FX Brokers Investigated by NYS AG for Spoofing

The New York State Attorney General is investigating FX brokers for spoofing on their electronic platforms. The investigation is looking into whether or not the brokers did this in FX options for emerging market (EM) currencies, to create the illusion of more trading and liquidity in order to increase customer demand for these instruments. FX options in EM currencies tend to be illiquid with a limited amount of trading.

Spoofing is the posting of orders to buy or sell with the intent of cancelling them without execution. While spoofing is frequently used as a means to lead a market in a particular direction, here it seems the concern is that brokers were trying to create the appearance of a more liquid, vibrant market in order to lure additional trades onto the brokers' FX EM options platforms. The AG is reported to have subpoenaed records from brokers including TFS-ICAP, Tullett Prebon, BGC Partners and GFI Group.

Investigations of Electronic FX Trading Continue

Reuters reports that the New York Department of Financial Services (NYDFS) investigation of several money center banks for FX rate manipulation on electronic trading platforms is continuing. They report that NYDFS has interviewed dozens of traders and executives at Barclay's, Deutche Bank and Credit Suisse among other banks (NYDFS has its strongest remit with foreign banks) over the past several months. Subpoenas have also been sent to BNP, Goldman Sachs and Societe Generale according to Reuters sources.

NYDFS has already been known to be investigating FX algorithms on these platforms at the banks to determine if there is an attempt by the banks to advantage themselves at their clients' expense during the time between a rate being posted and then being accepted by a client. The concern is that this period may be used to front run client orders or otherwise manipulate FX rates. Earlier bank settlements with regulators covered spot market trading, but NYDFS agreements particularly, did not cover electronic trading. The Department of justice is also investigating FX electronic trading.

No information is available on how these investigations will play out against the various banks involved. The fact that they continue and appear to have widened from initial reports limited to Barclay's and Deutche, may indicate that regulators have found potential issues worthy of investigation, but do not provide clues as to the outcome.

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.

JPMorgan Settles FX Benchmark Manipulation Lawsuit

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

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

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

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.

Settlements Approaching on FX Benchmark Rate Investigations

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

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

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

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

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

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

Regulatory Investigations of the FX Markets are Progressing

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

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

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

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

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.

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.

Reports of FX Traders Colluding on NonBenchmark Trades

Many of the charges in the FX manipulation  media reports are possibly explicable as banks carrying on risk management before and during benchmark fixings.  Without further details we do not know if there has been misconduct.  However, the reports of collusion between major banks in the time period when London Close FX rates are established certainly means that, if true, the banks were involved in misconduct.

Now Reuters reports that the British regulator, the Financial Conduct Authority, has chat room transcripts of top traders from three large banks in London discussing the spreads to be put on specific, apparently large non-benchmark trades.   If true, then collusion extended beyond benchmark trades to the general FX market as well.  As allegations continue to come out from the FX and other markets, conspirators who have long alleged that banks controlled "the markets" are looking less and less crazy and leading some to wonder just how pervasive was misconduct.  As reported here last week, estimates of regulator FX fines to come for banks are as high as $35 billion.  Such magnitude is apparently effecting banks and recent reports have mentioned that banks are moving to further increase their proportion of electronic trading as there is less regulatory risk and less chance of misconduct on the part of traders.

Report that DOJ is Investigating FX for being ... an OTC Market

Bloomberg reports today that people with knowledge of the matter say that the Department of Justice is looking into the practice by banks of charging different size markups to different clients, based upon how closely they watch market rates.  The DOJ is looking into whether not disclosing this practice represents fraudulent behavior.

FX, as an OTC market, does not charge commissions but instead banks earn profits by charging a markup on the rate to clients.  References in the article are to bankers executing trades that are sent to them via email, and then waiting some time to see if the later currency rate allows them to charge a worse rate to the client (this is similar to the fact pattern in the standing instructions lawsuits ongoing against several custodial banks).  In fact, all FX OTC trades, however initiated, include varying markups, based upon client relationship and client credit among other factors, including how closely the client watches market rates.

Buyer beware, whether buying FX or going to the store to buy milk, should be the underlying principle that protects buyers from unscrupulous sellers (and sellers from an overreaching government).  If the longstanding implications of the OTC market (unequal pricing) are no longer acceptable, what are the alternatives?  The least intrusive might include a warning notice about the OTC FX market, provided when opening an FX account (this account may be hazardous to your financial health).  The most would be to change the regulatory regime and create an exchange traded spot and derivative FX market, potentially to the detriment of the majority of market participants who benefit from a low cost, highly liquid market.

Regardless, the FX custodial lawsuits were followed by FX benchmark suits, and this leads me to suspect that there will be another wave coming.

Forex rigging investigation expands to taint more banks

The media have reported that German regulators are expanding their investigation of forex rate manipulation beyond the small handful of banks known to be targets. According to Reuters, "all German banks with forex trading activities have been asked to conduct internal probes and to submit their findings" to the regulators.  In fact, even banks with a minor market share in the forex market, such as Commerzbank, is suspending their forex traders due to alleged attempted manipulation.

Does anyone out there wonder whether this controversy will reach beyond the money center banks and start touching the investment banks? 

UK to Increase FX Oversight

Bloomberg reports that the UK will announce new regulations for the FX market as a response to the stories of WM Reuters benchmark rate manipulation at the London close.  Chancellor of the Exchequer Osborne may announce these rules at his annual address to be held next week.  While details are slim at this point, it is expected that they may include making the manipulation of benchmarks a crime, as well as mandating additional oversight of bank employees involved in benchmark rate setting, by their employers.

Clearly some change is required following the news reports, suspension of traders by banks and the first hints by some regulators that misconduct has been found in FX.  However, maintaining the liquidity of the FX markets should be paramount.  The information regarding potential manipulation has already started many market participants to review how they can improve their use of, or whether they should use, FX benchmarks.

Banks Seek Dismissal of FX Fix Rate Manipulation Class Action Lawsuit

Reuters reports that the 12 banks included in the WM Reuters manipulation class action suit are requesting that the case be dismissed.  This would seem to be a standard legal maneuver but we will need to wait to see the judge's ruling.

The banks state that no specific instances of manipulation are mentioned in the suit, nor is there any specific instance of harm brought forth in the suit.  The plaintiffs apparently are waiting for internal bank or regulatory investigations to provide them with some specifics.  The banks are hoping for dismissal before this occurs and to avoid the discovery process if the case is allowed to continue.

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.

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

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

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

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

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.

Clients will Need to Pay for Trading at FX Benchmark Rates

We have said in previous posts that trading with a bank for a fix later in the day, without paying the bank for the service (most fix trades are executed at the midpoint, avoiding even the usual bid offer spread paid for an immediate trade), is the source of much of the trouble with fixes.  Clients wanted it and banks accepted it.

This article in FX Week (subscription) describes the problem that the banks have with these trades.  Trading before or during the fix can bring accusations of front running or manipulation, and trading after the fix risks incurring losses, which banks have been particularly unwilling to risk since the financial crisis.  Based upon the allegations in lawsuits and the regulatory and bank investigations underway, many suspect that some bank traders may have found ways to make profits on such trades anyway, including collusion among the banks.

For those who wish to continue fix trading, they may ultimately need to be willing to pay a bank to take on this risk or manage the risk around the fix themselves, either utilizing algorithms or traders with tight risk parameters.  Managing the risk by the firm involves staffing/trading costs as well as the cost of variances between realized rates and the fix.  At the moment there is no indication that banks are considering charging for fix trades, but with continuing compression in bank spreads on non-fix trades, eventually this may be part of the solution.

Financial Times: DoJ raises stakes in forex probe

The Financial Times reports that US DOJ criminal prosecutors have traveled to London as part of its forex probe to interview people potentially involved in the alleged manipulation of the forex market. The article points out an interesting distinction between US and UK law, where the US has the right against self incrimination whereas the UK authorities can compel potential defendants to answer questions. While there has been a lot of smoke regarding the forex investigations, many of us are still waiting to see the fire. What exactly did the banks do and how did they do it and for how long?  Leaks to media sources are not the best way for the public at large to understand the scope of this thing.