Revolving door and entrance/exit of building.

“It is well enough that people…do not understand our banking system, for if they did, I believe there would be a revolution before tomorrow morning.”

09 January 2014

As another tale of market manipulation hits the headlines, one has to admit that Mr. Ford probably wasn't far wrong.

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This time it is the news of the Financial Conduct Authority (FCA) investigation into Forex which has the potential to be, as they say, a 'biggy', affecting the primary global financial market that underpins 90% of currency derivative trades.

Forex is the world's largest foreign exchange market responsible for enabling currency conversion globally. It is estimated to be a $5.3 trillion a day market, with the London market accounting for around 40% of all trading. Despite its size and liquidity, Forex remains one of the least regulated markets in the world, with a vast number of trades carried out in the sector taking place 'off-exchange'. Permitting 'off-exchange' trades benefits astute clients, such as hedge funds, as it enables them to obtain better rates owing to the volume of their trades.

Forex rates are set by the WM/Reuters benchmark. This is adjusted every 30 minutes for active currencies and is calculated by taking the median of bids and offers combined during various rate-setting windows for 159 currencies. At 4pm there is the largest fix of the day and it is from this rate that the majority of large institutional investors obtain their rates. The logic of this is that it provides an insight into the true value of the currency at the time, as accepted by the industry. Good plan, huh? Yes, except that when you group together off-exchange trading, an unregulated market and (sigh) another collection of roguish traders, you are once again placing an exceptional amount of trust in the systems of banks.

The interesting thing to note is that the Forex rate is calculated based on actual trades and the rates that are offered and accepted. This is unlike Libor, which relies on daily surveys between banks and is therefore widely open to manipulation. Forex shouldn’t be able to be manipulated in the same way. Speaking purely from a competition point of view, with its size, liquidity and the number of trading parties, the Forex exchange ought to present a text-book case of competition and be near impossible to manipulate.

But, where there's a will, there's a way.

In October, the FCA sensationally announced that it would be investigating the Forex market and the workings of a number of the big institutions (although it also stated that it would 'not comment further on [its] investigations'). Perhaps this is cryptic commentary; however, the fact that within two weeks of that statement Barclays, HSBC, UBS, Deutsche Bank, JP Morgan, Goldman Sachs and Citigroup all acknowledged the investigation and promptly suspended or removed traders suggests that this might not be about to blow over. Given that these banks account for over 50% of currency traded by volume on Forex, the potential effects if wrongdoing is proved could be monumental.

What we do know is that the FCA investigations are focused, at least presently, on the existence and operation of chat rooms with such cunning titles as 'The Bandits Club' and 'The Cartel'. These chat rooms were used by a number of traders to share information so that competitors could execute their own trades before filling out client orders, as well as to have general discussions concerning how they could fix the FX benchmark rate.

Whilst at this stage of the investigations there is little publicly known information available other than accusations and 'sources', it is perhaps the weary repetitiveness of it all that will stick in the throat. Once again, the powerful and influential guardians of the economy have seemingly failed to control their own staff and allowed manipulation to be carried out right under their noses. There will, undoubtedly, be another string of inquiries and pledges of 'transparency' and 'cooperation'. Another round of million pound fines and collective head shaking at the City will probably follow. Everyone will stop caring for just long enough until another scandal rears its ugly head. Is it just me or is everything starting to feel a little bit Groundhog Day?

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