It may be the largest financial crime case in history in terms of the number of people and entities victimized, the amount of money involved and the global impact. Worldwide, regulators and enforcement agencies are exploring the full depth and reach of alleged manipulation of currency exchange rates by traders at some of the largest global financial institutions.
The “foreign exchange” market, which deals with the exchange of nation’s currencies, is estimated by the Bank for International Settlements to involve $5.3 trillion in transactions per day, an amount far beyond any stock or bond market. On an annual basis the sums of money affected in currency exchange transactions reach a staggering amount that touches a huge range of financial markets and products.
Disclosures of the ongoing investigations being conducted in various countries, primarily Great Britain and the United States, sound eerily similar to the Libor rate manipulation scandal that unfolded over the past 18 months.
Even the cast of characters in the two major rate-rigging scandals remains largely the same. Barclays, Citigroup, Deutsche Bank, JP Morgan Chase and UBS have all suffered major penalties in the past year for rigging the Libor rate. They now find themselves at the epicenter of roiling scandal involving manipulation of currency trading.
In this latest rate-fixing saga, however, the stakes are even higher. Forex trading directly impacts the value of currencies worldwide, including the US dollar and the Euro. Currency rate benchmarks are also tied to an estimated $3.6 trillion in other investment products. These include everything from exotic derivatives to more prosaic pension and retirement funds.
The currency market is largely dominated by a small number of international banks operating with surprisingly little national or international regulation, especially as compared to other securities markets. With this backdrop, it is no surprise that in recent years, some regulators in the US, UK and other nations have voiced concerns that currency trading was ripe for manipulation.
Regulator says alleged Forex rigging is ‘every bit as bad as Libor’
These fears appear well-founded. In recent months, five major banks with the largest Forex operations have fired, suspended or placed on leave more than 20 currency traders and managers. In the US, a Massachusetts pension fund has filed a class action lawsuit against eleven banks over the damages it says it suffered because of currency manipulation. At least 12 regulatory and enforcement agencies, in Hong Kong, the US, UK, Switzerland and the EU, are all reported to have launched investigations.
To date, these investigations have not produced enforcement actions were prosecutions. No bank or person has been formally charged with wrongdoing. Yet, the gathering storm over Forex rigging suggests that a range of the key benchmark rates that undergird global financial markets may be vulnerable to manipulation by the same banks that are largely responsible for setting them.
“The allegations are every bit as bad as they have been with Libor,” said Martin Wheatley, head of the UK Financial Conduct Authority, the top British banking regulator, at a hearing before Parliament last month. “Given what has come out, no; people won’t trust the way rates are fixed,” he added.
As regulators investigate and banks suspend employees, cases gain steam
Investigations of Forex rate-rigging began in mid-2013, in the wake of a series of penalties and enforcement actions related to manipulation of the Libor rate. Evidence uncovered in the Libor investigations, conducted by 16 banks and by regulators and enforcement agencies in seven countries, suggested that trader collusion and rate manipulation had extended to their Forex desks.
By late 2013, nine major financial institutions had disclosed in regulatory filings or public statements that they were being investigated for Forex manipulation and were conducting their own internal reviews. In October, the Swiss Financial Market Supervisory Authority issued a terse press release announcing its investigation of “several Swiss institutions.”
Later, the UK Financial Conduct Authority (FCA), the US Commodities Futures Trading Commission and the US Department of Justice announced that some of the most important participants in the currency market, including Citigroup, Barclays, Royal Bank of Scotland and Deutsche Bank, had fired or suspended 19 currency traders and managers.
In past two months, the trickle of information concerning Forex investigations has increased to a flood. On March 7, Merrill Lynch and BNP Paribas announced the dismissal of employees who were connected to currency trading.
Last month, the New York Department of Financial Services issued subpoenas for documents related to Forex trading from 12 financial institutions, including Goldman Sachs, Credit Suisse and Standard Chartered. The SEC is also reportedly investigating Forex manipulation and its potential impact on options and exchange-traded funds.
Traders may have fleeced clients by ‘banging the close’
Regulatory and enforcement agencies have said little about the status of their investigations. Based on disclosures by banks and media reports, however, the investigations have focused on “spot” transactions in the Forex markets. Spot transactions are agreements to sell one currency against buying another for a price agreed on by two parties. They represent about 40% of the Forex market, or $2 trillion a day in currency trades.
Regulatory and enforcement agencies are reportedly seeking evidence that traders at major institutions conspired to manipulate a benchmark sometimes called the “London fix,” or simply “the fix.” Essentially, the fix represents a snapshot of currency prices agreed to in spot trades made one minute before 4:00 PM London time each business day.
The currency prices established by the fix are used as reference rates in a multi-trillion dollar array of Forex trades executed each day, including dealings in derivatives and securities tied to the currency markets. The fix is administered by two private companies, Thomson Reuters and World Markets Co., which collect the data and publicize the rates.
Often, the large banks that control the currency market have sizeable incentives to run up prices before the fix. This is a practice known as “banging the close.” Traders already know the major transactions they are going to conduct for clients once the fix is set, and often their bank or another one is the counter party in the trade. By trading to manipulate prices just before the fix is taken, traders stand to profit at their client’s expense.
Investigators digging into chat rooms, mining transaction data
Regulators reportedly suspect that traders also may have shared information on trades between banks and cooperated with each other to drive the prices of currency pairings.
Instant messages and chat rooms might have played a key role in disseminating information among traders. This alleged collusion has led Haverhill Retirement System, a Massachusetts pension fund, to file a class action antitrust suit last November against some of the world’s largest institutions. They include Barclays, Citigroup, Credit Suisse, Deutsche Bank, JP Morgan, Royal Bank of Scotland, UBS, Goldman Sachs, HSBC, Morgan Stanley and Lloyds Bank as defendants.
The Forex rigging investigation will be costly and complicated. It will require combing through huge amounts of transaction data. Investigators and forensic accountants will seek to combine this data with instant messages, chats, emails and phone records to match trader behavior with market moves.
Government regulators and investigators as well as the institutions are pouring vast resources into the investigations. The UK FCA reportedly has assigned more than 50 persons to the investigation, including outside contractors. The FCA has also established a liaison unit to coordinate with regulators in other countries.
The 10 banks with the largest Forex operations have assigned more than 500 staff members and external consultants to internal reviews, according to reports in the Financial Times. The financial institutions are also utilizing data analysis and data mining experts to deal with the volume of data involved.
Allegations ensnare Bank of England, Parliament demands answers
With the credibility of key financial benchmarks again in doubt, members of the British Parliament are asking regulators why they did not detect the currency exchange manipulation sooner.
On March 11, at a hearing of the Treasury Committee of the UK Parliament, Mark Carney, Governor of the Bank of England, was asked about a memorandum that indicated that the bank was aware of Forex manipulation as early as 2006.
This month, the bank suspended an employee after an internal review of Forex rigging. The bank stated it had found no evidence that its staff colluded in price manipulation.