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.

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.

Banks Settle Interest Rate Manipulation Lawsuit

Seven banks have settled a class action lawsuit brought in the US regarding the ISDAfix. The ISDAfix is a benchmark rate used in daily pricing of trillions of US dollars in derivatives, including interest rate swaps, futures and exchange traded options. The seven are JP Morgan, RBS, Deutsche, Credit Suisse, Barclay's, Citi and BOA.

The lead law firm, Scott + Scott, is the same as in the FX benchmark manipulation class action suit. The charges are similar to the FX suit and to the LIBOR charges as well. The charges included placing numerous orders at the close ("banging the close"), collusion leading to to submission of identical orders and placing off-market rates. Eight other banks remain in the suit. If this follows the trajectory of the FX suit, banks that settle later will tend to pay larger settlements.

EU Parliament Passes New Benchmark Rules

This week the EU Parliament addressed the benchmark rate rigging scandals that have plagued financial markets for the past several years, including LIBOR, FX, gold and oil. The goal is to “clean up the benchmark-setting process, improve transparency and prevent conflicts of interest.”

While not yet implemented, new rules will affect benchmarks while breaking them into three categories based upon the size of the instruments and/or contracts influenced (over Euro 500 billion, over 50 billion or below 50 billion). Administrators of benchmark rates will need to create structures to prevent conflicts of interest, will be subject to controls, will have to be authorized or registered, and will need to publish their methodology and procedures for calculating each benchmark. As well, quality standards will have to be put in place for the data used to set benchmarks.

Dismissed Citi FX Trader Wins with "everyone else was doing it"

The former trader brought a lawsuit in front of a UK employment tribunal saying that he was unfairly terminated by Citi. He said that his conduct (sharing information in chat rooms with other FX traders, including sharing private info regarding client trades) was quite common at the time and that his managers were aware that he was on the chat rooms. In 2009 during an employment review he was told by his manager to join chat rooms to gather market information, but was not provided any guidelines on what he could post.

The tribunal found in his favor, although saying that he contributed to his dismissal. A hearing next year will determine the compensation that Citi is required to pay him.

This argument is not one that usually wins in a court ("officer, why did you stop me? Everyone else was speeding also). Although this verdict may help other former bank FX traders who are bringing suits, it does not impact anything else regarding the fixing scandals, such as guilt or fines and settlements with regulators.

Upcoming FX Settlements for Barclays and Deutsche

While FX misconduct investigations began regarding attempts to rig daily spot fixes, it has broadened to additional areas. Now the Financial Times reports that Barclays is near a settlement of over $100 million with the New York Department of Financial Services (NYDFS) regarding the misuse of the last look feature on its FX trading platform, BARX. Last look gives a bank the ability to quickly back out of a trade if there is a significant spot move against them. Those trading on a last look platform would expect to see tighter spreads in exchange for the proper usage of the last look provision.

The FT also reports on several FX investigations into Deutsche. These include the NYSDFS looking into Deutsche's trading platform, Autobahn, a report that there is evidence the bank intentionally set up algorithms to rig the currency markets,and that NYDFS, the Justice Department and other federal agencies have evidence that the bank profited by front running client FX orders. The new CEO at Deutsche may be more willing to try to settle these FX, and other investigations of past misconduct, quickly so that they can concentrate on the changing banking environment.

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.

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 Investigations Widen Beyond WM Fix

When Bloomberg's initial story hit the wires in June 2013, the allegations, later confirmed to be true, were primarily limited to banks manipulating the WM benchmark rates. Since then regulators in the US, UK and Switzerland have instituted over $10 billion in fines on major banks related to FX, and in many cases, banks have acknowledged criminal wrongdoing. These fines related primarily to collusion by the banks in attempting to manipulate the fix, on the back of transcripts of chat room conversations by bank FX traders that clearly showed their collusion and attempts to profit at the expense of market participants. (For other wrongdoings acknowledged in bank settlements earlier this year, please see our blog post from June 1, 2015, FX Bank Settlements — More Misconduct than the Fix)

These regulatory and criminal matters relating to the fix are at least partially behind us now (individual traders and local emerging market fixes remain under scrutiny), although a class action civil lawsuit in the US related to these same matters is ongoing, with 9 banks having settled so far. In addition, law firms around the world are reported to be attempting to institute civil lawsuits in other jurisdictions as well, particularly in the UK. There, in the largest FX market in the world, new laws as of October 1 will allow suits similar to class action suits in the US (and will allow non-UK residents to participate). With over $2 billion in settlements to date in the US (with 7 banks remaining in the suit), there may be several billion pounds of additional settlements in the UK. Regulators in Australia, South Africa, Brazil and South Korea (and possibly others) are investigating benchmark rate rigging as well.

Banks fined by regulators and those settling the US class action have agreed to cooperate with regulators and the parties bringing the suit. Lawyers from the suit are reported to have said that evidence from the cooperation in the US points to bank manipulation of the bid-offer spread on currency trades through the rest of the day, not having to do with the fix. How this may have been done is not clear, but if true would dramatically increase the scope of bank wrongdoing. It would mean that the rates on many more trades are not entirely market driven and all such trades would have the bank gaining at client expense, while the benchmark manipulation had some clients gaining and some losing from each manipulated rate.

Until more information is released it is hard to know if there was additional rate-rigging in FX markets. Should it be shown to have occurred, a further move toward exchange-type trading should be expected, as well as further criminal prosecutions and civil suits. Bank traders and investors beware.

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).

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.

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.

From SCOTUS Blog: LIBOR Litigation

For those of you following the LIBOR litigation appeal in front of SCOTUS, here's an excellent write-up from the good folks at SCOTUS blog.   

Not Edgar Too! Do High Frequency Traders Have an Advantage?

Bloomberg reports that a study highlights another way that high frequency traders appear to be taking advantage of slower market players.  The SEC's EDGAR system receives companies' required  filings electronically.  There are some participants that pay to receive this service directly while most can access it for free online.

The study indicates that the documents are received between 0 seconds and up to one minute earlier by those who pay compared to when the documents are made available online to all others, 10 seconds earlier on average. The study also shows that in cases where the filing availability was made earlier to paying market participants, abnormal volume and price moves began on average 30 seconds before availability to the general public.  The study does not tie the early availability to these moves, stating that the cause is unknown.

While there are many reasons that some are concerned about high frequency traders making money at the expense of slower moving investors, this has not been heard of before by us.  While the article states that this is most likely unintentional, as high frequency traders did not exist when the system was initiated in the 1990s, it does seem to highlight another way that certain market players keep ahead of the regulators and the rest of the market.  Ironically the system replaced a much longer availability time discrepancy when reports were not available electronically at all.  The SEC has been reviewing the situation at least since June.

We will need to await the SEC's review to assess market impacts and the potential for a new set of "market rigging" lawsuits.

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.