Matthew Partridge explains the ins and outs of the latest scandal to be uncovered in the banking industry.
What’s happened in the ‘forex scandal’?
Five banks have agreed to pay a total of £2.7bn ($4.3bn) in fines to regulators in the UK, the US and Switzerland. JP Morgan has been worst hit, paying $678m, while HSBC, Citibank, RBS and UBS have also been fined. A wide range of institutions, including the Bank of England, have already been forced to dismiss those suspected of misconduct, or not supervising staff properly. The fines come after a probe into the currency (or foreign exchange) market found that traders in different institutions communicated with each other to manipulate foreign exchange rates. Beyond the record fines, there have been calls for the individuals responsible to be tried for fraud, though this is unlikely to happen.
How did the scam work?
The foreign exchange market is extremely liquid with a large number of participants. In theory, this should make it very hard to manipulate prices for any length of time. However, in addition to the live price, there are also benchmarks. The main benchmarks are set daily, usually by taking a snapshot of the market at a specific time. For instance, the WM Reuters fix looks at all trades that occur in a one-minute period just before and after 4pm. These benchmarks are widely used for a variety of financial tasks, from portfolio valuation by fund managers to some foreign exchange deals. By working together and sharing information, mostly through private internet chatrooms, it was possible for groups of traders in various banks to temporarily move the market, tilting the benchmark rate in their favour.
What can be done to stop this?
In the short run there have been calls for the benchmarks to be reformed so they are less vulnerable to manipulation. One solution floated earlier in the year was to base the daily rates on a snapshot taken at several points during the day, rather than one short block of time. There are also moves to reduce the number of trades made over the phone – which is how many large deals are still made – to further increase transparency. There has also been pressure on banks to beef up their compliance teams. One radical suggestion made recently by Bank of England boss Mark Carney is to make it possible to ‘claw back’ a portion of even fixed salaries if traders misbehave.
Are any other markets under investigation?
The forex market is not the only well-known market that has been thrown into question. As well as the controversy over Libor (interest rate) manipulation, there have always been claims that the gold market has been manipulated. Theories range from central banks secretly intervening to protect banks that had bet against the gold price rising, to claims that the US Federal Reserve was inflating the amount of physical gold that they had in their vaults. The latest criticism focuses on the way that the daily price is fixed. While an FCA investigation failed to find any evidence of actual collusion, it accepted in July that the market was vulnerable to manipulation. Recently, a report by the Swiss regulator FINMA admitted there had been clear attempts to manipulate the prices of precious metals. As a result, the gold benchmark will be automated and replaced by an electronic platform.
Can the City change?
The transcripts of the various traders chatting to each other in macho yet juvenile terms, has drawn the attention of various commentators. The FT’s Lucy Kellaway thinks it shows that little has changed since she worked at an investment bank in the 1980s. It remains “a nasty, cosy club, just as it was then, and anyone who isn’t in it is automatically an idiot”. Her colleague John Plender goes even further. In his view, “the people who inhabit trading floors” are “ bonus-hungry hired guns who show no loyalty to their banks, customers or the markets”. In his view “the culture of the world’s biggest banks is fundamentally rotten” and he doubts “whether it can ever be cleared up” – particularly while regulators focus on fining banks (and therefore “bleeding shareholders”) rather than “go for the directors and executives”).