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Forex probe: how to fix the fix

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.”


Asset managers often have hundreds or sometimes thousands of funds under their management, some of which only do business at the benchmark fix due to portfolio replication.

For the funds, transferring money from one to the other at midpoint prices is a no-brainer. Funds must track benchmarks as part of their prospectus-described duty to clients. When pitching for investment, a fund informs clients which benchmarks they mark their performance against.

“Fund managers have to use the fix, in line with what they offer in their prospectus,” says independent consultant Lequeux. “Benchmark replication is what they are legally required to do, and the fix is necessary for that.”

Moving away from fix-based trading would be easily possible if the legal framework for funds changed.

“Technology now allows fund managers to channel these trades to e-platforms, and they could calculate their asset valuations based on real-time and weighted prices,” he adds. “But for this to happen, legal requirements need to change.”

One asset manager that chose to move away from the benchmark now sets a random time for executing their flow orders. One month it would ask the bank to take the price where the market was at say, 10.23am. Next month, it would give another randomly selected time.

“Corporates and asset managers are getting more educated and we’ve seen a lot of people migrating from equities trading to FX,” says Dmitri Galinov, chief executive officer at trading venue FastMatch. “These firms are learning about best execution and increasingly adopting a pure agency execution model.”

Large orders normally get worked on during the day in small slices and depending on market conditions. The more liquid the market, the less impact an order will have. The most liquid times are roughly between 12pm and 2pm London time, when UK-based traders are still active and US markets open.

The current timing of the fix, at 4pm London time, is not ideal for minimizing market impact, making price swings bigger and easier to achieve.

The easiest alternative is to abandon the fixing-related orders and treat the flow as normal business. Some of the largest asset managers have long stopped trading the fix and use volume or time-weighted average to measure execution quality.

“The obvious way to go about sizeable orders is to work it throughout the day on electronic platforms – algorithmic functionality is easily available, which is totally transparent to the client,” Woolcock says.

Options and other problems

One less-discussed use for the fix is in options contracts. The London 4pm price is often used as the strike price for some contracts, and the fix hitting a particular level would trigger a payout.

These contracts, if large enough, could provide a sufficiently large incentive to try to move the price with the intent of manipulating it. GreySpark’s Ponzo reckons the fix is now primarily used for these derivatives contracts.

“What you spend on moving the market you have to make back, ideally with a profit, from the options contract the price move triggered,” he says. “The more liquid the currency pair, the more ammunition you need to move the price.”

The practice of defending options barriers is another grey area in FX. Some market participants think regulators’ efforts would be better spent on examining those practices instead of concentrating on the fixing.

“The practice of defending options barriers is much more murky,” says a fund manager who wished to remain anonymous. “People try to push the market one way or another all the time. Regulators should put their efforts into examining practices around big options books.”

Mark Taylor, dean of Warwick Business School

Taylor at Warwick Business School agrees. “There are huge incentives for people to try to manipulate the market, and small moves in currency prices can have a sizeable effect as the market is so vast – a heavy derivatives portfolio could be a strong incentive,” he says, adding that incentives to cheat must be taken away to eliminate the temptation to cheat. A further problem with the WM/Reuters fix is the lack of oversight, according to Jim Cochrane, a director at ITG. In the UK, the Bank of England published its own daily fixings until 2006, before handing it over to trading platforms EBS and Reuters.

Paul Fisher, then head of the BoE’s foreign exchange division, told Reuters at the time: “[The new page] ... provides a major improvement to the quality of pricing information available to the whole market. This is a very satisfactory outcome to this market-led initiative.”

Says Cochrane: “The alternative [to the current system] is so simple I’m surprised no one has tried it. The fix should not be run by a private organization. The FX market has become so big that it needs some oversight. It’s no longer a private matter.”