Foreign exchange: a can of worms

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Any hopes the $5.7 billion settlement between the leading FX banks and US authorities will finally put the FX fixing scandal to bed are likely to prove misplaced.

US Department of Justice-R-600

On Wednesday, five global banks - Barclays, Citigroup, JPMorgan, RBS and Bank of America - were fined a total $5.685 billion to settle FX manipulation allegations with US and UK authorities.

The fixing affair has proved costly for banks, in terms of hard dollars – penalties amount to $9 billion in total – and reputation.

For the moment, the latter appears to be the lesser issue. The main players in FX have continued to make solid revenues despite the scandal. However, make no mistake – the FX industry will change as the banks’ activities not only come under the spotlight but get scrutinized to microscopic levels.

Many banks will struggle to explain why their market-makers quote so few rates and why their positions are out of kilter with the amount of client flow they see. In other words, if a dealer only quotes a handful of rates in $5 million or $10 million a day – which is becoming the norm as electronic trading increases – how can he justify having a position of say $25 million or $50 million at all?

In essence, many dealers now are, in effect, prop traders.

Others will have to justify why their spreads vary from client to client based on their sophistication. Sales staff will struggle to justify mark-up, because it is starting to be seen as not providing the fair market rate that is available from the dealer or on any of the myriad FX trading platforms in existence.

A joke doing the rounds of the trading floor of one main FX player is that working there became like living in Argentina in the early 1970s – traders keep disappearing…

Clients might be foolish to still accept this, but salespeople will no longer be able to take advantage of their naivety, calling their existence into question.

Another pressing issue is expected to be the raft of litigation the banks face from the traders they have suspended or fired. The banks’ attitudes so far are familiar. They seem to have adopted the tactic they’re bigger and have deeper pockets than their former employees, and can string out any litigation for as long as possible.

However, there are too many disgruntled ex-employees to ignore. A joke doing the rounds of the trading floor of one main FX player is that working there became like living in Argentina in the early 1970s – traders keep disappearing, never to be seen again. Until now, that is, and some banks are nervous.

For example, a few banks are apparently offering to pay the costs of legal counsel for traders they sacked if they are questioned by the authorities, particularly the US Department of Justice (DoJ).

Desperation

The banks’ spin is that those who have disappeared were removed because they unilaterally broke the rules of the market. The reality is that most probably lost their livelihoods for breaching banks’ internal rules rather than trying to rig the FX market.

However, the banks were desperate to prove to regulators they were cleaning up their acts, and summarily ejecting wrong-doers.

Now, traders are taking their former employers to court for unfair dismissal. If in some cases the breaches of protocol were also in contravention of the regulators’ rules, the end result will be the same: grievances will be heard in open courts.

The wider public will probably have little sympathy for the traders, at least at this stage. That view might well change. The traders will claim that they were simply following orders – and this will be close to the truth.

The traders will say that the management forced them into chats to gain more market information to protect their bank’s risks. This was not only to handle fixing flows – and let’s not forget that the fix is a product that is logically not a profitable product unless it is manipulated – but as a defence against many of the more predatory hedge funds.

Further reading
 
FX scandal: in the spotlight

Given this last point, it is remarkable, so far, that few sales people have been caught up in the FX scandal. Others would argue it is inconceivable.

When the Bank of England first discussed the fixing problem in June 2006 – a month after Euromoney wrote about it – at a meeting of the FX joint standing committee, it stated there was "evidence of attempts to move the market around popular fixing times by players that had no particular interest in that fix".

It’s known that many banks tried to minimize the impact of fixing flows by matching it up with interested parties. That’s probably fine if you are talking to an ethical real-money client; it’s less so when the person being asked is from a hedge fund trying to beat you and the markets; and if it’s another bank, it suddenly becomes collusion.

Guess what? The practice of netting off fixing flows still goes on. It might be okay. Then again, it might not, depending on the view of the compliance officer on any given day. So the banks remain vulnerable to further action because they continue to provide nonsensical products such as the fix.

But looking at the past again, which "players that had no particular interest in that fix" were getting involved and how did they know what was going to happen? The answer would seem clear: so far no bank has had the courage to deal with the issue.

It is simply not credible that so few salespeople have been suspended or fired when so many traders have been seemingly readily thrown under a bus. The only logical conclusion is the banks have not gone after their sales staff in the same way as they have their traders because to do so would shine the spotlight on their clients’ activities as well.

This is a can of worms few banks will want opened, but make no mistake – the lid will be lifted.