Mon, Nov 11, 2013 page15

• FEATURE: After LIBOR, is the ‘4pm London spot rate’ next?

  • The Observer, LONDON
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  Until 1858, sending a message between the UK and the US could take 10 days, the time it took for a ship to cross the Atlantic.

  Yet after a cable was laid under the ocean in 1858 it cut communication times — including transmissions between financial markets — to just a few minutes.

  It was a huge leap forward and so dramatic that, even today, currency traders on the foreign exchange market call the sterling-dollar exchange rate “the cable.”

  Such jargon is typical of the currency markets, where a staggering ￡3 trillion (US$4.8 trillion) changes hands every day, and which are now the subject of an investigation into market manipulation said to be on the same scale as the one into LIBOR, which resulted in five big firms being fined ￡2.3 billion on both sides of the Atlantic.

  A growing list of banks have admitted they are cooperating with investigators. In America, JP Morgan, Citibank and Goldman Sachs are involved, as are the UK’s Barclays, Royal Bank of Scotland, HSBC and Lloyds. European giants Deutsche Bank and UBS of Switzerland are also “working with” regulators.

  Traders have been suspended — though there is no suggestion of wrongdoing — including six at Barclays.

  This subject should matter to everyone, from an individual going on holiday to a major company buying steel or manufacturing clothes; the currency markets affect all aspects of everyday life.

  Not only are the foreign exchange (forex) markets enormous, but they are also opaque. Unlike shares, there is no exchange on which trading is conducted to produce up-to-date prices.

  Neither is there an obvious moment at which trading ends: Forex is a 24-hour business. Trading in Hong Kong seeps into London before being picked up in New York then transferred back to Asia.

  London is the major dealing area, accounting for about 40 percent of the daily business because of its position “in the middle” of the relevant time zones.

  Dealers at big banks around the world trade between each other on behalf of clients — large and small companies, fund managers and commodity dealers, for instance.

  Participants deal in millions and often billions (known as yards) through electronic terminals and also over the telephone.

  Minute movements in currencies, with prices expressed to four decimal points, are magnified by the vast sums traded, allowing the banks to make vast profits — or incur painful losses.

  Regulators are now looking at this largely unregulated market and trying to work out whether rogue dealers found a way to make profits from the way a benchmark price — a bit like a closing price on a stock exchange — is set amid frenetic trading during a 60-second trading window.

  The benchmark, compiled by WM/Reuters, is used by fund managers wanting to know how their investments are performing.

  The benchmark differs from the LIBOR scandal in a key way. When submissions about LIBOR are made by banks, they are based on estimates of what rate of interest a bank would be expected to be charged by another bank for borrowing on the markets.

  When the foreign exchange benchmarks are set, they are based on actual dealing prices on which trades are submitted. It is not about estimates — traders have to trade.

  They are trading on behalf of clients who have placed orders to buy and sell currencies.

  These orders might be placed five minutes before the 60-second window — which opens for 30 seconds each side of the hour — or even as the trading is under way. The 4pm (London time) spot rate is said to be the most closely watched benchmark produced by WM Reuters.

  It was Bloomberg that first reported that dealers between the various banks might be exchanging details about client orders placed ahead of these trading windows, to try to gauge how the currency might move.

  Knowing the scale of orders could help a trader. For instance, a trader with a large order to buy euros and sell US dollars, who discovers other banks are in a similar position, could take it as a clear signal that euros are going to rise during the trading window.

  Theoretically, there could be an advantage in pushing up the price of the euros during the fixing period as it would fall back in the minutes afterwards, allowing the banks to sell at a higher price to their clients than they buy in the markets later.

  Regulators, including the UK Financial Conduct Authority (FCA), FINMA in Switzerland and authorities in the US are thought to be at an early stage, gathering information from recorded telephone calls and instant messages.

  It is a laborious process and the outcome may not be known for months. And, as was the case last week with a year-long investigation into gas prices by the FCA, evidence of manipulation may not be found. Yet if it is, the banks could be facing a whole new — and very expensive — scandal.
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