Bank FX Fine Scorecard (Follow Along at Home!)
The foreign-exchange settlements are very hard to keep straight so I made a little scoreboard of the various fines that various banks have paid to various regulators:
That is a lot of money. Bank fines feel a bit like abstractions these days, but this is a lot of money even in context. When the U.K. Financial Conduct Authority issues its FX manipulation fines, it makes a determination of "the firm's revenue from the relevant products or business area" over the period of the misconduct. 3 For these settlements, the relevant period seems to be March 2010 to October 2013, and the relevant revenue figures -- as calculated by the FCA -- are:
Honestly I don't know what "relevant revenue" is, so I don't know how useful this context is, but it does sure look like the banks paid much, much more to settle these charges than they made doing the bad stuff.
More context. The U.S. Office of the Comptroller of the Currency puts out a quarterly report on bank trading revenue. From the OCC's numbers, JPMorgan seems to have paid fines equal to just over half of its own total FX trading revenue for the two-and-a-half year period it was involved in FX manipulation. 4 If you use the rule of thumb that half of revenue goes to compensation expense, then JPMorgan would have been better off not having an FX business for those years. 5
So it's a lot of money. The fines accompany criminal guilty pleas for Citicorp, JPMorgan, Barclays, Royal Bank of Scotland and UBS. It is easy to say -- and I have said -- that those guilty pleas feel like curiously weightless things, a cost of doing business rather than a serious deterrent. And today's pleas come with all of the necessary waivers to allow the banks "to continue managing mutual funds and raise capital quickly," meaning that they won't have too many consequences beyond the fines. 8 But the fines are really big! If you are a manager or shareholder of a bank, you would strongly prefer not to pay these fines. But, yes, I know, I know: They keep paying more of them.
The settlements today, with the Department of Justice and the Federal Reserve and the New York Department of Financial Services and also a few others, are mostly for an antitrust conspiracy conducted in electronic chat rooms where traders from different banks would meet to discuss their client orders. We talked about this six months ago when most of these banks settled similar charges with other regulators. 9 Ordinarily here I would provide you with an assortment of dumb trader quotes, but since I did that six months ago I will skip it today. Also Benjamin Lawsky of the New York Department of Financial Services is preternaturally talented at selecting, boldfacing and underlining dumb trader quotes, so just go read his news release. Just running my eyes down the bold underlined bits I get:
"mess this up and sleep with one eye open at night"
"We gonna help u."
"yes, the less competition the better."
"hard mark up is key . . . but i was taught early . . . u dont have clients . . . u dont make money . . . so dont be stupid."
"if you aint cheating, you aint trying."
So there you go. Bad chat rooms, bad nicknames, bad spelling, bad quotes.
We discussed the actual conduct at some length in November; I thought it was bad, but not as meaningful as it sounds. The banks agreed to do lots of trades with lots of clients at a fixed price at a fixed time. That created a lot of risk for them, which they managed by trading ahead of the customer fixing. That is a totally normal practice, and one that makes markets more efficient, though it might at first glance look a little fishy. They also got together in chat rooms to, essentially, lay off some of their client risk to one another prior to the fixing. That laying off of client risk, again, looks a bit conspiratorial, but it probably made markets more efficient, and is not obviously bad or illegal. Then they went beyond that efficient laying off of risk, trying to move the price in their favor. They seem to have made some money doing this, at the expense of their clients, but my suspicion was that they were "tinkering at the edges of real supply and demand," optimizing how they made money trading their combined customer order book rather than truly rigging the FX market. 10
This is different from the Libor scandal, where banks just made up numbers to help themselves, unconstrained by supply and demand. But it's also different from a classic antitrust conspiracy, where all the sellers of a product conspire to make the product more expensive. These banks were not producing euros and conspiring to drive the price up. They were intermediaries between buyers and sellers of euros, and all they could do was conspire to make some extra money trading on whichever side predominated. But compared with classic antitrust conspirators, their market power was very limited, and they couldn't systematically push exchange rates one way or the other.
Dan Davies also wrote about the chat rooms in November, and if you read one thing about the foreign-exchange scandal it should probably be his post:
I think there’s a danger in viewing everything through the prism of previous scandals. Although there was some behaviour that was clearly on the other side of the line, the regulators also made clear that lots of the practices involved were not intrinsically criminal; this was an investigation into a grey area, not a straightforward case of lying.
The FX rigging stuff was bad, but it was bad at the edges rather than at its core, and a lot of the most offensive-sounding things -- trading ahead of client orders! sharing client orders with other banks! -- were hardly bad at all.
Today's pleas don't really add much to our understanding of the antitrust stuff. But they also address some miscellaneous non-antitrust misconduct. Hilariously, the Justice Department plea agreements require the banks to send their customers sad little "Disclosure Notices" that say, in part 11 :
The purpose of this notice is to disclose certain practices of [Bank] and its affiliates (together, “[Bank]” or the “Firm”) when it acted as a dealer, on a principal basis, in the spot foreign exchange (“FX”) markets. We want to ensure that there are no ambiguities or misunderstandings regarding those practices.
To begin, conduct by certain individuals has fallen short of the Firm’s expectations. The conduct underlying the criminal antitrust charge by the Department of Justice is unacceptable.
Imagine how hard the banks negotiated to get that form to say "conduct by certain individuals has fallen short of the Firm's expectations." It might as well say "a few bad apples ruined it for the rest of our good hard-working bankers." (As several bank executives did.)
The disclosure notices give limited space to the antitrust stuff, presumably because it's hard to explain in a short space. They spend most of their time on one or more bullet points about non-antitrust violations of the general "ripping customers off" variety. For instance Citi will be telling its customers that it:
- "added markup to price quotes using hand signals and/or other internal arrangements or communications,"
- "worked limit orders at levels (i.e., prices) better than the limit order price so that we would earn a spread or markup in connection with our execution of such orders," and
- "made decisions not to fill clients’ limit orders at all, or to fill them only in part, in order to profit from a spread or markup in connection with our execution of such orders."
Ehhh? From the little summaries in the notices, it is hard for me to tell exactly how bad this stuff was. The hand signal stuff, for instance, is spelled out a bit more in UBS's plea:
On occasion, UBS customers requested that a UBS FX salesperson provide them with an “open line” while the salesperson consulted with a UBS FX trading desk to obtain a price. Certain customers requesting an “open line” had an expectation that the price they heard was indeed the “trader price” and therefore did not include any sales markup. Certain customers on such an “open line” sought to be privy to discussions regarding price between the UBS salesperson and the trader working on the desk relevant to the customers’ specified transaction currency. Such customers sought an “open line,” in part, to ensure that they could hear the price quoted directly by the trader—the “trader price”—rather than receiving a price quote that included a sales markup.
Prior to, and continuing after the NPA, certain UBS FX salespeople and traders used hand signals during certain customers’ “open line” calls in order to conceal from customers that they were being marked up. For example, unbeknownst to the customer, a salesperson would hold up two fingers to signal that the trader should add mark up of “two pips” to the quoted price.
Ahahaha what charming rogues! This is: Dishonest! Bad! The sort of thing a client shouldn't like! But it does seem like it's in the category of what the Wall Street Journal last week called "Common Sales Tricks." It's a trick all right! But it's, you know, a sales trick. It's not fraud. The client isn't expecting UBS to tell him the true objective price of the currency. He's expecting UBS to tell him the price that UBS is willing to trade at. He just wants the price that UBS's trader is willing to trade at, not filtered through UBS's salesman. The client thought he was clever, cutting out the filter of the salesman. But the salesman was even cleverer, and pre-filtered the trader. 12
Ben Lawsky's news release puts it well:
FX Sales employees would determine the appropriate mark-up by calculating the most advantageous rate for Barclays that did not cause the client to question whether executing the transaction with the Bank was a good idea, based on the relationship with the client, recent pricing history, client expectations and other factors.
As one FX Sales employee wrote in a chat to an employee at another bank on December 30, 2009, “hard mark up is key . . . but i was taught early . . . u dont have clients . . . u dont make money . . . so dont be stupid.”
If you were to ask me to explain the financial services business while standing on one foot, I would say unto you: "Price things at the most advantageous rate for you that does not cause the client to question whether executing the transaction with you is a good idea, this is the whole business, the rest is commentary." This is the problem? The problem is that banks charged clients as much as they could get away with? That is literally capitalism.
I don't really know what to tell you. There is some genuinely bad stuff here, but it does not feel like we have any reasoned system for evaluating and weighing and punishing the bad stuff. Bank scandals are all one size: Everything is Bad, but no one wants to think about How Bad. Everything is an indictment of bank culture, and anything that any bank does is added to a list of misdeeds that starts in the financial crisis. There's no effort to evaluate how much harm any particular conduct does, or to correlate that harm with the punishment. The penalties, in FX as in Libor, seem to be indexed to how many bad chat messages you sent rather than how much harm you did. 13 These cases lump together cartel price-fixing, and sensible risk management, and failures of best execution, and common sales tricks, and just plain charging as much as the market will bear. Lawsky says that Barclays "engaged in a brazen ‘heads I win, tails you lose’ scheme to rip off their clients." That's what you say about any misconduct, when you don't care what the misconduct was. It doesn't describe the FX scandal at all. 14
But of course today's action isn't about FX manipulation. After all, Barclays and UBS are paying Libor-manipulation fines to settle their FX cases. No bank scandal can stand on its own any more; each is added to all the others. The crime that has everyone outraged here, and that has led to record-breaking fines, is not fixing FX rates in chat rooms. It's that the banks that did that also did all the other stuff. We're past the point that anyone cares about the details.
- The November 2014 Commodity Futures Trading Commission settlements with five banks, and today's settlement with Barclays. (Not shown: Today's other CFTC settlement with Barclays, for ISDAfix, which is different.)
- The November 2014 Office of the Comptroller of the Currency fines against three banks.
- Today's Justice Department guilty pleas from five banks.
- Today's Federal Reserve fines against six banks.
- Today's New York Department of Financial Services settlement with Barclays for a fine and the dismissal of eight employees.
- The U.K. Financial Conduct Authority's action against five banks in November, and against Barclays today.
- The Swiss Financial Market Supervisory Authority action against UBS in November.
In a few places I converted pounds and Swiss francs myself.
I'm counting $263 million of Libor-manipulation fines in this total because clearly the Libor fines today against UBS and Barclays were not actually for Libor manipulation, but for the foreign-exchange stuff. The FX stuff caused the Department of Justice to tear up UBS's and Barclays' non-prosecution agreements for Libor and fine them an extra $263 million, so I'm counting it here. I'm not counting other manipulations here, like the previous Libor fines, or today's Barclays ISDAfix fine.
It's in paragraph 5.5 of Annex D of the respective Final Notices, e.g. this one for Barclays:
The Authority considers revenue to be an indicator of the harm or potential harm caused by the breach. The Authority has therefore determined a figure based on a percentage of Barclays’ relevant revenue. The Authority considers that the relevant revenue for the period from 6 March 2010 to 15 October 2013 is £602,000,000.
There does not seem to be any further explanation of how it got that figure.
That is revenue for JPMorgan Chase Bank NA, not for the holding company; see, e.g., table 7 here. I suppose the holdco FX trading revenue would probably be more. According to the Justice Department, JPMorgan "was involved from at least as early as July 2010 until January 2013," so I'm using 3Q2010 through 1Q2013 numbers.
Of course, if you use that rule of thumb, the traders themselves have different incentives.
I mean, not really. That Wall Street Journal article only attributes today's $892 million to the one guy, though I assume that the November fines relate to the same conduct. Also if you read the JPMorgan plea agreement it mentions salespeople doing the same bad stuff as the other banks admitted to, so it's probably not literally all the one guy. Still, all in all a bad day's work for that guy.
Or there's this, from Dan McCrum at FT Alphaville: "The FT’s running total of legal fines and settlements paid by banks to US regulators since 2007 now comes to $155bn," or $53 million a day for eight years.
Incidentally, the Justice Department announced "parent-level guilty pleas" from the big banks, but Citi's guilty plea is from Citicorp, which is not the public-company parent. Similarly with RBS. Others are genuine parent-level pleas. I don't know what's going on here. Maybe Citi cleverly switched out its plea agreement when the DOJ wasn't looking?
Barclays did all of its settling today, so it has separate CFTC and FCA settlements today.
As Euromoney puts it, "The fix is a product that is logically not a profitable product unless it is manipulated."
It's Attachment B to most of the plea agreements, e.g. this one for Citi. Alterations in the text are mine. Here's the text of the Citi plea agreement requiring it to send out the notice:
On a date not later than that on which the defendant pleads guilty (currently scheduled for Wednesday, May 20, 2015), the defendant shall prominently post on its website a retrospective disclosure (“Disclosure Notice”) of its conduct set forth in Paragraph 13 in the form agreed to by the Department (a copy of the Disclosure Notice is attached as Attachment B hereto), and shall maintain the Disclosure Notice on its website during the term of probation. The defendant shall make best efforts to send the Disclosure Notice not later than thirty (30) days after the defendant pleads guilty to its spot FX customers and counterparties, other than customers and counterparties who the defendant can establish solely engaged in buying or selling foreign currency through the defendant’s consumer bank units and not the defendant’s spot FX sales or trading staff.
Oddly, UBS's plea doesn't seem to involve a disclosure notice, though the plea itself mentions the same sort of conduct.
Seriously how bad is this? Like obviously the client is expecting an un-marked-up price, and so thwarting his expectations seems straightforwardly dishonest. (In some cases some banks seem to have explicitly denied that they were adding a markup, instead of just implying that by using open lines.) So that's bad.
But at the same time, like, the whole point of a salesman is to help a trader understand how aggressive she should be in pricing for a client. Some clients will do everything in competition and fight for every last basis point. Some clients will take whatever price the bank gives them. The salesman tells the trader which clients are which, so the trader knows how to price trades to win the aggressive ones and make money on the complacent ones.
To be fair, as I've said, that seems more reasonable in an antitrust conspiracy case than otherwise. The crime here really was sending messages in a chat room! Called "the Cartel"!
Indeed, in a fair and functioning economic market, a business takes on risk in the hopes of earning a profit. However, Barclays’ traders coordinated with other banks to help remove that risk and instead just take profits at the expense of their clients. In other words, it was a “heads I win, tails you lose” trading system for Barclays.
But, first of all, Barclays was a service provider, not a pure market participant: It was supposed to make a profit on executing client trades. Clients expected it to make a profit. This is like saying that the grocery store has a "heads I win, tails you lose" trading system just because it charges a markup on groceries. It's supposed to charge a markup!
Second, de-risking the fix (by trading ahead of it) probably was desirable, and not illegal. Third, the banks in the chat room did sometimes lose money on it, and I have serious doubts that they could ever have entirely de-risked it. "Heads I win, tails you lose" is just a standard part of the prosecutor's rhetorical arsenal; it makes no sense here.
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