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.

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

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.

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.

DOJ probes bank sales practices in forex market

Bloomberg reports:

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

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

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

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

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

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

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

Bloomberg: Traders Join Exodus as Forex Probes Add Pressure on Costs

Bloomberg reports that more than 30 traders from 11 firms have been fired, suspended, taken leaves of absence or retired since October of last year when government probes of potential forex manipulation started picking up. The worst hit banks, according to Bloomberg, are UBS and Barclays. Supposedly some of the departures are due to personal reasons. Compared to the Libor scandal, the forex scandal has played out quite differently. Fires and suspensions are occurring before any settlements have been reached, thus leaving out a great amount of detail as to what these banks have uncovered that led to the departures. The media is not reporting any rumored settlements either, so it looks like we will have to wait a while longer. 

Swiss Name 8 Banks in Forex Manipulation Probe

Some expected names, but a couple of surprises when the the Swiss Competition Commission named the 8 banks under scrutiny relating to potential forex manipulation.  This comes, of course, on top of industry nervousness and concern over the scope of investigations, potential manipulation and, most of all, potential penalties and damages to be paid to regulators and law suit settlements.  

Given the global scope of the investigations, with even jurisdictions like New Zealand getting involved, the smart money should be betting that this will need more time to play out before we can start putting estimates of dollars and cents on the fix.

UBS Announces Internal Investigation into Precious Metals Trading

The UBS annual report released Friday mentioned this as an outgrowth of their earlier begun FX investigation.  A couple of interesting points:

1) The mainstream reports over the last year have referred to alleged gold price fix manipulation.  Only 5 banks are involved in the benchmark rate setting process, and UBS is not one of them.  Goldbugs, on the other hand, have screamed market manipulation (by banks holding down the price of gold) for years.  While we are not gold market mavens, it appears difficult to believe that a long term strategy to hold down the market price of a commodity can be successful.  However, if any manipulation is found at all, we can expect many more conspiracy theories to see the light of day (and manipulation reports over the last few years will make them all a bit more believable).

2) Since the LIBOR scandal, UBS has developed a reputation of being the first bank to investigate allegations of wrongdoing and the first to approach regulators when anything untoward is found, trying to reduce or eliminate penalties.  Thus, this raises the question if once again, UBS is an early mover and additional precious metal trading investigations are to be begun.

UBS Said to Cooperate in FX Investigations in a Bid for Immunity

Bloomberg today reports that people familiar with the investigations say that UBS is cooperating with regulators in the US and the EU into the benchmark FX allegations and will disclose any wrongdoings.  As we have reported in prior posts, there is a huge incentive for all banks to consider this course of action, and we would be surprised if other banks are not doing/planning to do so.  The biggest benefits go the first movers and so there should be a rush to the investigators, as many banks have mounted internal investigations to uncover wrongdoing.  In addition, it has been previously reported that LIBOR settlements require many of the banks to cooperate in any benchmark rate investigations.

More FX manipulation lawsuits to come?

Based on media reports there are currently two class actions against the major banks regarding the alleged manipulation of the FX market, filed by Haverhill Retirement System and Simmtech Co. Ltd.  Given the steady reporting of additional details of investigations and suspensions and firing of traders at the top banks, the question probably isn't whether more lawsuits will be filed but when and how soon. 

http://www.businessweek.com/news/2013-11-01/barclays-citigroup-among-banks-sued-over-wm-reuters-rates-1

Bloomberg: Banks assist regulators in FX probe

Libor, ISDAfix, FX, it all becomes one big blur.  Bloomberg today reports that cooperation agreements that banks entered into with regulators to settle Libor are now providing regulators with evidence as they investigate the FX manipulation.  Could these agreements reach other potential manipulation in the oil and gold markets?  http://www.bloomberg.com/news/2014-01-23/banks-aid-u-s-forex-probe-fullfilling-libor-accords.html