Barclays Fine Spurs U.K. Scrutiny of Derivatives Conflict

Britain’s markets regulator plans to scrutinize the conflicts of interest banks face when they use derivatives after fining Barclays Plc for manipulating the price of gold to avoid a pay-out to a client.

The Financial Conduct Authority will examine how investment banks manage such conflicts in coming months, with so-called barrier options “one of the most obvious examples of a conflict,” Chief Executive Officer Martin Wheatley, 55, said in a June 4 interview in New York.

The FCA last month fined Barclays 26 million pounds ($44 million) after finding a former trader had suppressed the London gold fixing on June 28, 2012 to avoid paying out $3.9 million to a client who had taken out a barrier option with the London-based bank. Such contracts are a winner-takes-all bet on whether an asset will reach a certain price or not.

“Barrier options are one of those classic cases where there are likely to be conflicts,” Wheatley said. If there is “the ability to influence a price that prevents a payoff, and therefore gain a significant profit-and-loss, that is a conflict that needs managing.”

British regulators are trying to revive confidence in benchmarks that have been tainted by manipulation scandals in recent years. At least nine firms have been fined more than $6 billion for attempting to rig the London interbank offered rate and similar interest-rate benchmarks. Agencies on three continents are also investigating allegations traders tried to manipulate key gauges in the $5.3 trillion-a-day currency market.

Fixing Ritual

The London gold fixing is a ritual dating back to 1919. Today, it’s led by representatives from four banks who on, a daily conference call, agree a price at which the metal is bought and sold. The rate, used as a benchmark by miners and jewelers, has come under criticism in the past year for being vulnerable to manipulation.

On the evening of June 27, 2012, Barclays gold trader Daniel Plunkett sent a routine end-of-day e-mail summarizing his risk positions to Barclays’s commodities business, the FCA said as it issued the fine.

He told them an option tied to the fixing sold a year earlier was his “main event” the next day and he was hoping for a “mini puke” -- a price drop, according to the regulator. To avoid the pay-out, he needed the price to fix below $1,558.96. The price that afternoon was $1,573.50.

The following day Plunkett made a fake sell order at the fixing to push the price down and dodge the payment to his client, a move known as running the barrier. Shortly after, the customer asked Barclays why it had settled below the barrier price and the bank started an internal investigation and notified the FCA of the incident.

Controls Absent

While commodity derivatives are regulated by the FCA, the London gold fixing isn’t. As a result, the trader’s actions fell outside the regulator’s criminal jurisdiction and Plunkett was fined 95,600 pounds for breaching the regulator’s principles of integrity and banned from the industry.

“The absence of controls that allowed that to happen have been a control weakness for many years,” Wheatley said. “We didn’t turn our attention to it because we didn’t have evidence at that time about whether this practice was rife across the market.”

Four traders interviewed by Bloomberg News said it was common practice to try and move prices to profit or limit losses from barrier options. It was more common when the counter-party was a large financial firm that could be attempting the same behavior rather than a company, said the traders, who asked not to be identified because they weren’t authorized to speak publicly.

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