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.

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.

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.

Lehmanizing Europe .... Incredible!

EU Banks May Get Asset-Backed Security Leeway in Liquidity Rules

    As we found in the Global Association of Risk Professional (GARP) news story above, the EU regulators are set to permit banks to count ABS bonds within liquidity requirements.

But this is precisely how Lehman Brothers failed in 2008 !!!

    Of course, there is a long story one may tell about the failure of Lehman.  See the exhaustive and authoritative report of the Examiner for the Lehman Bankruptcy.  There are many investigatory paths to follow in the analysis of complex institutions such as Lehman.

    But if one had to identify the dominant failure mechanism and to state in a simple yet accurate manner, here it is:

Lehman failed due to its stuffing its "liquidity pool" with (what it called) investment-grade ABS which, in crisis, were illiquid, mis-priced, and otherwise unacceptable as collateral to any lender that took the trouble to review the bonds.

See here one brief discussion of Lehman's Liquidity Pool "own goal."

Does the EU truly wish to replicate Lehman in Europe?!  Whether in time of Crisis or not, ABS bonds - regardless of credit rating - are not liquid!