The latest banking scandal has faded from the headlines, leaving some of the world’s largest banks with US$6 billion in fines to pay, and ongoing investigations that may or may not result in jail time for the traders involved.
The fines for foreign exchange manipulation join a pool of more than US$200 billion levied against large banks in the past five years for offences such as manipulation of LIBOR, money laundering and for sanctions busting. ASIC has still to report on its investigation into possible manipulation in the Australian foreign exchange market.
In these, and dozens of other cases, bank staff have colluded to manipulate the markets or move money illegally through the financial system. In doing so they made untold profits, before they were caught red-handed.
But if the banks and bankers made millions, who lost out?
This is not an easy question to answer because these are so-called “victimless crimes”. In such scandals it is very often not possible to identify precisely who would have lost money as a result of the misconduct.
In the Forex and LIBOR scandals, traders “nudged” financial benchmarks one way or another depending on which direction made them money, just because they could. In fiddling the system, they believed that no one was getting hurt, or at least no human with whom one could empathise.
Certainly, shareholders have been hurt by massive fines, which after all come out of their dividends, minus a little bit clawed back from traders’ bonuses. But shareholders are faceless - mere numbers in an ever-changing share register. And one could argue that shareholders were beneficiaries of the illegal activity when it was profitable (ignoring the fact that shareholders come and go all of the time).
The real losers
In fact, the main losers are even more faceless and remote than shareholders, who at least get a chance to turn up for a drink at annual meetings. The real losers are those who have their money in pension or investment funds. Most funds have some foreign currency exposure, even if it is only holdings in the largest US and UK stock market indices (the ones we see on our TV every morning). It turns out that every day the currency values of those indices were manipulated, if only by a fraction.
If you are in a superannuation fund, you are a victim. The amount you personally have lost will never be known, and is not likely to be large. But over a lifetime it will add up to something worth being concerned with.
We know this because at the same time as some of the banks admitted their guilt to regulators last week, they also settled private lawsuits with a number of pension funds, most notably the Oklahoma Firefighters Pension Fund. It turns out they settled early because they knew that they were about to plead guilty to crimes that may have class actions raining down on them for years (with even more shareholder pain).
This raises the question, why did those we pay to manage our pension funds not pick up this misconduct?
With great power…
The asset management industry has grown massively over the past twenty years. In a recent report into the industry, the IMF estimated that globally the industry has assets under management of some $76 trillion which is “equivalent to 100% of world GDP and is equivalent to 40% of global financial assets, including loans”. In other words, the industry controls assets equivalent to about 4/10th of the banking system, but, unlike banks, the industry is not regulated on a global basis but by local securities regulators, such as the US Securities and Exchange Commission (SEC) and ASIC.
More importantly, the industry, like banking, has consolidated and smaller asset managers have been acquired by major banking and insurance corporations. In a 2013 study, US regulator the Office of Financial Research, found that of the top 25 asset managers: nine are subsidiaries of large banks, such as JPMorgan, Deutsche and UBS; seven are subsidiaries of the world’s largest insurers, such as AXA and Prudential; while the remaining nine are independents, such as Blackrock (the largest) and Fidelity.
Why did these firms not pick up manipulation of the benchmarks that would negatively impact returns to their investors? Possibly because they were not looking for it. As the OFR said:
“Regulation of asset managers often focuses on limiting conflicts of interest between asset managers and their clients, which can help mitigate these risks. However, such regulation focuses on helping ensure that managers adhere to their clients’ desired risk-return profiles, but does not always address collective action problems and other broader behavioural issues that can contribute to asset price bubbles or other market cycles.”
Australia, which has the third largest Asset Management Industry in the world according to Austrade is similarly concentrated, with four of the top five banks among the top ten asset managers, with Commbank and Macquarie leading the pack. Whether there is manipulation or not, there is a conflict of interest here as, for example, asset managers in Colonial First State are working for the same company as FX traders at Commbank. If one could believe that all such conflicts of interests were being managed by the directors and senior managers of large banks then there would be little to worry about.
But evidence from elsewhere leads us to believe senior bankers have turned a blind eye to such misconduct. For example, State Street, the third largest asset manager in Australia, was fined last year by the UK Financial Conduct Authority for, in a clear conflict of interest, adding undisclosed mark-ups for its trading divisions to clients’ accounts.
Time for answers
While much publicity has been given to the wrongdoers in the latest financial scandals, and more will be generated when charges are eventually laid, we are forgetting the victims. There needs to be an investigation into why the asset management industry was not able, or seemingly willing, to go head to head with traders in the best interests of their customers. And the boards and management of large banks should be asking the same question also.
Australia is ideally placed to take a lead on this. Guy Debelle, Assistant Governor at the RBA, recently co-chaired an international inquiry into the FX manipulation scandal which recommended, among other things that “banks establish and enforce their internal systems and controls to address potential conflicts of interest arising from managing customer flow”. Maybe the RBA should prompt ASIC to take up the challenge?