News broke recently that Barclays has suspended six traders in an internal probe looking at whether its employees were rigging the foreign exchange market.
There’s also RBS, who emailed clients Wednesday to essentially say, Yikes, we’re going to go ahead and take a look at what our traders are doing in the minutes before rates are set.
Regulators in the U.S., Asia, and U.K. have all opened investigations, with multiple banks implicated. Even JP Morgan, already very much in the penalty box, has said that various regulators are prying into their currency trading practices. Here we go again!
This particular rigging saga is not to be confused with another well-known scandal — so-called Liborgate — where traders manipulated the short-term interest rate benchmark.
But it looks like this (fairly similar) one may be the next big Traders Doing Very Bad Things fracas to rock the financial world.
We’re here to answer your questions.
Hey, what’s going on here?
We’ll start with the basics. The foreign exchange market — “forex” — is the biggest market in the world, though it doesn’t get as much mainstream press as its stock and bond brethren. Traders buy and sell money on the forex market.
“The FX market is like the Wild West,” one forex expert told Bloomberg. “It’s buyer beware.”
That’s in part because the market is lightly regulated and a ton of currency trading happens in the shadowy realm outside of exchanges.
This particular currency rigging story has been going on for some time, with Bloomberg reporting in June that traders at some of the world’s biggest banks had been toying with rates by pushing through trades before the 60-second window when the FX benchmarks are set.
What is the rate they are messing with?
That would be the the WM/ Reuters rate. Here’s a good description:
The WM/Reuters rate set at 4 pm London time is considered the benchmark by many companies and investors because more than 40 per cent of daily global FX trading is done in London. It is the nearest thing to a closing price in a 24-hour, self-regulated market.
For the big, frequently traded currencies — like USDEUR (dollar/euro) — the rate gets published every half hour. For the little guys, ever hour. Without getting too detailed, the rate is calculated by taking the median of total trades during a 60-second period every half hour.
“If there aren’t enough transactions between a pair of currencies during the reference period, the rate is based on the median of traders’ orders, which are offers to sell or bids to buy,” Bloomberg reports. “Rates for the other, less-widely traded currencies are calculated using quotes during a two-minute window.”
Not really. Why is this rate important?
Like Libor, the WM/Reuters rate is peculiar to those outside the financial world. Actually, many people in the financial world probably don’t pay that much attention to it (unless they are concerned with currency trading).
But the rate matters to society at large because, as Morningstar estimates, $3.6 trillion in things like pension funds and savings accounts can fluctuate in value when the rate moves.
Now I’m listening. So how do traders mess with the rate?
Traders at these big banks are market-makers. They are buying and selling for clients and for the bank itself.
In that June report, Bloomberg spoke with some traders who described how their contemporaries managed to exploit the WM/Reuters rate.
The gist: Knowing that their traders will try to trade against them, customers wait until just before 4 p.m. to place their orders. So traders get the orders minutes (plural) before 4 p.m. and then in the minute (singular) before the 60-second window, traders adjust their own position because the large order they just got from some index fund will move the market.
It’s called “banging the close,” which, of course it is. Here’s the nitty gritty if you’re interested, from Bloomberg:
One trader with more than a decade of experience said that if he received an order at 3:30 p.m. to sell 1 billion euros ($1.3 billion) in exchange for Swiss francs at the 4 p.m. fix, he would have two objectives: to sell his own euros at the highest price and also to move the rate lower so that at 4 p.m. he could buy the currency from his client at a lower price.
He would profit from the difference between the reference rate and the higher price at which he sold his own euros, he said. A move in the benchmark of 2 basis points, or 0.02 per cent, would be worth 200,000 francs ($216,000), he said.
“If they didn’t do so, [the traders] said, they risked losing money for their banks,” according to Bloomberg.
Are these traders just smart… or are they jerks? Or are they smart jerks? Or are they smart jerks doing something illegal?
It kind of depends on what your baseline theory of trading/financial regulation is.
If, as Bloomberg columnist Matt Levine desribes, you believe that the fundamental precept of regulation is that A) Regulators attempt to write the rules B) Banks sit down and try to figure out how circumnavigate those rules and C) Banks are way better at it for a variety of reasons, then you might call this whole forex gambit a “risk strategy” instead of “manipulation.”
As in, this isn’t free money, it’s merely a tactic to mitigate a trader’s risk. It could backfire! One of the whistleblower traders told Bloomberg that the strategy doesn’t necessarily work with A) highly-traded currencies where the market is so big or B) If someone else comes in and messes with your bet during the 60-second window.
Isn’t this like Libor though?
The Libor rate gets calculated by bank estimates, so that scandal was rigging in the truest sense of the word. If you want proof, we have hilarious traderspeak emails such as:
Swiss Franc Trader: can u put 6m swiss libor in low pls?
Primary Submitter: NO
Swiss Franc Trader: should have pushed the door harder
Primary Submitter: Whats it worth
Swiss Franc Trader: ive got some sushi rolls from yesterday?
Primary Submitter: ok low 6m , just for u
The forex market rate is based on actual quotes, not bank estimates (or the promise of sushi).
Though, two of the trader sources told Bloomberg that dealers were colluding to move the rates, so maybe we’ll eventually see a paper trail like the above.
And, hey, traders are (maybe!) messing with a rate that has reverberations for our pensions. And there’s this:
In the space of 20 minutes on the last Friday in June, the value of the U.S. dollar jumped 0.57 per cent against its Canadian counterpart, the biggest move in a month. Within an hour, two-thirds of that gain had melted away. The same pattern — a sudden surge minutes before 4 p.m. in London
on the last trading day of the month, followed by a quick reversal — occurred 31 per cent of the time across 14 currency pairs over two years, according to data compiled by Bloomberg.
The market goes crazy and then corrects on the last day of the month… when clients are placing huge orders. Interesting.
So what’s going to happen?
It’s hard to say exactly. Barclays suspended those six traders (including its head currency trader in London). A smattering of banks will probably cough up fines and fire traders and/or slap wrists. There’s always a slight chance of criminal proceedings, but it’s too soon to tell what regulators are going to game for.
But they’ll change the rules for the WM/Reuters rate, right?
Sure! And then everyone on Wall Street will sit down and figure out how best to make money next.