Was the 4pm fix mechanism just inviting manipulation by greedy traders and banks?
Last week, in an interesting piece called “The forex market is designed to encourage crime” the Financial Times newspaper picked up on an important issue.
Written from a forex industry outsider’s perspective (the author’s first complaint was the 30% spread in buying or selling currency at airport kiosks , the FT posits that the entire way the FX industry is structured, and in particular the daily 4pm fix, just begged for manipulation by providing the easy opportunity for industry insiders (i.e. traders at big banks) to lock in arbitrage profits on the backs of their clients.
For example, the FT states, the mildest allegation is that some banks routinely pushed clients to use one reference rate (that is, a 4pm fix) when a better deal was available privately, leaving the bank with a potentially bigger profit margin. The more serious allegations are that chummy traders at big banks around the world (at supposedly competitive banks) would engineer deals, particularly in the run-up to the all-important 4pm fix, preempting client transactions with their own trades, to their own profit.
These allegations have led financial regulators around the world to investigate some (if not most) of the world’s leading financial institutions active in currency markets. It has also led to the leave / suspension of senior FX traders at a number of leading banks. And not surprisingly the lawsuits from supposedly wronged FX clients have begun.
The FT’s suggestions to fix all this?
1) Change the structure of the FX market — making everything electronic and transparent, or, better yet, putting FX onto an exchange.
2) Eliminating bonuses for traders, which basically reward cheating.
We believe that both suggestions are somewhat naive, and are unlikely to happen anytime soon. As long as governments remain big FX clients, wanting to exchange one currency for another with minimal interference, it is unlikely for FX to go on-exchange. And good luck getting rid of traders’ bonuses. But a change in the way the 4pm Fix is set might be a start.
The full FT article, which we found very interesting, is available here.
Forex Industry Report