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Explainer: how bankers fixed forex trades and why it’s criminal


“Oh what a tangled web we weave. When first we practice to deceive”.

Sir Walter Scott’s comment could have been made about the LIBOR and foreign exchange (forex) scandals engulfing the world’s largest banks.

For the first time, it looks like the banks in question may have to face criminal charges for manipulating forex benchmarks, instead of the civil settlements and huge penalties they have agreed up to this point in time. How did we get here?

Imagine if you had a good friend who came to you saying that he/she was short of cash and was selling an investment property. An agent was coming around today to value the property and he would offer it to you at the valuer’s price, if you could proceed right away, they needed the money as fast as possible. You know the property, have a bit of ready cash and agree, for a friend.

What have you done? You have bought a property for an unknown price that you don’t really want so will have to sell again. The house price may go up but also may go down before you sell it. And what about the sales costs? You have taken a lot of risk, for not a lot of return, except friendship. This is not a very “rational” investment.

Believe it or not that is what the masters of the universe on the world’s forex trading desks were doing. No wonder they ran into trouble.

Why do it?

While there are very many similarities between the LIBOR, and forex scandals, not least the deplorable behaviour of market traders and brokers amid the failures of senior management and regulators to detect and manage this bad behaviour, there is a fundamental difference between the two scandals that is important.

The LIBOR scandal was about traders who held large positions in Interest Rate Swaps (IRS) setting benchmark rates that advantaged themselves at the cost of their customers. Basically it was greed.

To an extent, the same is true of the forex traders who manipulated the internationally used WMR “4 o'clock fix” benchmark, often shortened to the “Fix”. But unlike LIBOR, the Fix was not set by guesswork but by actual trading in the market.

While not condoning the abominable behaviour of the forex traders who manipulated the Fix, they have an argument that “it was the market made me do it”, a juvenile argument of course but one that is economically rational.

The forex market is huge, with a turnover of some US$5.3 trillion worth of currencies each trading day. The World Trade Organization (WTO) estimates that the total annual trade in goods and services between countries in the world was some US$17 trillion, in 2012. This means that the foreign exchange market turns over 80 times the total of global trade exports in one year. What is the economic purpose of the almost 99% of foreign exchange trading that is not related to commerce between countries?

To some extent (but not all), a large chunk of that trading is our obsession with global equities markets. Many of us (wittingly or unwittingly through our super/pension funds) are invested in equities that are denominated in US$, Euros, Yuan and so on, and there is a need to move money between these currencies each day and also to “revalue” our holdings on a regular basis.

The largest pension funds are “friends” with the world’s forex dealers as they have to trade billions of dollars of equity transactions with one another each day. In fact, in many cases, they are very close friends indeed being part of the same large banking group, for example, NAB and MLC. (Note: neither of these organisations has been implicated in manipulating the Fix).

In order to keep business with asset/fund managers, the forex market has over time engaged in a very irrational trading practice, in that they have agreed to buy/sell currency for asset managers “AT FIX”, i.e. the price at the Fix. They have, like our “friend” above, bought something they didn’t really want for a price that they don’t know yet and must get rid of it pretty quickly or they might make a loss if the market moves suddenly. This is really a “no win-no win” situation.

So what to do? If you could find “another friend” who was in the opposite position and wanted to buy when you wanted to sell, you could just agree to swap and everyone would happy, even though neither of you have made money on the deal. But the customers are happy.

Unfortunately, the “friend” in this case is another Forex dealer in another bank and technically you are not allowed to talk to him/her under the rules of the industry self-regulator, the Association Cambiste Internationale (ACI), also known as the Financial Markets Association (FMA).

But you talk to your friends all the time, you meet for drinks in the local pub, and chat to each other via internet chat rooms that you set up to boast about your golf handicaps. Pretty simple, you scratch my back this time and I will scratch yours next time.

And that’s how it starts. Soon you are talking to “friends” every day, helping each other out and even inviting more friends into the chatrooms to help them out too. The market is working as it should be if the rules are being bent a little bit.

But even though your friends are very helpful, sometimes there is a gap and there is a risk you have bought something you can only sell at a loss. What if the Fix could be nudged just a little bit to reduce the risk? Maybe a friend could put in a buy/sell order just before the Fix to nudge the Fix in the “right” direction? And if you knew this was going to happen why wouldn’t you tell your friends in the chat room about the “nudge”, and they can make a bit on it to compensate them for the risk they took on buying/selling “AT FIX”.

A slippery slope

By now of course, you have well and truly crossed the line between levelling out the market and manipulation and filled with bravado you name your chat-rooms with outlandish names like “the Cartel”, the “Bandit Club” and the “Mafia” – boys will be boys.

And once it became known that the Fix could be fixed, all sorts of misbehaviour started, such as deliberately triggering client’s “stop loss” orders. The US regulator the Commodity Futures Trading Commission (CFTC) gives an example of some of the shenanigans by a HSBC trader, as if that particular bank needs more bad publicity.

It is obvious that, in the beginning, the use of “At Fix” trades was not very rational but it could be seen as helping cement client relationships but as the practice grew it became economically unsustainable to give everyone the same break. Rather than address the irrationality/stupidity, however, some Forex traders went over to the dark side, first plugging the gap then taking advantage of the illicit opportunity to make profits.

Meanwhile, bank management reaped the profits and regulators were blissfully unaware. The traders were to blame but the “system” was at fault and to fix that there must be systemic regulation. Nor is it only LIBOR and the Fix, commodity benchmarks also appear to be under attack. Regulators need to stand back and understand the market and social pressures that traders work under to close loopholes like benchmark manipulation in the market.