Forex probe: how to fix the fix

Eva Szalay
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As the investigation into the alleged manipulation of FX widens, the jury is out on whether the practice is tantamount to front-running clients or simply a case of hedging. Suggested reforms to the benchmark include handing it over to a public body, or banks’ abandoning fixing-related orders altogether and treating the flow as normal business, while others think regulators’ efforts would be better spent reforming the fix in options contracts.

Colluding to manipulate prices would count as illegal, but simply moving the fix is not against the rules. Large orders that asset managers ask to be executed at the fix price naturally move prices as price discovery takes place.

A pick-up in volumes, volatility and temporary spikes in currency prices had been cited as evidence of improper trading practices.

“Increased volatility is a natural consequence of high volumes – it does not indicate attempts to manipulate the fix price,” says Pierre Lequeux, an independent consultant and former head of currency management at Aviva Investors. “It is similar to what happens at the opening and closing times in stock markets. It’s the process of price discovery.”

David Woolcock, chair of the ACI Committee for Professionalism, adds: “There is no evidence of wrongdoing so far. If banks have to execute very large client orders in a short time-period, the price will naturally move.”

David Woolcock, chair of the ACI Committee for Professionalism
Price swings can also be magnified because of the fragmented nature of currency trading. When buying or selling starts, smaller players and high-frequency trading firms jump on the move on electronic platforms.

“The fix is based on trades in a one-minute window,” says Mark Taylor, dean of Warwick Business School. “It doesn’t make sense to concentrate lots of large trades in such a short time-period. It’s easy to see why the price spikes before settling back again afterwards.”

Taylor adds that the price-setting window should be widened and a randomized element added, to prevent possibilities of gaming.

“The window should be an hour long, 30 minutes before the fix and the same after, with a randomly selected one-minute period then setting the fix price,” he says.

In the current system, banks have to do the deals and sometimes can face steep losses. One head of real-money sales at a bank recounted how impossible it is to deal with fix-related flows. He says once a client asked for $4 billion to buy against the Canadian dollar at the fix.

“There was no liquidity for such a large order,” he says. “We moved the market by something like three big figures, but there was nothing we could do.

“You must hedge yourself before the fix. You simply cannot offer to provide such a large amount of money on your balance sheet. It’s impossible. That’s not front running – it’s taking the risk and hedging it, as you are supposed to do as a bank.”

There are no restrictions on who can trade and what can be traded around the fix. People with no real orders to execute can just as well take large punts on the fix as those who are trying to execute benchmark flows.

“You stick a flag in the ground and say this is something that will happen every day and you know big volumes are going through,” says an executive at a large bank-only platform. “It’s just like a set major data release. People take positions on it and there is nothing wrong with that. That’s trading.”


Fix-related flows might be big but banks don’t get paid for executing the orders as they would in the course of normal business.

“There is nothing that banks would like more than eliminating the fix and just getting the flow to execute during the day, getting paid the spread and getting flow information,” says the former head of electronic FX trading at a large bank.

One issue is that fee structures in equities and FX are different. In stock trading, which has a central exchange, clients get charged a fee for being provided with securities to buy and sell. In FX, the commission is built into the bid offer spread, and liquidity providers have to trade currencies before they can offer a service to clients.

Frederic Ponzo, managing partner at GreySpark Partners
Execution at the mid-point rate eliminates the fee banks earn from providing customers with foreign exchange services that is expressed in the spread. The spread takes market conditions, creditworthiness and relationships into account when it’s calculated how much fees each customer will pay.

If the trades are executed at midpoint, banks will only get a commission if they profited from the set price themselves. Is this front running client orders or just effective hedging? While in stock trading it would be an open-and-shut case, in currency markets this is normal hedging practice or, at worst, a regulatory grey area.

“It is a grey area in terms of regulation,” says Frederic Ponzo, managing partner at GreySpark Partners, a capital markets consulting company. “Regulators would have to prove intent to manipulate the price, which is very difficult. There is no clear rule-book that describes acceptable practices as FX is completely OTC.”