FX fixing is no Libor scandal – yet

Peter Garnham
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News that UK regulators are investigating alleged manipulation in FX benchmarks has hit the headlines, but can it be compared to the Libor scandal?

Anybody with even a cursory knowledge of the FX markets knows that the 4pm London fix is likely to generate a spike in the movement of currency rates. That is because it is the time that fund managers fix the price of their currency hedges, most of which are benchmarked to WM/Reuters fixing rates.

It is unsurprising that these fixes cause short-term volatility in FX price movement – they are, after all, the benchmarks to which an estimated $3.6 trillion of investment funds are tied.

That is not to say there will be a spike in movement every day. In EURUSD, for example, US and European fund managers might well have equal and opposite hedging requirements. However, a lot of the time fund managers around the world will find themselves the same way round in their hedging requirements.

As one trader puts it: “If European and US fund managers are all buying Toyota stocks because its new car is the bomb, then they are all going to be buying yen. So watch out.”

It is these fixing rates that are at the centre of the investigation in the UK.

The news was broken by Bloomberg News, which alleged that the world’s biggest banks have been front-running client orders and rigging the WM/Reuters rates by pushing through trades in their favour during the windows when the rates are set.

Focus on the issue is intense in the wake of the investigation into the Libor scandal, which resulted in banks paying nearly $2.6 billion in fines, and which pushed global regulators to examine the integrity of a range of global benchmarks.

The Libor scandal was particularly sordid, with colourful emails between dealers doing nothing to improve the reputation of the banking industry.

However, there is a crucial difference between this and the Libor scandal: banks have to commit capital to affect the price in the currency market.

If a bank receives a fund manager order half an hour or 15 minutes before the fix, it has a choice as to when it goes into the market to deliver the required fill to the customer. Sometimes, due to the large size of the order, it can push the price away from the client.

Equally, the market might go the other way. It is, in other words, a risk that the banks – which have promised a fill to a client at the WM/Reuters fixing rate – take. FX banks are, after all, in the business of making money through taking risk; it is the nature of the beast.

One former FX sales trader, who worked FX orders for fund manager clients at large FX banks ahead of the fix for more than five years, says his traders never tried to manipulate the benchmark.

“But sometimes our clients had so much to do that we pushed it,” he says. “There was nothing illegal about that. It was just that we were buying so much.”

The trader describes as insane the idea that dealers at one bank would call another bank and ask them to buy €500 million because if the currency goes higher they will make some money and – such as in the notorious Libor emails – make it “worth their while”.

“It is not like Libor where it is a theoretical rate you are pushing up,” he says. “These [FX fixes] are based on actual trades, so it can only be manipulated if you are willing to risk capital. It is not that you are submitting what you think a Libor rate is going to be in a few months – this rate is built of actual trades.”

Still, despite that scepticism, the Bloomberg report states that five dealers with knowledge of the practice allege that manipulation of the fixing rates takes place.

If that is the case, rather than simply pushing the rate away from a customer as they work an order, then traders say it is most likely to have occurred in less-liquid currencies.

The fixing rates for leading currencies are taken using no last-look, guaranteed tradable quotes from large trading platforms such as Reuters and EBS. A bank, in other words, would need to commit capital to move prices and affect the fixing rate.

“I don’t think you can manipulate any of the majors, but there might be some currency pairs where there is manipulation,” says a trader.

Indeed, in other less-liquid currencies, such as non-deliverable Latin American currencies, the fix might be taken from indicative non-tradable quotes. That would mean the fix could be affected by a bank without necessarily having to commit capital, making the potential for manipulation higher.

It is not clear from the Bloomberg report that there is proof of manipulation of FX fixing rates, such as the smoking gun of the Libor emails, or simply allegations at this stage.

Still, it is likely to turn the attention of regulators towards the near $5 trillion-a-day FX market, which many consider too big and too dangerous to escape the scrutiny of lawmakers.

A good place to start could be to force WM/Reuters to open its books and explain how the fixing rates are calculated. Proof that the fixing rates are based on tradable market quotes could go some way to cooling the furore.

On the other hand, if some suspicion of manipulation were uncovered in, say, the fixings of some emerging market currency pairs, then the market would at least have a starting point to develop a more transparent way for fund managers to benchmark their currency exposure.