forex market manipulation clientalert - norton … 16, 2014 forex market manipulation – the story...
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December 16, 2014
Forex Market Manipulation – The Story Is Not Over Yet
On 12 November 2014, six of the world’s largest banks reached settlements with five differentregulatory bodies and were fined a total of US$4.3bn for their attempted manipulation of a key foreignexchange (“forex”) benchmark, the WM Reuters (“WMR”) fix. Each of the five UK Financial ConductAuthority fines surpassed the previous record of £160m levied upon UBS for its role in the LIBORmanipulation scandal. There are indicators that these early settlements and fines represent only the tipof the iceberg for the forex market, as banks and their traders may be exposed to further fines, costs,damages and possibly even criminal sanction.
The WMR fix is a benchmark rate set according to actual forex trades transacted on various electronictrading platforms within a one-minute window at certain times of the day. WMR rates, which areavailable for several currency pairs, are widely used for trades by a variety of forex market participantsfor many reasons, including their perceived fairness when compared to prices quoted by forex dealerson an ad hoc basis.
Ironically, however, regulators have uncovered collusion by bank traders designed to control the flowand pricing of trading during the relevant time periods, so as to manipulate WMR rates to theiradvantage, but at their clients’ direct expense. The evidence acquired by the regulators includestranscripts from Reuters instant message chatrooms participated in by some of the most senior forextraders in the market, many of whom have now left their posts as a result of the revelations. Thesechatrooms were given suggestive names, such as “The Cartel” and “The Bandits Club”. The transcriptsrecord the sharing of client orders, planned co-ordination of trades designed to move the market andsubsequent praise of successful attempts to do so.
The regulatory findings range from a lack of proper supervision that would have prevented themisconduct, to attempted manipulation. However, no findings of actual manipulation have yet beenreached. This may reflect evidential difficulties, or a desire to achieve swift settlements with the banksconcerned in return for their acknowledged co-operation.
It is clear that further regulatory findings will emerge. Some banks who have admitted being underinvestigation (including Barclays) have yet to reach settlements with regulators. Barclays has publiclyadmitted withdrawing from the recent settlements at the eleventh hour in pursuit of a more “general”settlement, by which it meant one that will involve other regulators who did not participate in thosesettlements. The New York Department of Financial Services may well be at the top of that list, asunder its current head Benjamin Lawsky, it has acquired a reputation for levying heavier fines thanother US authorities, federal institutions included. The US SEC is said to be another investigating themisconduct.
Criminal investigations in both the US and the UK have also been opened, but are in their early stages.It is rumoured that the US Department of Justice will level charges at one bank before the end of 2014,although there is only speculation over who that bank might be. Individual traders may not findthemselves immune from prosecution, either and, in fact, the DOJ has already begun interviewingindividual traders in London.
C L I E N T A L E R T 2
Thus far, civil courts have been relatively untroubled by the issues. The only proceedings reported tohave been filed are two antitrust class actions brought by various pension and investment funds in theUS (In Re Foreign Exchange Benchmark Antitrust Litigation and Simmtech Co. Ltd v Barclays et al.).Similar actions brought in relation to LIBOR manipulation were summarily dismissed earlier this year,but certain differences in the way LIBOR and the WMR fix are set may make these latest casesdistinguishable.
One key difference between the LIBOR and forex manipulation scandals is that the latter involved directcustomer trading. This would make it easier for those customers seeking damages to establish that thebanks’ actions were in breach of contractual and/or tortious duties owed to them. On the other hand, itcould be hard to quantify losses given the difficulties of proving the counterfactual, i.e., what the WMRfix would have been were it not for the manipulation. Having said that, sophisticated economic modelsmay fill the void.
Mis-selling claims may also result, given that currency derivative contracts are often linked to the WMRfix. Disgruntled investors may seek to have these contracts declared void on the basis that they wouldnever have entered into them had they known that the reference exchange rates were beingmanipulated. Such a claim was made in the context of LIBOR manipulation and interest rate derivativecontracts in the well-publicised Guardian Care Homes case against Barclays Bank, but as that casewas settled there is no court precedent.
Interestingly, the press reports suggest that the forex market may be plagued by other abuses, also,including the unauthorised taking of profits. We would certainly not be surprised if this were to berevealed as a widespread practice, as we acted for an investor who successfully clawed back someUS$3m of unauthorised and undisclosed profit from its broker. Such claims would be much easier toestablish. (See previous client alert).
It is perhaps not surprising to some that the forex market, being as it is largely unregulated, shouldhave fallen subject to abuse. In fact, there have already been suggestions, including from the UKgovernment, that regulation will be introduced. One thing that remains certain is that the recentregulatory fines do not signal the end of the story.
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