State Street Bank Settles FX Custody Trading Suits

In 2009 a whistle blower filed a suit on behalf of CalPERS and CalSTRS, alleging hidden markups in the FX rates given to custody clients when they used the "standing instructions" custody method of FX trading. State Street has settled this suit, DOJ, SEC and DOL investigations, as well as a private client lawsuit relating to FX matters, totaling $530 million. In effect this wipes the slate clean for State Street relating to FX pricing matters.

The suits alleged that markups were hidden from clients, while certain custody clients were told by State Street that rates were based on interbank market rates. In the settlements State Street acknowledges that markups were taken.

While these issues are quite different than the more general FX benchmark manipulation and other related charges settled by numerous banks, Bank of New York and State Street, two major custody players, were hit with charges related to "standing instructions" pricing. These trades tend to be numerous, small "nuisance" trades that, however, could be quite profitable to the banks with large markups in price. Since the original suit was filed, custody banks have become more transparent, and now typically provide known fixed spreads to their clients on such trades.

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.

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 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).

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.

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.

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.

From AVC Blog: The Bitcoin Hype Cycle

Fred Wilson of AVC blog has a great piece about the Gartner Hype Cycle, which lines up rather nicely with the price history of Bitcoins.  Bitcoin enthusiasts should definitely check it out. 

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.

Peer-to-peer currency exchange startup

Saw this pitch from WeSwap which is a peer-to-peer (p2p) fx exchange startup. Its success will depend heavily on adopters and volume of transactions that take place. But it's an interesting and ambitious attempt to apply the p2p business model to yet another aspect of the banking business model. 

Comments Published Regarding FSB's FX Benchmark Recommendations

The Financial Stability Board had issued general recommendations for changing foreign currency benchmark fixes, open to comments through August 12.  This week the FSB released the comments from 36 interested players, including asset managers, banks and others.  A page with the links to these comments is included here.

Two areas that may be considered controversial seemed to have a lot of support.  The first concerns paying the banks for taking fix orders and charging a bid/offer spread or specified fee (discussed in a prior post here).  Comments included the logic of paying for this service to reduce the incentive for banks to look for ways to make profits in ways that hurt their customers.  Comments acknowledged that any such charge will not eliminate this possibility, and thus the need for a better process / monitoring the market makers will remain.

The second involves widening the period of the fix.  The current WM Reuters fix window is one minute for major currencies.  While there was much support for this, there seemed to be concern that the period not be widened to much, perhaps beyond a half hour, as this could add difficulty to managing trading risk and could add volatility from exogenous factors such as market news impacting the fix rates.

The FSB is scheduled to issue final recommendations in early November.

Who Likes the Financial Stability Board's Recommendation of a Fee for FX Benchmark Trades?

The Financial Stability Board released a consultative study on FX benchmark rates that includes several items for the industry to consider as well as a couple of recommendations.  One recommendation was to widen the period of the window for calculating rates.  Another was that the banks should charge for the service of filling fix orders.

As it currently stands, the WM Reuters rate, the London Close benchmark which is the fix with by far the largest daily volume, includes a bid, mid-rate and offer rate for each currency pair.  Most large and many small users of the fix are filled at the mid-rate, and thus do not pay any fee or bid offer spread to their bank for filling their order.

Why does this occur?  Banks allow it as the cost of doing business with large customers.  If others are doing it, you need to do it as well - it became a market practice in effect.

Bank customers, of course, would like all trades executed for free, so how did fix trades become the only trade type executed routinely without spread or fee? This occurred as many funds use the WM Reuters FX rates to translate their local currency asset values into base currency values each day.  The investment managers then wanted to execute any trades for that day at the same rate to avoid FX tracking error for their funds.  Many managers also saw these rates as a means to achieve market rates without going through the work of negotiating rates with their banks. Others such as corporates began using the mid rate for execution purposes while hedge funds and others did so for speculative purposes.

While this seemed to be a win for the customers, it was not for the banks.  When the fix began in the early 1990s FX spreads were quite wide compared to today and perhaps the banks could more easily tolerate these "free trades".  Apparently as pressure increased on traders to perform in an environment of reducing spreads, some misconduct occurred, including collusion, as a means to generate profits on these trades.

The FSB's suggestion seems quite sensible to us.  Expecting free services does not. In effect, the actions that traders took in recent years reinforces the adage regarding no free lunches.  Using bid offer spreads or a small commission should reduce this tension between bank and customer.

While not the only change required to benchmark trading, this change is reasonable and should go along way in making this a more rational part of the FX business.

Asset managers and other fix users may not like the concept initially, but its inherent reasonableness and the need to increase market participants' faith in benchmark rates should see customers agreeing.  The devil being in the details, however, the size of any commission or spread (tracking error to many) may be much more controversial.