The foreign exchange market is not immune to price fixing at major banks

“Bankers! Can’t live with ‘em! Can’t live without ‘em!” That may sound like a line from the latest Hollywood take on high crimes and misdemeanors in the banking sector, but retail forex traders began muttering these words after reading the recent headlines about their financial market. Those words from the world of reality read, “Germany’s financial watchdog finds evidence of forex price manipulation.”

Before you scurry back to your screen to confirm your trading account balance, you should be aware that these regulatory investigations have been ongoing since April of last year. By November, according to the Wall Street Journal, “More than a dozen traders at five banks are now either suspended or on leaves of absence in connection with global currency-rigging investigations, according to people familiar with the probes.”

And these figures have grown over the past six months. “More than 30 foreign exchange traders at many of the world’s biggest banks have already been put on leave, suspended or fired as forex probes in various countries expand,” was reported this week by “The Guardian”, and we are no where near the end of these witch hunts.

These probes have spanned several countries, but the financial regulator from Germany was the first one out of the box to share his results. Raimund Roeseler, the head of the Bafin regulatory group, noted in his annual news conference, “There were clearly attempts to manipulate prices, that’s what was disturbing… It’s not the really big currencies, not the dollar/euro, but several currencies were involved.” He mentioned the Mexican Peso as one example.

What is going on behind the scenes?

The suspected culprits are the head forex traders at many of the world’s largest banks. They are accused of sharing sensitive trading information in established chat rooms on Bloomberg terminals with such exciting names as “The Cartel” and “The Bandits’ Club”. These are not the social exchanges that many leading edge brokers offer today to entice your patronage and broaden your trading experience. These chat rooms are not easily accessible, but seem to be populated by world’s top currency traders.

The fraudulent act relates to manipulating key fixing rates that occur at specific times of the day. These rates are then used by money mangers the world over to value their individual portfolios. The “fix” is determined by market activity in a brief window of time. If you can influence that activity for personal gain, then greed wins another battle with the public and the regulators. According to insiders, top traders were sharing major buying or selling information in chat rooms before execution in order to sway the market action. The obvious targets would be the more exotic, less heavily traded pairs, where a large buy or sell order at the right moment might easily broaden spreads due to low liquidity.

This kind of fraud is reminiscent of other recent scandals involving Libor and Oil benchmark fixings. Fines of over $3.5 billion have already been assessed in the Libor investigations. The mind can only ponder how high these fines might be in the Mother of all markets, the forex market where over $5.3 trillion in turnover occurs daily.

What is driving this type of fraudulent activity?

The simple answer is greed, but this phenomenon is not something new. It has been building for decades. The tipping point was reached back in 2008, when the global banking collapse created the Great Recession. Trading rooms were over-leveraged on arcane OTC swap instruments where prices were determined more by formula than by market forces, until lightening struck. When everyone realized what was happening, buyers disappeared. Everyone tried to sell at once. Prices plummeted. Collateral agreements drained liquid cash, and the crisis was launched.

For anyone in the senior ranks of banking or any other corporate entity for that matter, the pressure to produce an ever-increasing profit stream is all encompassing. Banks had been leveraging technology for years to increase trading profits, first with algorithmic tricks, then to FPGA (Field Programmable Gateway Array), and finally to integrating actual trading regimes with real-time news feeds. Trading profits grew, but senior management became addicted to this revenue stream, much as with a drug, and demanded more and more. The stage was set to manipulate the market for gain.

As any retail trader knows, no clever strategy lasts forever. The “herd” will find out about it, and the earning potential will get homogenized amongst the entire community, until it nearly disappears. The same is true at a major bank level. Technology has been leveraged to the hilt. If the “pie” is not growing, then your growth can only come from someone else’s losses. As a result, recent quarterly reports from banks decry the decline in trading profits, as well as complain about new laws attempting to curtail their reliance on trading profits, as if it were some newfound economy or right of banking.

Concluding Remarks

The Libor scandal grabbed news headlines for months, but it was only a matter of time before price fixing in the forex space would find the limelight. Regulators have already admitted that investigations may drag on for years, but for retail forex traders, it appears that this fraudulent activity is too far up the food chain to impact any execution orders on a daily basis. These misdeeds, however, are not like the recalcitrant rogue trader that may have lost a billion on a bet. The integrity of the industry is at stake, and if one sector is draining off profits illegally or having to pay huge fines for doing so, then the cost for that fraud will have to be borne by us all in broader spreads or higher fees.

What should we do going forward? Fraud will never be eliminated. It is everyone’s responsibility to be skeptical of something that just does not smell right. In the retail forex space, ensure that your broker is competent and of high integrity. If you sense that slippage, re-quotes, or arbitrary triggering of stop-loss orders are prevalent, then you might want to consider a change. You will always be your first and last line of defense against fraudulent activities. Stay vigilant!

Chris Lee

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