review the actions of market
players and then fully report to the investment world what has occurred. Only by such investigations, proving to
investors that the markets are not (or no longer) rigged against them, can new
more reliable benchmarks be devised, and investor faith in the fairness and
efficiency of markets be maintained (restored).
Friday, January 17, 2014
Thursday, January 16, 2014
May a Bank "Tell-All" to Regulators Regarding FX Benchmark Rates?
This article discusses prior investigations by regulators and the incentives to the first mover to cooperate.
http://www.sfgate.com/business/bloomberg/article/Banks-Said-to-Snitch-on-FX-Competitors-in-Race-to-5080967.php
http://www.sfgate.com/business/bloomberg/article/Banks-Said-to-Snitch-on-FX-Competitors-in-Race-to-5080967.php
Wednesday, January 15, 2014
The “Great” Alleged FX Manipulation By Jon Wetreich and Jack Chen
When news broke of the alleged
manipulation of the world’s largest market, the daily five trillion dollar
foreign currency (“FX”) market, this appeared as another entry in the long list
of scandals implicating some of the world’s largest financial institutions. The
investigations are centered on the possibility, reported by Bloomberg News in
June 2013, that dealers shared information and used client orders to influence
widely-followed FX rates to boost trading profits. Specifically, the index is
the WM/Reuters currency rates published by World Markets Co., a unit of State
Street Corp., and Thomson Reuters Corp. at 4 PM London time, also known as the
London close (“London Close”).
While we have seen reports of
the FX market size in the press reports, what we have not come across are some
estimates of possible dollars affected.
We have prepared the following
table to provide a very high level assessment of the potential impact that such
market manipulation could have on financial institutions. We obtained publicly
available information about the portfolio holdings of a large public pension
fund, two life insurers and industry information for life insurers and mutual
funds. Our assumptions on portfolio turnover are based on our initial review of
the public information. The assumption on percentage of trades manipulated is based
upon our initial review of the currency mixes in the portfolios and on media
reports of how the alleged manipulation occurred. For the table we provided a
range of 10 to 30 bps of manipulation based upon a study reported by Bloomberg
News.[1]
A more accurate picture of damages requires a review of actual trades and
portfolio information as well as a better understanding of whether the London
Close was actually manipulated and, if so, how often and to what degree.
For our table:
§
We selected a pension fund and life insurers
because they are more likely to have entered into trades referencing the London
Close.
§
We included four asset classes in our analysis:
foreign equities, foreign bonds, forwards and swaps.
§
We considered American Depositary Receipts but based
on preliminary information we do not see significant impact from any potential
manipulation.
After the table we present a
list of FAQ along with our answers.
The following information is on an annual
basis.
Annual Damages
(Millions)
|
||||||||||||||||
By Entity
|
Notional Value of Foreign
Assets (Millions)(A)
|
Level of Manipulation (bps)
|
||||||||||||||
Bonds
|
Equity
|
Forwards
|
Swaps
|
Other (B)
|
10 bps
|
20 bps
|
30 bps
|
|||||||||
Large US Pension Fund
|
$56,000
|
$4,000
|
-
|
-
|
-
|
$16.0
|
$32.0
|
$48.0
|
||||||||
Large US Life Insurer #1
|
$28,200
|
$2,000
|
$1,100
|
$8,000
|
-
|
$9.2
|
$18.3
|
$27.5
|
||||||||
Large US Life Insurer #2
|
$12,700
|
$2,650
|
$4,200
|
-
|
-
|
$8.2
|
$16.4
|
$24.5
|
||||||||
By Industry
|
Notional Value of Foreign
Assets (Millions)(A)
|
Annual Damages
(Millions)
Level of Manipulation (bps)
|
||||||||||||||
Bonds
|
Equity
|
Forwards
|
Swaps
|
Other (B)
|
10 bps
|
20 bps
|
30 bps
|
|||||||||
Insurance Industry
|
$608,498
|
$30,608
|
-
|
$77,904
|
$3,098
|
$169.8
|
$339.5
|
$509.3
|
||||||||
International Equity Mutual
Funds
|
-
|
$1,248,000
|
-
|
-
|
-
|
$624.0
|
$1,248.0
|
$1,872.0
|
||||||||
(A) Dashes are used for
notional values for which we have no or insufficient data.
|
||||||||||||||||
(B) Includes preferred shares
and replications.
|
||||||||||||||||
Assumptions
|
Equity Variables:
|
Forward Variables:
|
||||||||||||||
Annual Portfolio Turnover:
|
100%
|
Turnover x Spot Sensitive
|
175%
|
|||||||||||||
% of Trades Manipulated:
|
50%
|
% of Trades Manipulated:
|
50%
|
|||||||||||||
Bond Variables:
|
Swap Variables:
|
|||||||||||||||
Annual Portfolio Turnover:
|
50%
|
Annual periodic payments
|
4%
|
|||||||||||||
% of Trades Manipulated:
|
50%
|
% of Trades Manipulated:
|
50%
|
|||||||||||||
Sources:
NAIC, 2013 ICA Factbook.
Frequently
Asked Questions
What are the allegations?
Although the WM/Reuters index
provides exchange rates for 160 currencies hourly and half-hourly for the 21
most traded currencies, regulators are focused specifically on the rates that
constitute the London Close. Media
reports say investigators suspect that FX dealers at banks may be sharing
information and “banging the close,” which involves executing a large number of
trades over the 1 or 2 minute period during which the rates are fixed for the
London Close, to move the rates to their advantage.
Why is the London Close important?
The London Close rates have
significant market importance as they are widely used by index and benchmark
providers such as FTSE Group and MSCI World Index, which are in turn used by
fund managers to determine their own performance and by banks to establish
conversion rates for its customers. Many banks provide a service to their
customers where they guarantee to trade for them at the London Close rates. Customers
provide the trade amounts to their banks within the one hour prior to the
London Close, also known as “the fix”.
Those banks that have agreed to make transactions for funds at the
London Close need to push through the bulk of their trades during this window
where possible to minimize losses from market movements.
Mutual funds, investment
managers and others use the WM/Reuters rates to:
1. Value,
benchmark and mark to market their international portfolios because most main
stock and bond index compilers, such as FTSE and MSCI, use these rates for the
currency portion of their calculations.
2. Execute
spot trades with banks.
3. Settle
maturing futures contracts
How do banks make money trading typical FX and London Close FX?
Fix-related flows might be large
but banks do not profit for executing the orders as they would in the course of
other FX business. Banks generally make much of their profit in FX trading by
capturing the difference or “spread” between bid and offer as they execute
customer trades. Although
WM/Reuters rates provide a bid, mid-point and ask rate for each currency pair,
most customer trades based upon these rates are converted at the
mid-point. Thus, there is no bank
spread income for most of these trades.
A typical trade where the bank
is earning a spread (and thus is not based off of the published fix) would work
as follows. If a bank sells a
customer 1 million Euro at the ask rate of 1.3746 in return for a payment of $1,374,600
and then purchase the same 1 million Euro at the bid price for $1,374,500, the
bank would have earned $100. The
wider the spread, the higher the bank’s profit. A five point spread would yield the bank $500. On a 5 or 10 million Euro transaction,
which is a typical size in the interbank market, the 5-point spread would
generate $2,500 or $5,000.
Two realities complicate this scenario
for banks. The first is that the
interbank market rarely allows a bank to capture a spread much above 1 or 2
basis points on large trades. The
second is that the spread takes certain market costs into account, such as counterparty
credit and market volatility and thus not all of the spread should be
considered profit.
Nonetheless, the banks know the
London Close orders before the fixing and may place trades to benefit from the
fixing. As Michael Melvin and John Prins of BlackRock wrote in 2011 in “Equity
Hedging and Exchange Rates at the London 4 P.M. Fix,” “The large market-makers
are adept at trading in advance of the fix to push prices in their favor so
that the fixing trades are profitable.”[2]
How could a bank profit by manipulating the
WM/Reuters rates?
Example: a fund notifies the
bank counterparty that a spot trade to sell €500 million / buy US dollars needs
to be executed at the WM/Reuters fix that day. If the fix rate was $1.4020, then the fund pays €500 million
and receives $701 million. If,
however, the bank manipulated the fix so that the rate was 1.4000 (a
manipulation of 20 pips or about 14 bps), then the fund would only receive $700
million US dollars, a manipulated loss of $1 million for the fund. As many funds execute trades at the fix
on a daily basis and in many different currencies, the number of potential
manipulations can be substantial over a period of time.
Could activity perceived as potential manipulation be justifiable risk
management?
Increased volatility can be a consequence
of high volumes, similar to what can be observed at the opening and closing
times in stock markets. Because the London Close is widely used by asset
managers and other institutional clients, it is not unusual for a bank to
receive a large order, sometimes extremely large, a few minutes before the
fix. The bank, having promised its
customer the London Close rate, must reduce its position in a short amount of
time or else the bank is stuck with a potentially large loss. These flows are especially large at the
end of each month and quarter as these managers put new money to work or
reposition their index portfolios.
In a typical transaction, the
bank’s spot traders would be able to fulfill the transaction by conducting a
series of $5 or $10 million in the course of the trading day. The result would be an average rate for
the customer and a minimal impact on the marketplace. This averaging is desirable because a market impact of a
large transaction would move the market in the opposite direction desired by
the client. The client would
effectively be trading against itself.
A one point in time fix, at 4pm London time, is not ideal for minimizing
market impact, making price swings bigger and easier to achieve.
Simple prudent risk management
requires a bank to make sure that it is not harmed by the customer order. For example, if the bank is running a
$50 million short position in EURUSD, and the desk gets an order to buy $400
million, it is in the bank’s interest to close out its position before executing
the client order. Whether this
constitutes front running (dealer profiting or avoiding losses for its own
account by trading for its own account before executing a client order) or
simple risk management explains some of the controversy surrounding the fix.
If the FX market is so large, how could it be manipulated?
In the 24 hours a day, 5 days a
week world of currency trading, there is no closing price. For convenience,
traders, funds and benchmark providers use the London Close as a reference point
in a number of ways. Thus, if
banks really wanted to manipulate FX rates, by focusing on the London close,
which is a sliver of time in the trading day, they can still affect a
significant amount of FX activity.
Moreover, despite the overall
size of the market, FX trading is actually concentrated in a handful of banks,
where the top six banks reportedly receive collectively around 60% to 65% of FX
customer flows. Because they receive client orders in advance of the London Close,
and some traders allegedly discuss orders with counterparts at other firms,
banks have an insight into the direction of rates before the London Close. That
would allow them to maximize profits on the client orders and sometimes make
their own additional bets.
Who are most likely to have been damaged by the alleged manipulation?
Because of the reference by
large financial institutions to the WM/Reuters rates, we suspect that private
individuals and smaller firms and entities that engage in FX transactions at
all hours of the day are less likely to have been directly impacted by any
potential manipulation. Smaller participants would experience indirect impact,
for example, buying and selling fund shares that are based upon a share value
including manipulated FX rates. The mutual funds, pension funds and other large
institutions that trade at London Close rates will be the most directly impacted.
Why do fund managers track indices?
First and foremost, fund
managers must do what the fund documents require, which often will reference
published indices. Additionally, fund performance is often compared to an
index, thereby further incentivizing managers to rely on published rates.
What do we not know?
Unfortunately there is in fact
much that we do not know.
Unanswered questions that would provide critical information include:
Was there actual manipulation?[3]
Which banks were manipulating?
For how many years did the
manipulation occur and did this occur on a daily basis or only sporadically?[4]
Which currencies did they
manipulate and by how much?
Is the London Close the only ongoing fix case?
In addition to its FX
manipulation investigations, British, EU and US regulators have so far assessed
a combined $6 billion in fines over manipulation of the London interbank
offered rate, or Libor, used to price $300 trillion of securities from student
loans to mortgages. Separately, more than a dozen banks have been subpoenaed by
the U.S. Commodity Futures Trading Commission over allegations traders worked
with brokers at ICAP Plc to manipulate ISDAfix, a benchmark used in
interest-rate derivatives. Other benchmark price investigations currently under
way include the London Gold Fix (set twice daily by five banks) and Brent Crude
oil (involving three major oil companies and a pricing service).
***
About the Authors
Jonathan Wetreich is a
Co-Founder of the blog Financial PESTs (www.financialpests.org) and has spent
20 years working in the foreign exchange markets, beginning with Honeywell
International where he managed the foreign exchange execution and hedge
programs. He was responsible for
managing the risk to this multinational firm from changes in foreign exchange
rates, which included buy side trading in spot, forwards and options. Jonathan followed his corporate foreign
exchange experience with sell side positions at Brown Brothers Harriman, a
private bank. His positions at the
bank included consulting with the senior management of corporations to improve
their foreign exchange risk management and execution. Jonathan also spent several years on the foreign exchange
trading desk, working primarily with asset management firms, as well as
spending time as an FX Strategist, authoring commentary on news and market
activity. Since 2012 Jonathan has
run FX Hedge Consulting, an independent consultant to corporations on matters
of foreign exchange risk management, as well as on litigation matters dealing
with foreign exchange. Jonathan
received an MBA from Columbia Business School in Finance and Accounting.
Jack Chen is a Co-Founder of the
blog Financial PESTs (www.financialpests.org) and a finance professional who
has testified in federal court on financial products and currently provides
litigation support services on LIBOR and capital markets related matters. He is
a recognized expert in structured finance where he has nearly 20 years of
experience working in different roles in the capital markets. He started as a lawyer working at
Willkie Farr & Gallagher and then Sullivan and Cromwell before going to the
business side rating structured products at Moody’s Investors Service. He subsequently worked in asset
management firms before beginning his consulting practice. His product
expertise includes credit default swaps, interest rate derivatives and total
return swaps, cash, market value and synthetic collateralized debt obligations,
collateralized loan obligations and structured investment vehicles. Mr. Chen has appeared on the CBS
Evening News and has been quoted or cited in a number of newspapers and trade
journals, including Wall Street Journal, Market Watch News Hub, Risk,
Creditflux, Asset-Backed Alert and Structured Credit Investor.
To contact the authors please
call or email Jack Chen at 646.580.9372 or jack.chen@financialpests.org.
About Financial PESTs (Promotion of Ethics, Simplicity and
Transparency)
With deep experience and
expertise in capital markets, banking, investment products, insurance, and
legal disputes, Financial PESTs cover the gamut of Wall Street activities. We promote eternal core values of
ethical conduct, simplicity, and truth at the intersection of the legal,
financial and regulatory worlds.
Economic development, wealth
creation and social progress demand efficient global capital markets and
financial infrastructure. Guiding
capital effectively to existing and new businesses, inventions, and industries
is a noble endeavor when properly imbued with core values. Unfortunately, the ideal of
uncompromised promotion of ethics, simplicity, and truth often fails to win its
battle against perceived self-interest within financial organizations.
Knowledge and information are powerful tools that
best serve the common good in distributed, rather than concentrated, form. Through writing, lecturing, and
training, Financial PESTs bring our core values to center stage to advocate the
sharing of knowledge and information so that today’s markets serve all
people. We analyze financial world
issues to create clarity, context, and corrective proposals. Financial PESTs push professionals to
the highest standards of probity, candor, and conduct. We distill complex topics to their
simplest forms and campaign incessantly for the simplest implementations of
financial transactions, fiduciary investment programs, government laws and
regulatory rules. We seek truth in
the disclosure of risks, conflicts, agendas, and loyalties.
[3] While we do not know for
certain whether manipulation has occurred, various media sources have reported
that about a dozen currency traders from the major banks have been fired, suspended
or put on leave in relation to this matter.
[4] Bloomberg News has reported
that the alleged manipulation could have gone on for over a decade.
http://www.bloomberg.com/news/2014-01-13/federal-reserve-said-to-probe-banks-over-forex-fixing.html
Subscribe to:
Posts (Atom)