ECB to Inhibit Trading Utilizing Daily EUR Reference Rates

The ECB publishes reference rates on 30 currencies at 2:30 PM each day, based upon spot rates at 2:15 PM. The ECB wants these to be used for reference or informational purposes only, not for trading. The ECB has not said whether or not it suspects rigging of these daily rates, as existed in the WM Reuters daily fixings. As of July 1, 2016 these rates will not be published until 4:00 PM, thus seemingly reducing their usefulness as a basis for trading or for that matter, for rate-rigging by any parties interested in such behavior. The ECB said this change is a reaction to recommendations by regulators reforming global FX benchmarks.

It has been our experience that these rates are used for trading, particularly by asset managers, although not to the degree to which WM Reuters rates are used. Any such traders after July 1 will have to either utilize other means to trade or wait much longer between when positions are provided and trade rates are known. This time is at a minimum an operational delay/complication, or worse, an additional operational risk.

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.

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

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.

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.

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.

All Announced on One Day: Five Banks Fined for FX, One for Precious Metals and BOE Chief FX Dealer Fired

As had been rumored for a few weeks, FX settlements between multiple regulators and several FX banks were announced on the same day, today. The banks prefer not to be singled out for misconduct but just to be one of many, so that this is viewed as more of a market problem. The banks were not found to have attempted to manipulate FX rates but instead found to have had ineffective controls allowing traders to engage in manipulative behavior. However, the DOJ is still looking into criminal charges, the New York regulator would not sign on to this agreement as it was felt to be too weak and penalties against many other banks by these same and other regulators will be forthcoming.

The Swiss regulator FINMA also fined UBS for precious metals misconduct, finding "clear attempt to manipulate precious metals benchmarks", particularly in the silver market. As FINMA also fined UBS for FX market violations, UBS would certainly have wanted both announcements at once.

Then the Bank of England hopped onto the bad news train today as well. They have been quiet for several months after announcing that an unnamed employee had been suspended for misconduct regarding FX. Today they announced that the chief FX dealer had been fired yesterday, but still provided little information, other than misconduct was discovered as part of the FX manipulation probe but the behavior itself was not related to the probe.

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.

How to Build DISASTROUSLY WRONG Financial Models

Here’s the secret:  begin with the wrong goal.

(Adapted from How to Build Disastrous Financial Models, a Quant Perspectives column published by the Global Association of Risk Professionals)

Perhaps the greatest weakness we quantitative financial people have is that we assume at the outset of our careers that all colleagues and competitors share the philosophy that the goal of model development is to seek truth.  That is, imagine the current model task is to estimate the value of a loan or derivative trade, or the risk of a portfolio, or the proper credit rating of a bond, or the likelihood of repayment of a residential mortgage.  Clearly, we assume, everybody would prefer that the model have good accuracy (i.e., truth) in estimating value, or risk, or credit rating, or repayment likelihood.

Unfortunately, real life is different.  Many, though not all, actors in the financial world – business heads, traders, rating analysts, executives, regulators, consultants, auditors, politicians – desire models that describe and promote their reality.  As an example, the head of a trading desk wants models for derivative pricing that permit her group to win an adequate number of trades in competition with other firms.  (The direct experience of a friend of mine is that the tranche correlation desk of a first-tier investment bank rejected the quant team’s improved pricing model because it made the desk lose trades!)  In this case, rather than accuracy, the “reality” of the trading desk is that a good model will help win trades.

Another example is the difficulty of the CEBS (Committee of European Banking Supervisors) and EBA (European Banking Authority) in implementing stress tests for European banks beginning in 2009.  Stress tests are models.  For the CEBS and then the EBA, the “reality” of the stress test model is that it must be credible to the public and build confidence that the banks are adequately capitalized.  (See Kevin Dowd’s penetrating and entertaining “Math Gone Mad,” CATO Institute 754, 1-64, September 3, 2014.)  Needless to say, the goals of credibility and confidence are not synonymous with truth and accuracy.

Yet another, albeit indirect, example of a manipulated model is the U.S. Consumer Financial Protection Bureau (CFPB) determination that bank lenders enjoy a presumption of prudent mortgage lending practices under “Ability-to-Repay and Qualified Mortgage Standards.”  This “QM” standard specifically does not require the lender to impose or consider the loan-to-value (LTV) ratio of the mortgage loan.  Yet, if the goal of mandated underwriting standards is to reduce loan defaults, which harm both lender and borrower, then omission of LTV consideration from the “model” for a qualified mortgage is a huge oversight.  (See, for example, “Housing Industry Awaits Down-Payment Rule for Mortgages,” Bloomberg News, January 18, 2013.)  Unfortunately, the “reality” for the CFPB and self-appointed advocates is wide access to mortgage loans rather than low default risk of the loans.

There are numerous further examples of both high and low public notoriety in which practitioners create or adjust models in “helpful” directions only.  Lehman Brothers in 2007-8 (see page 180 of the Examiner’s Report) and J.P. Morgan in 2012, for example, tweaked their internal models to reduce apparent risk.

The focus on reaching desired end results rather than true and accurate results is certainly a misuse of financial models, but there’s a nuance to consider.  To judge truth and accuracy, one must inspect the model results and determine somehow whether the results “seem right.”  It could well be that the loan underwriter who watches competing lenders make loans that he had rejected will legitimately question the accuracy of his own bank’s model.  But how does one distinguish legitimate questioning of the model result from abusive adjustment of the model?

There is no simple answer other than to rely on the expert judgment of the quantitative model developer and for all analysts, users, and management to adhere to a principle of good faith.  This good-faith standard is the commitment to truth and accuracy.  Senior executives of the institution must understand that models are, by nature, malleable given their numerous judgments and assumptions.  With this understanding, the executives must then set, proclaim, and maintain a culture of good-faith, unbiased model construction and use.

The best uses of quantitative models are:  (i) the learning, intuition, and judgment one develops while building the model and (ii) the testing for completeness and quality of the firm’s data that exercising the model provides.  By virtue of assumptions and insufficient information, many financial models are less useful as generators of precise numerical results (e.g., for bank capital, loan default probability, et cetera).  When it’s imperative to have such numerical model results, then the principle of good-faith model construction is critical.

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.

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.

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.

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.

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?