Rigging currency markets
Are foreign-exchange benchmarks the latest to be manipulated by bankers?
IT HAS been a dreadful couple of years for financial benchmarks. Banks turn out to have rigged LIBOR, an interest rate used to peg contracts worth trillions. Its equivalent in the world of derivatives, ISDAfix, has also come under question. Commodities prices from crude oil to platinum have been the subject of allegations and inquiries. Now prices in global currency markets, where turnover is $5 trillion a day, are being scrutinised by authorities, who suspect bankers have tampered with those too.
Switzerland’s financial watchdog announced on October 4th that it was investigating a slew of banks it thinks have manipulated currencies. Britain and the European Union also have probes under way. None has detailed its suspicions, but concerns reportedly centre around abnormal movements ahead of a widely-used daily snapshot of exchange rates, known as the 4pm “London fix”. It represents the average of prices agreed during 60 seconds’ trading, and is used as a reference rate to execute a much larger set of currency deals. Bankers, who are big participants in the market, have huge incentives to nudge the price of a given currency pairing ahead of the fix. With billions of dollars changing hands, a difference of a fraction of a cent can add a tidy sum to the bonus pool.
If proven, the charge would amount to banks fleecing their clients. Banks know the big trades they are about to execute on others’ behalf, and are often themselves the counterparty. By moving the markets ahead of the fix, they could alter the rate to their profit and their clients’ loss. One suspected method is “banging the close”: submitting a quick succession of orders just as the benchmark is set, to distort its value. Though indicators based on real trades are meant to be harder to game than those using hypothetical figures (such as LIBOR, a daily poll of banks’ estimated borrowing rates into which respondents fed duff data), they are clearly not incorruptible.
The 4pm fix is used to calculate the value of all sorts of assets, such as the foreign holdings of mutual funds. Fiddling the rates could thus have an impact far beyond the banks and their clients. Worse, if the bankers talked to each other ahead of their trades, as regulators think they may have, collusion will be added to the charge sheet. Investigations into other fiddled benchmarks have unearthed reams of messages between traders blithely discussing their swindles.
The risk of manipulation could be vastly diminished by using a benchmark that relies on more than just 60 seconds of trading, points out Mark Taylor, dean of Warwick Business School and a former currency-fund manager. The damage to implicated banks’ reputations will be harder to fix.