Understanding Forex manipulation

14 Apr 2014

(amended 4th Sept 2014)

Following on the heels of the LIBOR manipulation scandal, the latest allegation levelled at the banks is that they conspired to manipulate foreign exchange rates. This has been covered in the news but, given the complexity of the allegations, rarely is it adequately explained.

We describe below in simple terms

  • what the alleged manipulation is;
  • who may have suffered from it; and 
  • the ongoing investigations into it.

In what ways is it alleged the Forex market has been manipulated?

The Forex market sees trades of over $5 trillion per day. Around 80% of this market is controlled by 10 large institutions. Four banks – Deutsche, Citi, Barclays and UBS – have a combined market share of around 50%.

Exchange rates are constantly changing, so benchmarks are useful for portfolio valuations. A popular benchmark is the 4pm London Fix, which sets rates based on the median of all trades in a one-minute window at 4pm. Portfolio managers frequently instruct dealing desks to make transactions at the fix time and price. This advance information creates potential for abuse.

Two main types of manipulation of the London Fix are alleged:

Front-running (also known as “pre-hedging”) is where a bank knows a particular large order is to be placed at the fix, thus impacting the benchmark rate. The bank makes trades based on that information before the fix, in order to make a profit at or after it.

There is some debate about whether this constitutes market abuse. The allegations largely relate to collusion between banks, as there is less debate that sharing the information for mutual advantage is abusive.

Banging the close involves focusing client orders in the moments before and during the 60-second fix. This allows traders directly to manipulate the fix rate of a particular currency pairing, allowing them to profit from it. Again there are allegations that the banks shared information on their trades so they could align their strategies to the detriment of their clients.

Blogger Stephen Bornstein describes the situation succinctly on http://aroundwallstreet.com:

“For example, if the colluding group had net orders to sell ¥100 billion on a given day, they would collectively sell ¥100 billion in the spot market from their own inventories (or short) during the 60-second window and, in so doing, drive down the spot closing price that day.  They would then buy the ¥100 billion from their customers – still within the 60-second window – at the lower spot price, reaping an easy profit for themselves and flattening their positions (or covering) for the day. Their customers, meanwhile, got whacked.”

Who may have suffered?

One obvious group is the banks’ clients, particularly large institutional investors and pension funds which regularly trade currencies at the fix.

There are a number of actions in the US by pension funds. For example, in New York, State-Boston Retirement System and Newport News Employees’ Retirement Fund have each bought their own antitrust actions under the Sherman Act against co-Defendants Barclays, Citigroup, Citibank, Deutsche, HSBC, JP Morgan Chase, RBS and UBS.

The London Fix is used to value a large number of assets, such as foreign holdings in mutual funds. Manipulation would therefore affect valuations, so investors may also have a claim. However – in a déjà vu to those who have studied LIBOR manipulation – outside a class action, the distortion will be too small to justify action by anyone other than the largest investors.

What regulatory investigations are taking place?

Financial Service Regulators

  • The FCA confirmed in October 2013 that it was investigating possible Forex manipulation, but did not give any details. Heads of the FCA were questioned by the House of Commons Treasury Select Committee on 4 February. They said the investigation was ongoing, and they could not comment further. 10 banks had apparently volunteered information, but they would not say which, and they said there were unlikely to be any findings reported in 2014.
  • The Bank of England is investigating allegations that its employees were involved.
  • FINMA, the Swiss Regulator confirmed on October 2013 that it was investigating several Swiss financial institutions in connection with possible Forex manipulation.
  • CFTA, SEC and Fed: On 10 March, Bloomberg reported that the Commodity Futures Trading Commission, the Securities & Exchange Commission and the Federal Reserve were conducting investigations but so far there have been no official announcements.

Competition regulators

  • The European Commission stated in a 4 December 2013 press release – primarily about the manipulation of LIBOR and other interest rate benchmarks – that it was “also investigating other financial products and sectors, such as… the foreign exchange markets”. In a speech on 7 March, Joaquin Almunia said that “still at a preliminary stage, we are looking into possible collusions to manipulate other financial benchmarks for oil products and derivatives and in the foreign exchange markets.”
  • WEKO, the Swiss competition regulator, is also widely reported to be conducting an investigation. According to Reuters, WEKO said it had opened an investigation against various banks on 30 September, and said that, "through discussions [banks] are said to have manipulated various exchange rates". WEKO declined to name the banks under investigation.
  • FINMA, the Swiss Regulator confirmed on October 2013 that it was investigating several Swiss financial institutions in connection with possible Forex manipulation.
  • BaFin, the German regulator announced in January 2014 an investigation focused on, but not limited to Deutsche Bank. On 20 May, it went further than other regulators, saying it had clear evidence of manipulation in multiple currencies, “not the really big currencies, not the dollar/euro, but several currencies were involved”.
  • CFTA, SEC and Fed: On 10 March, Bloomberg reported that the Commodity Futures Trading Commission, the Securities & Exchange Commission and the Federal Reserve were conducting investigations but so far there have been no official announcements.

Authors: Stephen Critchley, Senior Associate and Robert Andrews, Trainee

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