The biggest open secret in the financial world has been confirmed. Regulators in the UK, the US and Switzerland have announced massive fines for some of the world’s largest banks for a manipulation of global currency markets that in its callous ubiquity says so much about the banking behaviours that sparked the global financial crisis.
Fines levied by the UK regulator add up to £1.1 billion. The US regulator announced fines of $1.4 billion. Banks hit by these fines include UBS, Citi, JP Morgan, HSBC and RBS. Barclays is yet to come to a settlement on the back of the investigations.
The probe uncovered individuals traders within large banks who were working together in trading clubs which had names you would expect from the “ruthless narcissists” on BBC TV show, The Apprentice. These included “the players”, “the 3 musketeers” and “1 team, 1 dream”.
These clubs worked together to influence the WM Reuters 4pm fix – essentially the official number used to fix currency rates. It shapes everything from how much we pay for currency when we go overseas to how much our pension fund pays when it wants to buy into an offshore investment. This is one of the core numbers in global finance.
So, it sounds important, but why should we actually care? Well global currency markets are worth over £5 trillion a day. They are the world’s biggest financial market. More than 40% of the trade takes place in London, and more than half of this trade is dominated by just four players: Citi, Deutsche Bank, UBS and Barclays.
A small percentage of the trade relates to buying actual things (such as a shipment of coffee or oil). Most of it is either purely speculative or part of the process buying other speculative financial instruments. According to one piece in the Financial Times, there are really only a hundred or so people who really matter in this market. About 30 of them have been either placed on gardening leave or have been fired from their position in the last year.
The various documents released reveal a world where people talk in a mix of financial jargon, and the salty slang of an Cockney street trader. The traders say things like “you getting betty on the mumble still” or “have that my son” and refer to “other numptys” in the market. The documents also reveal strategies used to manipulate the markets.
In one, based on records of traders activities at RBS, we find traders using three techniques to get the fix to move the way they wanted it to. They might conduct deals outside of the accepted channels, skew their trades to one buyer in an effort to consolidate influence or simply go hell for leather on trades in one direction as the fix approached. Such methods were given descriptions such as “taking out the filth” or “leaving you with ammo”.
Perhaps most worrying was the institutional failures of process at work. Various reports show that the large banks did not have systems in place to understand what was going on. They did not monitor the chat rooms where traders co-ordinated market fixing. When concerns were spotted, they were not elevated. One official at the Bank of England who was aware of irregular behaviour in the market did not push this information upwards in the organization. When whistleblowers did speak out about practices they were concerned about, their concerns were largely overlooked.
The investigations reveal a number of serious failings in the world’s biggest financial market. These include significant shortcomings in the way markets are designed, the way firms function, and the over-arching culture at play.
There are big problems with the design of the global currency market which make it a hot-house for growing bad behaviour. It has almost no rules, meaning activities like sharing insider information, collusion or trading on your personal account at work – illegal or banned elsewhere – are perfectly legal in the currency market. There has been little in the way of oversight or policing. The main body involved in regulating the market based at the Bank of England is made up of a group of senior traders (some of whom have subsequently been suspended for bad behaviour).
There is little or no transparency about what is actually going on in the market. Because it is an “over the counter” market there is no centralised record of what price people are actually making trades at or any indication of the number of buy and sell orders on the market. The only people who have a reasonable idea of this are traders working for the biggest banks.
Finally, the market remains highly concentrated – the position of the four banks that run the market is increasingly entrenched due to their ability to deal with large scale orders, their tight client relationships and their electronic trading platforms.
There are also significant problems with the way currency trading has been managed within the banks. The various reports paint a picture of a business division which was allowed plenty of autonomy – as long as it returned juicy profits. There was little in the way of internal oversight with control and risk functions weak or non-existent.
Rules that applied in other parts of the bank’s trading operations – such as not trading ahead of your client or not trading on your personal account – did not apply. What is perhaps most striking is that the currency trading divisions seemed to be immune from learning from other scandals. The furore following LIBOR did not mean currency traders stopped manipulating their own market.
Underlying all this was a culture of collusion in the world’s biggest market. Currency traders identified more with each other than they did with their employer or their clients. They formed a frat-house sensibility, bonded by a shared salty language, dense and ongoing interactions and shared experiences working on the same trading desk.
Investigations by journalists at Bloomberg also suggest they frequently socialised with one another, and many London-based traders lived close to each other in Essex. They shared an unofficial code of ethics.
It was based on keeping the market liquid, responding to each other almost instantly and in some cases being loyal to their own clique. If you didn’t follow these rules, you could be frozen out.
The question of how to fix the market is complex. There are already initiatives underway by the Bank of England to address the structure of the market and conduct issues.
Unfortunately many radical reforms in this market have already been taken off the table. The idea of moving away from an over the counter market towards a centralised market structure has been rejected. Questions of providing more transparency – such as information around order flow are still on the agenda. There is a nervousness around adding rules of regulations to this ultra-light touch market. And the question of creating meaningful competition remains somewhere in the background.
There has been more progress in addressing dynamics within banks. Each of the banks has undertaken significant reforms in its currency trading divisions. Many senior people have left. Those who remain are under a great deal of scrutiny. They have banned chat rooms and stopped trader operating their own personal accounts at work (though some have found ingenious work arounds). They have also beefed up their risk and compliance function. Much of the trading activities has disappeared into automated algorithms, leaving less space for “human interference”.
The big question that remains hanging is what to do with the market culture that systematically encouraged collusion. Some initial steps might be for the forex community to take a serious look at its own moral code. They need to ask what the line is between collusion and hedging risks.
There also need to be clearer forums – both within organizations and beyond – for people to speak out when things go wrong. Some degree of external oversight would probably help and a degree of diversity would help break up a homogeneous culture which encourages collusion. The goal must be to give traders a sense of what the outer limits are of acceptable behaviour and a better sense of where their ethical duties lie.