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.

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.

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.

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.

Something Funny Happened on the Way to Court

News about the alleged forex manipulation has sucked most of the media's attention and focus away from the Libor and ISDAfix scandals.  I just saw, however, this recent piece from Global Insurance Intelligence discussing the potential payouts on the ISDAfix scandals. The article suggests that the payouts for ISDAfix could dwarf the costs of Libor and forex but does not share any analysis as to how they got to that conclusion. I don't have a crystal ball telling me whether there will in fact be any payouts on ISDAfix and if so what they will be, but this is a welcome distraction of the steady drumbeat of news about forex traders at big banks being suspended or fired. 

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? 

GARP: Barclays Fined $44 Million by U.K. FCA for Gold-Fix Failings

Here's a great article from GARP reporting on the $44mm fine Barclays received from the UK's FCA for alleged manipulation of gold prices.  What's next?   

Growing trends: increased regulation of forex trading

The Sydney Morning Herald reports that Australian government "may be forced to beef up forex regulations." This follows reports that the UK's Chancellor Osborne is also targeting forex manipulation. That is no surprise. What remains to be seen is exactly how regulators can "beef up" the forex market to prevent the types of manipulative practices reported in the media.  And while they're at it, don't forget about ISDAfix, LIBOR, gold, and other metals trading too.

Bloomberg Business Week: Bank of Canada Conducting Survey as Part of Currency Review

Bloomberg Business Week reports that the Bank of Canada is conducting a survey as as to the usage of forex rates as part of its review of potential manipulation.  You can view the press release here and take the survey here. 

Bankers' New Clothes? Authors' New Clothes? Whose Clothes are Real?

The Bankers' New Clothes:  What's Wrong with Banking and What to Do about It

We've just finished this popular criticism of modern banking by Anat Admati and Martin Hellwig.  We pay the highest compliment (in our view) that a book of this type can earn:  the authors are right.  Well, backtracking just a bit, the authors are qualitatively right on their central point.

Admati and Hellwig have one clear and dominant message:  banks should have much more equity.  The book pushes risk weighting of assets to the side and complains that modern banks - even after the Credit Crisis - may have equity that is just 3% of total assets.  The authors want 20-30% equity as the minimum rather than 3%.  Say it again - banks should have much more equity!

These bank antagonists spend much of the book (correctly) anticipating bankers' objections and giving sound refutations.  For example, increased capital requirements will not reduce lending IF banks choose to raise equity rather than reduce assets.  Also, bank ROE may certainly decline with increased equity, but the bank shareholders' RISK also declines - making the outcome more of a trade-off than a penalty to equity investors.

The downside of Bankers' New Clothes is everything else.  There is nothing resembling a justification of the 20-30% equity-to-asset prescription.  Admati and Hellwig simply state that bank equity was higher in the 19th century and was in this 20-30% range at the beginning of the 20th century.  This "analysis" is not adequate - the authors would have retained more credibility by admitting this shortcoming themselves.

While Admati and Hellwig give reasonably thoughtful discussions of recent failures of regulation, unholy alliances between governments and banks, the negative consequences of political meddling with banks, and the great desirability to just let banks fail, they then DEFEND and argue for the preservation of regulators, government and political control, and the imperative NOT to let banks fail!!

The Admati-Hellwig thesis is simple (and simple is good!):  force banks to have 20-30% equity relative to assets and don't change anything else.  We like the first part (qualitatively) ....

Money Managers Ask Congress To Increase Duties Of Trustees In Mortgage-Backed Financings

Saw this interesting blog post from the law firm of Perkins Coie regarding duties of trustees in mortgage-backed financings.  This debate about the duties of trustees pits the Association of Institutional Investors against the American Bankers Association and can be seen as one of the battle fronts in this war. The other battle front being in the courtroom where investors have taken on trustees of residential mortgage backed securities. For more info head to the blog post or check out this story on Bloomberg.

British regulators charge 3 Barclays bankers in NYC for Libor manipulation

NYT Dealbook reports that regulators from the British Serious Fraud Office announced charges against 3 former Barclays bankers based in NYC as part of the ongoing Libor manipulation prosecutions. This brings to 12 the total number of defendants facing charges in Britain for the Libor scandal, even though British prosecutors say they have identified as many as 22 individuals involved. Dealbook reports that one of the newly charged defendants is "expected to argue that he did nothing wrong and that the Libor manipulation was going on before he joined the bank two years out of college."  Perhaps he is thinking of striking a plea deal? 

Fannie, Freddie say overhaul would boost mortgage rates.

WSJ reports that Fannie and Freddie have written a memo stating that an overhaul of the mortgage market that excludes them would (surprise) increase the cost of a mortgage. With the midterm elections this year and lack of consensus even among Republicans, the smart money would bet that no reform bill gets passed this year. The WSJ link contains links to download the memos. The Senate bill being considered by the Senate Banking Committee would replace Freddie and Fannie with a system whereby private companies can package mortgages into federally insured mortgaged backed bonds. I have not yet studied the bill so cannot comment in a substantive manner but conceptually I do not see how the proposal can be better than what we have today. I am not saying that Fannie and Freddie are faultless for their roles in the credit crisis but a solution of a distributed system but with the federal government still on the hook seems like it could create as many problems as it solves. 

Class Action FX Benchmark Lawsuit Filed

A dozen individual lawsuits alleging antitrust and anti-competitive behavior on the part of the 12 largest FX trading banks, based upon their behavior at the WM Reuters London Close FX fix, were consolidated and filed as a class action last week.  The plaintiffs and defendants are listed below.

The allegations are similar to those aired in the press over the last nine months or so.  This suit has updated some of the individual suits based upon recent information from the Bank of England and recently fired or suspended bank traders and include some examples of how FX rates were allegedly manipulated.  While for bank customers and those interested in the integrity of markets, the issue is simply whether or not the allegations are true, for the success of the suit, antitrust and anti-competitive behaviors must be shown.  Thus much of the suit contains the plaintiffs' building of such a case.  Similar issues drove the LIBOR case.

Much of the information for the case and press stories, relates to banks' internal investigations and their cooperation with regulators.  As highlighted in the suit, DOJ LIBOR non-prosecution and deferred prosecution agreements require many banks to provide information relating to benchmark manipulation, including manipulation of FX benchmark rates.

The class has been defined as those trading FX at or around the London Close since at least June 1, 2003. Included are those not trading the fix but trading at around that time of day and those trading forwards and swaps as well as spot.

No attempt is made to quantify damages or who are the members of the class.  Reference is made that records should exist, which we can only assume would be held by the banks.

Plaintiffs                                                                        Defendants
Aureus Currency Fund                                                     Bank of America
City of Philadelphia, Board of Pensions and Retirement     Barclays
Employees’ Retirement System of the Government of       BNP Paribas
       the Virgin Islands                                                     Citigroup
Employees’ Retirement System of Puerto Rico Electric      Credit Suisse
       Power Authority                                                       Deutsche Bank
Fresno County Employees’ Retirement Association           Goldman Sachs
Haverhill Retirement System                                           HSBC
Oklahoma Firefighters Pension and Retirement System     JP Morgan
State-Boston Retirement System                                      Morgan Stanley
Syena Global Emerging Markets Fund                               RBS
Tiberius OC Fund                                                            UBS
Value Recovery Fund
United Food and Commercial Workers Union and
       Participating Food Industry Employers Tri-State
       Pension Fund

Who Run the World? Rating agencies?!?!

Gizmodo went beyond their usual comfort zone and published this post about rating agencies and one (of the many) proposed solutions on how to rid the evil that is ratings.  In my years working in the capital markets I have heard many complaints about the rating agencies, but at the end of the day, investors rely on ratings. Why? Because they value the opinion of the agencies.  If they truly thought that ratings were completely broken, why do they still rely upon them?  As for the conflicts issue, well, nationalizing agencies only create more problems than resolve them. And if issuers are not supposed to pay, then that only leaves the investors. But guess who often complains about the possibly investors paying for ratings?  Investors. 

How Soon They Forget!! (Or Did They Never Learn?)

Hard to believe - we learned today that the EU is troubled by new Fed rules for foreign banks operating in the U.S.

Michel Barnier, one of those innumerable European commissioners nobody really keeps track of, is worried.  He's fretting about the potential impact on the global level playing field since we must always ensure competition on an equal footing.

Where's the substance??!!

Why isn't M. Barnier making the strongest case he possibly can that European banks have plenty of capital now?!  Prove - or at least argue - that the banks on his side of the Atlantic are highly immune to insolvency risk and that they no longer have assets much longer in maturity than their liabilities.  In other words, make the argument that your banks are strong and NOT just that you want regulation to be "fair!"

These concepts of "fairness" and "level playing field" are not new!  Putting such amorphous and non-essential concerns ahead of true substantive analysis of banking risk is one of the many enablers of the disarray of the past 7 years.

See here the text of a conference presentation we made in Sydney in 2001.  Here's an excerpt:

"Why are the BIS rules so bad?  Well, the portfolio credit risk puzzle is quite difficult.  More importantly, BIS regulation is unavoidably a political process.  That means the end result must be simple and comprehensible to all, everybody - worldwide! - must agree, and all banks and countries must be treated “fairly” (where “fairness” is generally in the eye of the allegedly offended).  That can’t work.  We end up with rules that are wrong but for which there is universal agreement."

(If we had it to do over again, we'd certainly leave out the idea that rating agencies could do a better job than the BIS.  Live and learn!)

FX Benchmarks for Indonesia's Currency Changing to Rectify Deficiencies found by MAS

Another aspect of the widening of the FX probes - Reuters reports that Singapore banks will no longer set the benchmark rates for the Indonesian rupiah. This follows last years's investigation by the Monetary Authority of Singapore which censured traders for attempts to manipulate both interest rates and currency rates, including ones used in the pricing of Southeast Asian non-deliverable forward FX contracts.  

News stories have spread from the original London close benchmark rate to other FX benchmarks and also include reports of collusion, traders trading for their personal accounts, sharing client orders with certain clients and trades against client interests relating to option levels.  Investigations by regulators around the world continue.

Additional Regulator to Investigate FX Benchmark Rates

Today saw the addition of a 12th regulator investigating the allegations of banks colluding in the manipulation of the WM Reuters fix.  The New York State Department of Financial Services regulates banks in NYS including the US operations of many non-US banks.
Bloomberg Article

The increasing stream of suspensions and firings of senior traders at many banks as part of internal investigations, makes it appear increasingly likely that the investigations will find misconduct on the part of at least some of the major banks.

In the event of such a finding the banks will be facing large fines ($6 billion in the LIBOR rigging), additional regulation, the loss of profits from the misconduct, and additional pressure from customers to reduce spreads after the bad publicity.  Benefits for the banks may include trades moving away from fix prices that provide the banks with no spread income as well as, in the long run, greater trust from customers due to a different type of fix / fix trades and the additional regulation.

How does Bitcoin help criminals? Let him count the ways.

Dealbook reports that law enforcement officials testify as to how virtual currencies like Bitcoin help criminals.