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The Next Big Rate Manipulation Scandal Is About to Break

Oct 7th, 2013
By Shah Gilani
Wallstreetinsightsandindictments


Back in June, the U.K.’s Financial Conduct Authority said it was “aware of allegations” of manipulation in the biggest trading market on the planet…

The $5.3-trillion-a-day cash foreign exchange (FX) market.

Well apparently there’s more than just “awareness” going on.

The Swiss Financial Market Supervisory Authority (FINMA), according to its website on Friday, is “currently conducting investigations into several Swiss financial institutions in connection with possible manipulation of foreign exchange markets.”

The site goes on to say, “FINMA is coordinating closely with authorities in other countries as multiple banks around the world are potentially implicated.”

Without getting too complicated here, FX (foreign exchange) manipulation is pretty similar to Libor (the London Interbank Offered Rate) manipulation.

It’s not about a bunch of traders and brokers manipulating interest rates (or FX “fixings,” (in the case of the cash foreign currency trading markets) to throw the world off its axis. It’s about traders manipulating data, prices, rates, and “fixes” to profit individually, in most cases, and to benefit the bank’s balance sheet or liquidity needs in desperate times.

Here’s everything you need to know about the next big scandal…

Libor manipulation is managed by conspirators who agree to post misleading rates – rates at which they say they would make certain term loans to each other. The idea being that those rates are “base rates” that banks then mark up to other borrowers.

There are some $300 trillion worth of loans in the world that are priced off Libor.

Currencies are traded all day by banks. You can get a quote at any time of the day on any currency (all currencies trade in pairs; one currency is always priced relative to another currency) from your bank or a broker (who gets it from his trading platform, which is really just an aggregation point for multiple quotes posted by multiple banks).

Contracts and trading positions and balance sheets denominated in currency terms have to be valued regularly, sometimes every day. Because currencies trade almost 24/7, there has to be a point in time that currency prices are “fixed.” The principal time for currency “fixes” is 4:00 pm London time. That’s the London fix.

Prices are fixed, similarly to the way Libor is fixed, by banks submitting quotes or actual prices to an aggregation point, where a single number is derived from submitted data to arrive at the fix or prices used for accounting purposes.

And as with Libor, there are traders that have positions whose profit and loss are dependent on what FX fixes are.

Who is involved in the FX manipulation? I don’t know, but I can guess.

And while I don’t know exactly how the game was played, I can guess.

But rather than guess, I’ll tell you how the “marking game” has been played… and here I’m not guessing. These are the facts.

How to Play the “Marking Game”

Tom Hayes was a big-shot, big-deal, mucky-muck trader at UBS. He’s now fighting fraud charges in a London courtroom and faces possible charges here in the U.S. too.

Tom used to put on huge interest rate trades, most of them denominated in Japanese yen.

Besides the Libor you know – which pertains to dollar-denominated interest rates – there are other currency-specific Libor fixings, yen-Libor being one. Tom’s trades, being mostly denominated in yen, were priced regularly using yen-Libor fixings that are themselves quotes from panel-member banks that get aggregated, sliced and diced, and come out as rates for the day that everybody who needs to calculate their positions’ value and profit and loss uses.

Tom liked making millions and being a big deal at the bank. So to accomplish both of those ends, he needed his positions to be profitable. To ensure they were regularly marked at good prices, Tom “allegedly” manipulated the same yen-Libor rates that everyone in the world had to price their stuff off too.

While Tom’s plight is playing out right now, we know he had help doing what he allegedly did.

We know that because the London-based broker ICAP, who Tom used to allegedly manipulate yen-Libor, said several of their brokers were involved. ICAP fired them (they will likely be prosecuted), paid $87 million in fines for doing it, and said they were sorry.

That ICAP brokers manipulated yen-Libor for Tom so he could make millions from his bonus, out of which brokers at ICAP expected payment, is a matter of fact.

It worked like this: Tom told the brokers what yen-Libor rates he needed. The brokers got on their phones to all the other bank traders who were on the submission panels posting quotes into the aggregation hopper that spits out Libor rates, and talked them into posting the rates Tom wanted to see.

Here’s where brokers come in.

How Brokers Help Traders Hide Their Tracks

Brokers are middlemen. Big traders use them to buy and sell through.

Traders all want an edge. They all want information about where the market is, who’s doing what, and whatever objective insight they can get, from whomever they can get it. They are supposed to get some of that information from the brokers they do business with.

As a trader with a big position, let’s say you’re selling a huge position. You don’t want the potential buyers of the massive position you’re unloading to know you want to sell, or worse, have to sell. Other traders will back away and won’t buy and even sell what you’re trying to sell to knock the price down on you to force you to sell at cheaper prices. And who’s going to buy at those cheaper prices? The traders who want to buy what you have at better prices, if they can get them.

Traders hide who they are and what they are doing by using brokers.

Brokers know who’s doing what. They generally don’t want to screw their clients, because if it’s found out that they’ve screwed you, you won’t use them again. And sometimes, if you are an angry trader, you might rip the throat out of a broker who screwed you out of tens or hundreds of millions of dollars, and yes, sometimes billions.

It happens. It happens because brokers always protect their biggest clients and will screw other clients to help their best clients. Tom was a big client at ICAP. ICAP is no small-time broker either. According to their annual report, they handle about $1.4 trillion in trades… a day.

Brokers provide “color” to their clients. Color includes their insights and sometimes inside information about other traders’ positions. ICAP’s brokers colored other bank traders’ outlooks with information and actual suggestions as to what they should submit to the aggregators pricing Libor based on what Tom wanted those rates to be.

That’s how easy manipulation can be.

See, nothing fancy. Just some color added to an otherwise unprofitable day for some grateful trader somewhere.

Are there co-conspirators? Of course there are. Was Tom Hayes the only person allegedly manipulating Libor for a bigger bonus? Of course not. Did Tom’s bosses know? Who knows? But I allege that of course they knew. They got bonuses based on Tom’s profitability.

I’m not speculating whether there was any FX manipulation at any banks. I’m not speculating whether there was or is any manipulation of the ISDAFIX used to price derivatives (more on that one another time). Nor am I speculating whether there was any manipulation of Libor.

I would never speculate on anything that I already know is true.

Shah

http://www.wallstreetinsightsandindictments.com/2013/10/the-next-big-rate-manipulation-scandal-is-about-to-break/