Anonymous informants at some of the world's biggest banks have confessed to the systematic manipulation of the foreign exchange market, affecting trillions of dollars in global investments. The key measure of global exchange rates, the WM/Reuters rate, was for years manipulated by large banks to increase profits at the expense of their clients. As today's financial markets continues to offer a dizzying array of tools and products, many of which depend on unregulated rates and benchmarks, government oversight is more necessary than ever.
According to State Street, the financial metrics firm that performs the calculations, the WM/Reuters rate is put together using an anonymous, automated process. For most major currencies, the rate is calculated at half-hour intervals, using sample data from a minute-long period starting thirty seconds before the half-hour mark (160 smaller currencies are calculated every hour). This automated system might, in theory, serve to allay fears of rate-fixing in markets where rates are determined by the traders themselves, as was the case in the 2010 Libor scandal. However, by making a high number of low-volume trades in the one-minute period before the WM/Reuters rate is calculated, bankers can artificially increase or decrease an exchange rate by hundredths of a percent.
Sources from many of the largest banks have described how this tactic — dubbed "banging the close" — is systematically used by banks to rig the system and exploit clients. For example, if a bank's client has given instructions to sell $100 million, which by increasing supply of the currency would decrease its value in the market, the banker would sell his dollar reserves at the higher, earlier rate, timing his trade to maximally reduce the exchange rate, decreasing the selling price for his client's currency. The banker could then buy up his client's own currency for the lower price, go home, and do it all again tomorrow.
This kind of manipulation in the foreign exchange market has in the past been met with skepticism. To many, the foreign exchange market which trades $4.7 trillion on daily basis, is too large for manipulation. Even certain governments struggle to affect the value of their currencies. If a bank tries to influence the rate in one direction, another bank might just as well be moving it in another. There would have to be systemic collusion between major financial institutions to pull off the large-scale manipulation of exchange rates.
Unfortunately, that is precisely what has been happening. Taken together, four large banks — Duetschebank, Citigroup, Barclays, and UBS — dominate more than 50% of the market. According to anonymous sources, traders at rival banks instant message each other on a routine basis when respective client orders match up enough to allow for rate-setting, a.k.a. the systemic exploitation of global markets and their own clients. Britain's Financial Conduct Authority, which supervises London's financial markets, is considering a probe into charges of rampant manipulation.
Some Americans might consider this old news. This exchange rate scandal follows on the heels of revelations that another obscure market measurement — the ISDAfix rate – has been subject to industry-wide manipulation. The ISDAfix, an important benchmark that guides the $379 trillion interest swap market, is calculated by ICAP, a financial measurements firm based in New Jersey who on daily basis collects voluntarily submitted data from 13 of the world's biggest banks, such as JP Morgan and Goldman Sachs. The Department of Justice is investigating whether banks submitted manipulated quotes to affect the ISDAfix rate and if certain traders took advantage of ICAP's at times slow data-entering process to boost profits. In 2010, another scandal revealed that major London banks had manipulated the Libor rate, which measures the interbank interest rate between London financial institutions and presumably measures their overall financial health. Bank executives had colluded to artificially keep the rate high or low before UK financial authorities stepped in and assumed responsibility for measuring it.
Unfortunately for the families, cities, and pensions that have lost billions of dollars to the systemic manipulation of financial rates, much of what banks have done is not, technically speaking, illegal. A federal judge in New York recently ruled that the Libor racket did not actually break the law, since the collaborative nature of how the rate was put together by London banks was not competitive in nature. The WM/Reuters rate that measures exchange markets is not deemed a regulated financial instrument by the EU's Markets in Financial Instruments Directive and is not even covered by Dodd-Frank. The victims of white collar crime might never receive restitution, but, as financial markets continue to prove their inability to ethically regulate themselves, we can at least hope that government will at some point assume responsibility for benchmark rates across the industry.
In other words, time to call your congressman, folks.