Traders at some of the world’s biggest banks have manipulated the WM/Reuters foreign exchange rates used as benchmarks to set the value of trillions of dollars of investments, according to five people with knowledge of the practice. Bank employees have been trading ahead of client orders—a practice known as front-running—and rigging the rates by pushing through trades before and during the 60-second window when the benchmarks are set, say the five, current and former traders who asked not to be identified for fear of reprisals. Dealers colluded with counterparts at different firms to boost chances of moving the rates, say two of the people.
The manipulation occurred daily in the spot foreign exchange market and has been going on for at least a decade, affecting the value of funds and derivatives. The $4.7 trillion-a-day currency market, the biggest in the financial system, is also one of the least regulated. “The FX market is like the Wild West,” says James McGeehan, co-founder of FX Transparency, a firm that advises companies on foreign exchange trading. “It’s buyer beware.”
The Financial Conduct Authority, Britain’s markets supervisor, is considering a probe into potential manipulation of the rates, according to a person briefed on the matter. “The FCA is aware of these allegations and has been speaking to the relevant parties,” says Chris Hamilton, a spokesman for the agency. Regulators around the world are already investigating the integrity of at least three market benchmarks. The FCA fined three banks about $2.5 billion in 2012 for rigging the London interbank offered rate, or Libor. The European Commission is probing companies including Royal Dutch Shell, BP, and Platts, an oil pricing and news agency, for potential manipulation of the $3.4 trillion-a-year crude oil market. The three companies all say they are cooperating with the investigation. U.S. regulators are looking at the ISDAfix rate, the benchmark used for the swaps market.
Introduced in 1994, the WM/Reuters foreign exchange rates are used by fund managers to compute the day-to-day value of their holdings and by companies such as FTSE Group and MSCI that maintain indexes of stocks and bonds. They’re also used in futures and other contracts that require an exchange rate at settlement. Even small movements can affect the value of what Morningstar estimates is $3.6 trillion in funds, including pension and savings accounts, that track global indexes. “The price mechanism is the anchor of our entire economic system,” says Tom Kirchmaier, a visiting fellow in the financial markets group at the London School of Economics. “Any rigging of the price mechanism leads to a misallocation of capital and is extremely costly to society.”
The data are collected and distributed by World Markets, a unit of State Street, and Thomson Reuters. (Bloomberg LP, the parent company of Bloomberg Businessweek, competes with Thomson Reuters in providing financial news and information as well as currency-trading systems and pricing data.) State Street hasn’t been alerted to any allegations of wrongdoing involving the rate, says a person briefed on the matter. “The process for capturing this information and calculating the spot fixings is automated and anonymous, and the rates are monitored for quality and accuracy,” State Street said in an e-mail. Thomson Reuters referred inquiries to State Street.
WM/Reuters publishes the rates hourly for 139 currencies and half-hourly for 21 major currencies from the British pound to the South African rand. For the major ones, the benchmarks are the median of all trades in a minute-long period starting 30 seconds before the beginning of each half-hour. If there aren’t enough transactions between a pair of currencies during the reference period, the rate is based on the median of traders’ orders, which are offers to sell or bids to buy. Rates for the other, less widely traded currencies are calculated using quotes during a two-minute window.
Companies and asset managers typically ask banks to buy or sell currencies at a specific time later in the day, most commonly at WM/Reuters’s 4 p.m. London closing price. That arrangement is open to abuse, as it gives traders a window in which they can adjust their own positions and try to move the benchmark to boost their profit, three of the dealers say. By concentrating orders in the moments before and during the 60-second window, traders can push the rate up or down, a process known as “banging the close.” Three traders say that when they received a large order, they’d adjust their own positions in the knowledge that their client’s trade could move the market. If they didn’t do so, they say, they risked losing money for their banks.
To maximize profit, traders would buy or sell client orders in installments during the 60-second window to exert as much pressure as possible on the published rate, three of the traders say. Because the benchmark is based on the median of transactions during the period, placing a number of smaller trades could have a greater impact than one big deal. Traders would share details of orders with brokers and counterparts at banks through instant messages to align their strategies, two of them say.
One trader with more than a decade of experience says, for example, that when he received an order at 3:30 p.m. to sell €1 billion ($1.3 billion) in exchange for Swiss francs at the 4 p.m. price, he would have two objectives: to sell his own euros at the highest price, then to move the rate lower so that at 4 p.m. he could buy euros from his client at a lower price. On a trade of that size, lowering the euro-to-Swiss franc rate by 2 basis points—two hundredths of a percentage point—would be worth 200,000 francs ($216,000), he says.
While hundreds of firms participate in the foreign exchange market, four banks dominate, according to a May survey by Euromoney Institutional Investor: Deutsche Bank, Citigroup, Barclays, and UBS have a combined share of 50.4 percent. The five traders interviewed by Bloomberg declined to identify which banks engaged in manipulative practices and didn’t specifically allege that any of the top four companies were involved. Spokesmen for Barclays, Citigroup, Deutsche Bank, and UBS declined to comment.
One of Europe’s largest money managers has complained about possible manipulation of foreign exchange rates to British regulators within the past 12 months, according to a person with knowledge of the matter who asked that neither he nor the firm be identified because he wasn’t authorized to speak publicly. While U.K. regulators require dealers to act with integrity and avoid conflicts, there are no specific rules or agencies governing spot foreign exchange trading in Britain or the U.S. That may make it harder to bring prosecutions for market abuse, according to Arun Srivastava, a partner at the law firm Baker & McKenzie in London.
Spot foreign exchange transactions aren’t considered financial instruments in the same way as stocks and bonds. They fall outside the European Union’s Markets in Financial Instruments Directive, or MiFID, which requires dealers to take all reasonable steps to ensure the best possible results for their clients. They’re also exempt from the Dodd-Frank Act, which seeks to regulate over-the-counter derivatives in the U.S. “Just because MiFID doesn’t apply, the spot FX market shouldn’t be a free-for-all for banks,” says Ash Saluja, a partner at law firm CMS Cameron McKenna in London. “Whenever you have a client relationship, there is a duty there.”
Sixteen of the largest banks, including Barclays, Deutsche Bank, and JPMorgan Chase, signed a voluntary code of conduct for foreign exchange and money-market dealers in 2001 that was later included as an annex to guidelines issued by the Bank of England in November 2011. The BOE’s Non-Investment Products Code, which some banks use in contracts with clients, states that “caution should be taken so that customers’ interests are not exploited when financial intermediaries trade for their own accounts.” It also says that “manipulative practices by banks with each other or with clients constitute unacceptable trading behavior.” That only goes so far, according to Saluja. “The thing about the code is it is a voluntary code,” the lawyer says. “It may be that compliance with that has almost been seen as optional.”