The fallout from allegations that large banks manipulated prices in currency markets at the daily fix could put an end to voice broking, the traditional way of executing currency deals, and shift regulatory focus on trading in the world’s largest financial market.
The latest survey from the Bank for International Settlements puts daily currency volumes at $5.3 trillion a day, most of it over-the-counter and lightly regulated.
However, in the past few months financial regulators in Europe and the US have been investigating allegations that banks might have tried to manipulate the WM/Reuters daily currency fix, front-run client orders and colluded in their attempts to move the price.
Banks’ trading practices have come under intense regulatory scrutiny and particularly in the wake of the Libor-rigging scandal.
This latest round of investigations – which involves at least Barclays, Deutsche Bank, Citi, Morgan Stanley, UBS, RBS, JPMorgan and Goldman Sachs – could have far-reaching implications for the voice-trading business, where some of the trades in question are executed.
So far, the precise nature of investigations by the UK’s Financial Conduct Authority, Swiss financial regulator Finma and the US Commodity Futures Trading Commission are unclear. Nevertheless, currency traders at large banks say they are preparing for a witch hunt and fear the fallout will put an end to the voice-trading business.
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“It’s already happening – voice traders are being sidelined within banks,” says Simon Wilson-Taylor, CEO of Molten Markets, who directly managed the WM/Reuters FX benchmarking subsidiary in a previous role at State Street. State Street owns benchmark provider WM Company. While the internal struggle between voice traders and electronic heads of trading has been has long existed, traditional traders managed to keep hold of the majority of fix-related business. As a result of the investigation, those flows could also migrate onto electronic venues, which could deliver the final blow to the traditional way of trading currencies.
The alleged misconduct centres on the daily fix that takes place every day at 4pm London time. In the 24/5 world of currency trading, there is no closing price. For convenience, traders, funds and benchmark providers use the 4pm London fix as a reference point. The WM/Reuters price is based on bids and offers submitted in a 30-second window before and after the price is set, with orders executed at the midpoint.
However, Bloomberg reported in June that traders deliberately tried to push the fix price around in a bid to make more money.
Comparisons with the Libor-rigging scandal abound, but market participants argue that the regulatory investigations around the daily fix are likely to be much less far-reaching and the outcome of any investigation less conclusive.
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“Anyone can move the fix if they have enough firepower,” says Frederic Ponzo, managing partner at GreySpark Partners, a capital markets consulting company. “It’s different from Libor, because there is no need for collusion to move the fix.” In fact, every player looked to move the fix, even some large corporate treasuries, according to people familiar with the matter.
“Half an hour before the fix, you would call around the brokers and start buying rounds of dollar,” says a former head of FX trading at a large corporate treasury. “Then you go around again and the market starts to follow the move higher. Then just before the fix you dump it on the market and you made a nice tidy profit.”
There are no allegations of wrongdoing on the buy side. In fact, one curious feature of this investigation is the lack of complaint from bank customers.
The battle for flows
During the past decade, currency trading has migrated to electronic platforms with far-reaching consequences. Ticket sizes shrank, the number of orders hitting the open market declined and market-making banks turned to internalization. Currency trading has become a volume business, with the largest players gaining ever more market share.
“For the past four to five years, the top six banks collectively receive around 60% to 65% of FX customer flows,” says Molten Markets’ Wilson-Taylor. “In electronic trading they handle up to 85% of all flows. This means the top six banks have effectively become exchanges by internalizing flows.”
The leading banks in currency trading have been lavishing money on technology and infrastructure that enables them to handle flows electronically, by slicing orders onto various trading platforms to minimize market impact. The risk of market making is now offloaded in dark pools instead of platforms such as EBS and Thomson Reuters, away from prying eyes.
One exemption from the migration was the daily 4pm London fix. As orders for fix execution tend to be in large sizes, the anonymity provided by the voice business was still needed for effective execution.
“Voice traders still had a hold of large ticket sizes, while e-FX guys handled transaction sizes of up to between $10 million to $20 million,” says Wilson-Taylor. “Whatever the results of this investigation, banks will be under pressure to handle all trading electronically, with an auditable trail, properly time-stamped.”
According to some market participants, the fact voice traders and voice brokers are still in business is mainly due to fix-related business. These flows around the fix allowed banks to channel some business to voice brokers and saw it, as one source put it, a risk-free way of saying thank you and maintaining relationships.
As fix-related flows are extremely difficult to slice into the market using algorithms, voice traders managed to hang on by trading these flows. Their survival was helped by the rising popularity of fix-business on the buy side.
The road to fixing
The lack of national best bid and offer in currency trading meant there was a need for a common benchmark, that portfolio- and asset managers could use to value their assets on a daily basis.
“The WM started out as a result of a bunch of actuaries getting together in Edinburgh to devise a common method for valuing pension funds,” says Wilson-Taylor. “I don’t think they ever intended to use it for trading purposes.”
However, over time, the WM fix became the basis for all the main benchmarks, and as a result trading at the fix price helped reduce the apparent volatility of fund managers’ portfolios by eliminating tracking error.
Growing focus on execution quality and fund managers’ performance meant the popularity of the fix became a qualitative benchmark used by external performance-measurement firms, that further incentivized non-specialist currency funds, such as equity portfolio managers, to trade at the fix and achieve a “market” level of execution.
However, the surge in popularity at executing at the fix greatly helped the survival of the voice-trading business, with one broker putting the estimated level of fix-related flows as 60% of such volumes.
As a result of the investigation, two main benchmark providers revealed they are considering a move away from using the WM London fix, and anecdotal evidence suggests that fix-related volumes have dropped dramatically in recent months.
As one trader put it, the fix has become a dirty word in the City, leading to a loss of business and turf for voice-trading desks. Dwindling customer flows at the fix will likely make life difficult for the voice industry, which has managed to carve out a niche in the space during the past five years.
The consequences
“Voice broking is both the saviour and the victim of the fix,” says a partner at a currency trading platform. “It’s ironic that the accusations of collusion could finish the business that removes that very risk.”
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Voice brokers are there as intermediaries that go out to other counterparties and do deals without giving away the name of their client. In currency trading, information is everything and anonymous execution prevents information leakage. “With voice broking, the discussion of collusion becomes problematic because they played a neutral role,” the partner continues. “In fact, allegations so far seem to centre around traders chatting between each other and not using brokers. But the problem they’ve got now is that everyone is scared of the fix and they are struggling to find business.”
Whatever the outcome of the regulatory probe, a further blow to banks’ reputation will have ripple effects.
“There will be a lot of collateral damage from this and banks could be made an example,” says a former currency trader who spoke on condition of anonymity. “This could be the end of the voice market.”