The FX fixing scandal

New allegations suggest that key benchmark rates have been manipulated in the foreign-exchange (FX) markets. Are traders gaming the system? Matthew Partridge reports.

What happened?

World regulators are examining allegations that bank traders colluded to manipulate key benchmark rates in the foreign-exchange markets. At least eight banks, including RBS and Barclays, are being formally investigated or are carrying out their own internal investigations. Several traders have been suspended or put on leave.

Even if the allegations are untrue, there are concerns that traders are allowed to have a large amount of unsupervised contact with their counterparts at other banks. It is accepted practice for them to share information that would normally be considered confidential, such as the size and direction of their positions.

As the FT says, this means that even if there is no direct conspiracy, "it could be a short step for the regulator to deduce collusion".

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Is the entire currency market rigged?

Experts agree the market is too large and liquid to rig for any extended period, with an estimated $5trn traded every day. The allegations involve the WM/Reuters rate, used by institutions as a reference point for settling deals.The value of an estimated $3trn of funds, including money in pensions and savings accounts, is indirectly linked to it.

Because it is calculated at a specific time (it represents the average of prices agreed during 60 seconds' trading and is set at 4pm London time), it is possible for concerted activity by a few traders, or even one big trader, shortly before, to affect it. This is known as "banging the close".

Studies suggest that around a third of the time prices have moved sharply in one direction just before 4pm, only to reverse immediately after.

How does this compare with the Libor scandal?

There are several similarities. In both cases there appears to be evidence of market manipulation. Similarly, both Libor and the WM/Reuters rates were semi-official benchmarks produced by third parties.

However, as Business Insider's Steven Perlberg says, the Libor rate was based on estimates of the going rate from a few selected banks, rather than objective trading data. This made it easy to make profits by rigging Libor.

By contrast, Bloomberg's Liam Vaughan says that in many cases sudden market movements, either due to sudden developments or other traders placing bets in the opposite direction, meant that forex manipulation attempts frequently backfired.

Libor traders were also far more brazen about what they were doing, including agreeing to change data in return for free food and champagne.

Will the banks be punished?

Opinion is split. Some experts say the regulators will extract the maximum pain, with large fines, as with Libor (see below). The FT's Alice Ross suggests the consequences "might eventually match the scale of the Libor manipulation saga".

Others argue that there is substantial uncertainty about the extent to which regulations against such behaviour apply to the more lightly regulated foreign-exchange market. Perlberg says banks may be able to defend their behaviour as "shrewd hedging".

While he thinks that "it is too soon to tell what regulators are going to game for", he predicts that they will take a softer approach. The most likely outcome is that "a smattering of banks will probably cough up fines and fire traders and/or slap wrists".

Are there any other markets that could be rigged?

Libor and foreign exchange are not the only ones being investigated. The European Commission is investigating energy companies for allegedly providing distorted energy price information to market intelligence company Platts. More importantly, they are looking at the ISDAfix index, used to track interest rate swaps.

Since the market is worth over $379bn, this could be the biggest scandal of them all. Of course, allegations aren't limited to private banks. There are complaints that central banks are colluding to keep down the price of gold, a practice that allegedly extends to the Federal Reserve over its reporting of the amount of bullion held in its vaults. While this view is well outside the mainstream, there have been calls for a formal audit.

How can we prevent such scandals?

One solution is to ensure the benchmarks are better designed. In the summer, the International Organization of Securities Commissions, which represents global regulators, suggested policies to make sure that they were properly monitored and based on observable trades, rather than just on the perception of traders or market participants.

Professor Mark Taylor of Warwick Business School thinks that the trading period used to measure foreign-exchange prices should be widened, making it harder for traders to game the system, and increasing the chances of any manipulation backfiring.

The fallout from the Libor scandal

The Libor scandal began in 2007, with Barclays complaining about the rates that other banks were setting. However, the story didn't hit the headlines until regulators took action last summer.

Ironically, Barclays was the first to be fined, paying $450m to British and US regulators in June 2012. Since then other banks have paid up, with UBS paying an unprecedented $1.6bn and RBS $612m. Dutch bank Rabobank recently settled for $1.1bn, bringing the total so far up to $3.5bn. However, other banks are under investigation, with more fines likely.

The US Department of Justice is also looking to see if any criminal charges could be brought. Meanwhile, a number of civil lawsuits have been filed. The most prominent of these is by the US mortgage firm Fannie Mae, which is seeking to recover $800m from nine banks.