Financial institutions, forex and unregulated rates: following the scandals in Libor, the multi-trillion $ market is the next focus of regulator scrutiny over rate manipulation.

Author:Scheiner, Eric C.
Position:COMPLIANCE
 
FREE EXCERPT

On the heels of the London Interbank Offered Rate (Libor) scandal, regulators appear to have found a new area of potential improprieties with regard to the foreign exchange (forex) market. The forex market fluctuates, but can reportedly reach a value of up to $4.7 to $5.3 trillion per day. To date, at least 15 banks are reportedly under investigation by various regulators regarding the forex market.

Moreover, more than a dozen currency traders have been suspended or put on leave as a result of the ongoing investigations. Some banks have hired criminal defense attorneys to represent employees.

While these investigations remain in the preliminary stages, and no wrongdoing has been announced, there are indications regulators and plaintiffs' attorneys are ramping up scrutiny of unregulated rates.

Background

In essence, the forex market is a global and decentralized system on which currencies are traded. Much like when someone wants to buy foreign currency before international travel, a common method for a company or investor to make a large currency transaction is to review prices posted by various banks for a given currency and pick the best rate. However, as with making a trade in the stock market, banks active on larger currency exchanges will post two prices: the bid price and the offer (or ask) price. The bid price is the price the market would pay for a given currency, and the ask price is the price at which the market would sell the currency. The difference between these prices is how the banks profit on these transactions (commonly called the bid/ask spread). In essence, the banks try to buy currency at a lower rate and sell it later at a higher rate for a profit.

There are other pricing issues that can influence whether a person wants to make a currency trade. For example, the banks commonly charge various forms of commission. Further, the price can depend on the size of the transaction, whether the currency is being bought or sold, and even the nature of the relationship between the bank and the client looking to make the trade.

In light of these complexities, companies and investors who are not as concerned with trying to squeeze the best rate out of the banks often seek to use a benchmark rate. For example, forex index funds may use currency benchmark rates to keep their returns in line with the indices. While this may not sound like a particularly significant issue, even small fluctuations may affect these funds* value. Given that Momingstar Inc. estimates $3.6 trillion in index funds track global indices, there may be a large pool of potentially affected investors.

The most common benchmark rates in the currency market are set at 11:00 am and 4:00 pm London time. This is because London is considered to be the global center of the Forex market, with an estimated 40 percent of trades taking place there. These rates, commonly referred to as "fixes," are essentially daily rates that can be used to trade currency. The most common fix is computed at 4:00 pm by a joint venture between State Street's WM unit and Thompson Reuters (Thompson Reuters was also involved with setting the Libor rates). However, at least one recent article discussed potential investigations into Tokyo fixing", referring to Japanese currency benchmarks (which are set at 9:55 each morning in Tokyo). The potential attempted manipulation of these fixes appears to be the focus of regulators' investigations.

For the currencies that are traded more frequently (21 in total), the WM/Reuters fix is calculated by reviewing trade data from various platforms for 60 seconds at 4 pm. Since the currency market is very large, it...

To continue reading

FREE SIGN UP