Spot trading ethics questioned in WMR probe
The global regulatory investigation into possible manipulation by foreign exchange dealers of the WM/Reuters (WMR) 4pm London fix benchmark could be ignoring the structure of currency markets and the way spot desks routinely execute large client transactions, three London-based currency managers tell Euromoney on condition of anonymity.
“There may be a major misunderstanding with respect to claims of manipulation of the spot foreign exchange rates at fixing time,” one manager says.
“Spot dealers have to manage large flows for their clients all day long, providing execution at the best possible prices, which involves taking risk, and hopefully making some money. The fixing flow is no different from the other flows of the day in this respect.
“The fact that there are so often frauds in the financial markets doesn’t mean everything is, and this noise on the FX fixing could be misleading.”
After an announcement in June that the UK’s Financial Conduct Authority (FCA) was gathering information in relation to potential manipulation of benchmark foreign exchange rates, the FCA last week confirmed it has progressed to a formal investigation as part of a coordinated effort. This now involves Swiss regulator Finma, the Hong Kong Monetary Authority, the European Commission, and the Department of Justice and the Federal Bureau of Investigation in the US.
Although none of the parties to the investigation has disclosed the details of the alleged manipulations, it is believed the FCA inquiry stemmed from reports – from a news outlet that operates a competitor FX benchmarking service to WMR – that a group of traders representing different banks had colluded to front-run client orders and manipulate the WMR by executing trades just before and during the 60-second fixing windows when rates are set.
Front-running is an illegal market practice whereby dealers exploit private information about pending client orders to either buy or sell proprietary positions at increased profit.
According to market sources, UK-based banks, including Barclays, Citi, Deutsche Bank and RBS, have allegedly handed to the FCA their electronic communications between currency traders at different banks, which are said to share information around proprietary trading positions, client orders and target rate fixings. All of the banks declined the opportunity to confirm or deny their involvement in the investigation.
While clear evidence of collusion between traders would probably lead to legal proceedings against the culprits, regardless of the impact to clients, currency managers say there is nothing improper with traders adjusting their prices in anticipation of future supply and demand as such.
Moreover, suggestions that individual traders could rig the £3.2 trillion market are implausible, given the volume of risk capital required to impact prices, and the level of certainty would-be riggers would have given on how much other volume other traders have in the market.
“You would need to put something in the order of tens of billions to work for relatively little return,” suggests one source.
Furthermore, an increased focus among certain FX overlay clients on benchmarking their FX execution against WMR rates means that spot dealers are often instructed to execute substantial buy or sell client orders with little notice ahead of the 4pm fixing.
Notwithstanding the possibility of illicit advance communication with other market participants, a bank might reasonably expect its spot dealers to protect its interest while achieving best execution for its clients.
“The asset management industry’s focus on benchmarking their transaction costs against WMR means that banks are being presented with orders 15 minutes before the fix for amounts that they know that aren’t going to be tradable at the absolute moment of the fix,” says another currency manager.
“If the bank is running a $50 million short position in EURUSD, and the desk gets an order to buy $400 million, it is in the bank’s interest to close out the bank’s position before executing the client order. Are you illegally front-running, or are you protecting the bank’s interest?”
In addition to the alleged anti-competitive communication between dealers, suspicions have also centered on spikes in market rates at the time of the 4pm fix, which some commentators say indicate potential manipulation by dealers seeking to maximize profits around client orders.
However, this dynamic could equally be an effect of concentrating execution on the 4pm fix window, managers say.
“If you try to execute a very large ticket all at the same time, you will necessarily get price spikes and this is what happens around the fixings,” a manger says. “There are a lot of better ways of executing large trades, and with electronic trading engines it is perfectly possible to buy $10 million every 30 seconds over a longer period to avoid bunching.”