What happens is that most derivatives like options or variance swaps are tied to the daily WM/Reuters fixing in the London afternoon. There's a bunch of different types of derivatives, but the thing about most of them is they have some sort of characteristic where the price dependency gets highly nonlinear towards an expiry.
So this means that someone who had a moderately sensitive position on one day might have an extremely sensitive position a few days later.
To the point where it might make sense to make sure the price doesn't hit a certain level at the fixing, by doing a bunch of trades in the spot market leading up to the fix. Or conversely by making sure it does hit some level by ramping up the price.
Now you might think it's all more or less a wash, because someone is gonna have the other side of that derivative, but that's not the case. The banks tend to have the same sides of the trades against their customers, because the customers are mostly all after certain payoff schemes.
Apart from there being a motivation, I also believe the allegations because I've been told the actual positions on certain days. You'd have these days where nothing was happening at all, and then just before the fix the price would ramp, or the price would be moving but the graph would have a weird flat ceiling. So you'd call the brokers and ask him WTF happened, and they'd say something like "XYZ bank has a huge barrier there", or "Bank X has wants to knock out this level".
It's very apparent to anyone who looks at any product that has a fixing, I've traded several (Swaps, FX, Equity Derivs). You start by thinking it's just noise and there's always someone in the office who will say that, but after a while you get suspicious of it happening at the same time, plus you have the broker rumours lining up. It would be great if the free market were restored.
The people playing with complex quantitative systems that depended on single basis points had no idea of the integrity of the data they were playing with if they were using LIBOR.
The conclusion I got was: Get out of your code and check your data and how much you trust it. Then get back in with a whole load of caveats.
This is what happens in a free market.
- Perfect market information
- No participant with market power to set prices
- Non intervention by governments
- No barriers to entry or exit
- Equal access to factors of production
- Profit maximization
- No externalities
The less you have those, the less efficient your market is. "Free markets" aren't these magical things that arise on their own in nature. They are carefully crafted and maintained artificial environments and most are far from efficient.
Market forces are not a silver bullet that will solve all problems if we just sit around and wait long enough for the invisible hand to do everything.
Although some would draw the line at different locations, but anti-trust, collusion, patents etc. part of the system. It's just a matter of how much to limit either the government and public good vs. the corporations.
In this case, collusion in trade is obviously a violation of anti-trust law.
Thanks for clarifying. That was really confusing me because it did sound like it ought to be a wash.
The other thing is: is this illegal? I am assuming there are no insider trading laws that apply to FX because there is no fiduciary duty to a currency.
I felt the same way when I used to watch bitcoin. It's the coherency that is oddly convenient.
I believe the courts agree with you. That is, per the second paragraph, this is not new news, simply a new lawsuit (by entites that opted out of the previous suit).
In short: It didn't work very well, but that's not the point.
Longer form: Traders from several banks shared client positions, and made very enthusiastic if somewhat amateurish efforts to manipulate the price at the close. The core of it was trying to figure out if there was going to be a lot of pressure one way or another on various price pairs, and then trying to manipulate the spot price at the close to take advantage of it. For example, if you know a few large clients will be selling a net of £100m for USD, you might try accumulating a bunch of USD slowly in advance of the close (to avoid driving the price up), so when the sales hit you can profit. Or you might try and buy a little USD early, then hold off until right before the close, and buy a bunch very quickly to try and spike the price heavily, making your earlier purchases more valuable. Etc.
None of it sounded especially like it would work, many of their techniques were completely contradictory, and nobody really bothered to try and calculate if it did work. The FCA said "that it is not practicable to quantify the financial benefit". One example of a very good trade apparently made US$100k for the offending banks (on a volume of over $500m); many others lost money. Total profits from the activity were at most a few millions of dollars per bank per year, if they even came out ahead; their fines were orders of magnitude higher.
Or as the CTFC described it:
> If traders in the chat room had net orders in the same direction as what they desired rate movement at the fix to be, then the traders would at times either (1) match off these orders with traders outside of the chat room in an attempt to reduce the volume of orders in the opposite direction transacted during the fix period; (2) transfer their orders to a single trader within the chat room who could then execute a single order during the fix period; or (3) transact with traders outside of the chat room to increase the volume traded by chat room members during the fix window in the direction favored by the private chat room traders
In other words, to try and drive the price of GBP up the traders might 1) try and buy GBP from outside banks to stop those banks from selling GBP at the close 2) not do anything in particular 3) try and sell GBP to outside banks so that the traders wouldn't need to sell GBP at the close. It seems pretty unlikely that these are all valid strategies, and indeed, they mostly didn't seem to work.
> In what sense were these individuals 'manipulating' these markets?
Primarily in the sense they had intent. The actual impact seems questionable. But with chat transcripts that damning, what more do you need?
(Matt Levine has written about this extensively, among other places, here: https://www.bloomberg.com/opinion/articles/2014-11-12/banks-...)
If this is true, it would seem most unwise to discuss your cartel in a chatroom named "The Cartel".
How high-level would employees in these alleged rooms be likely to rank at?
We had a blanket ban on any project or program name that was even slightly insidious sounding, which is easy to do on accident when there are hundreds of projects and the name will be examined out of context by a regulator with 0 sense of humor.
While it’s possible that the “cartel” started with that intention, it’s also likely that someone thought it sounded cool at first.
He was shocked when the firm required him to rename it & not use that name in any communication.
One of the first things I did when I took over a trading team was turn off chat. Trading involves stressful, adversarial interactions with counterparties and clients. Every person and deal eventually earns a nickname. It helps nobody when those nicknames appear in writing.
it would seem most unwise to discuss your
cartel in a chatroom named "The Cartel".
Some people have odd ideas about Linguistic reclamation.
What this means is that we all pay higher interest rates on our loans, and the bankers get a tiny fine.
3 years later and the banks ended up in court for interest rate rigging, all the regulators decreeing innocence from upon high now have lucrative private sector finance jobs and the relevant ministers lying through their teeth have long moved on.
No one held at all accountable for supporting a rotten industry, in fact the opposite. Banks are the new untouchables.
Manipulation is manipulation. Lots of circa 2008 rates manipulation pushed rates down, not up. Ripping off investors versus borrowers isn’t an excuse.
The “close” (aka the “fix”) has a real need. Lots of financial systems need to enter a FX or Libor rate. You cannot enter a real time rate. You need a rate on a daily basis. I am sure all systems will go real time at some point, but that does not solve the problem today.
It is technically simple to come up with some average for the day for both Libor and every FX pair. I can imagine different algos for this, all open source (eg. trade weighted average). Systems that need a daily FX or Libor rate can choose which algo they use. If one algo gets gamed too much, you can switch to a different one.
That would be a simple surgical fix. It would move the last vestige of Victorianism from our global financial markets. In the meantime, I am sure we will get a lot more pain-killers and bandages in the form of lawyers listening to data mined chat rooms (which will simply force the bad guys to collude in the sauna or other place where nobody can listen).
I cannot prove it (would be interesting) but most financial scandals - and probably most risk - would vanish if most trading was open independent exchanges - am I missing something?
Yes and no. Firstly, these sort of manipulations happen on exchanges too. Historically, the main difference has been that it's in the exchange's interest to spot this stuff quickly and stamp it out.
Also, and this is asset dependent, it's generally easier for an individual to manipulate a stock price than FX or Libor (back in the day) as they're much less liquid. As such, more focus was put on detecting and prevention.
For many FX markets, it's practically unfeasible to manipulate the market without collusion. This is because of the huge liquidity. So the reason why this was a big deal, and the reason for the convictions, was because of the collusion. Without that there wasn't much to see here (arguably there wasn't much of an effect anyway but the private prosecutions should throw more light on that).
Libor is an interesting case. Similar to FX, it was nigh on impossible to manipulate in a liquid market without collusion. It is true that the rules do not apply to an observable rate but, in practice, it was trivial to tell if a single institute was doing something fishy so they didn't.
Where it all went to crap was when the banks stopped trusting each other. Libor is the uncollateralised borrow rate. In the period preceding the crash everyone stopped lending uncollateralised as they weren't sure they would get their money back. As such, the premise of Libor became flawed as it depended on an answer to the question "what rate can you borrow uncollateralised?". It didn't have an option for "there isn't one", and worse, the setters were pressured into not giving an indication that that was true.
So, in the Libor case, if the borrowing had been on an exchange and the rate set from an observable price, things would have been better in the sense that it would be obvious that there was no liquidity (although everyone knew that anyway). But, ironically, it would likely have been much easier to force material moves as a single entity because of that illiquidity. And we'd still end up with the same convictions as they were due to collusion.
Finally, for FX, it's not obvious that an exchange would help for the same reasons. It's difficult to manipulate without collusion because of the liquidity. An exchange won't change that. And exchanges are no less susceptible to collusion than the current FX market. Arguably, they may be more so if there were multiple exchanges each with less liquidity but that's just speculation.
Open independent exchanges can be and are being rigged and abused too.
First, in the FX market it's quite common to make trades "at the close", ie, the price at a specific time. In principle this serves everyone's interests, because you need to agree to some price, and "the price it happens to be at 4pm" makes about as much sense as anything, and it means that customers can easily check to see what the price was at that time, confirm they paid it, and feel good that, while they may not have got the best price going that day, at least they got the "standard" price.
(It might be tempting to tell your bank you want the "best price that day", but obviously, you only know what that price is after the fact. You could hire the bank's traders to take a wild stab at guessing when it might be, but people who can reliably predict the FX markets are too busy sunning themselves on their yacht made out of gold plated diamonds. Better to just take the price at the close.)
Second, the bank, having agreed to sell your pile of GBP for USD (or whatever) for whatever the price at the close is now have some risk. They've got to go and buy all that USD, and then once they swap it with you for your GBP, they have to then go sell it for USD, so they can sell that and get back to where they started. And what if the price crashes in the meantime? So as is proper (not to mention generally legally required), banks hedge that risk, by, eg, selling GBP and buying USD in the run up to the close, to make sure they're covered if prices move against them.
(Hey, doesn't all that hedging actually make GBP cheaper and USD more expensive? Meaning you'll get less USD for your GBP at the close? Why yes, it does. If you tell your bank to sell £50m for you for whatever the price is at 4pm, you would expect to see them busily driving the price down in the runup to 4pm. That'd just good hedging, and it's perfectly legal.)
Third: What's not legal is making a chatroom called "The Mafia" with traders from other banks, sharing client information, and talking about "taking out the filth" or "front running". Again, it's fine if it's just within your own bank, and you properly disclose it in your fine print, and you don't call your customers names; the issue here is more of branding that substance. There's nothing wrong with knowing an insurance company is about to sell you £50m, which means you'll be selling £50m so you frantically run around selling it in adance...as long as you can plausibly claim to be doing it hedge your trading risks. If you're doing it a chat room called "trading risk compliance committee", that might be plausible. If you're doing in a chat room called "The Mafia", even your lawyer will struggle to keep a straight face.
Fourth: The banks in question already got sued and had to settle for $2.3b in penalties; it was in discovery that all the colourful chat room names came out. So it's not in question whether this happened; it did. Nor has any new information came out (the stuff about the chat rooms came out years ago at this point); this is just the residual lawsuits from the people who opted out of the first one.
In short: This is interesting primarily in a horrified "I can't believe these idiots said this stuff where it was being recorded" sort of way, not because what was going on was actually that bad. It's not even clear that the traders in question actually made money from it, or that any actual customers were harmed. But it seems clear they intended to make money and harm customers (on purpose, that is, because again, you're allowed, and in fact, strongly encouraged, to hedge your trading risks, including the risk that your going to lose a pile of money from your agreement to sell a bunch of GBP on behalf of a client this afternoon, and the way you hedge that risk is to sell it now.), so...billions in fines. Good job guys.
As a German I have to ask what is wrong with this sick piece of a company. They seem to have their ugly fingers sticking in every pile of dirt potentially hiding gold nuggets. Disgusting.
I'd say that the biggest aggravating factor to this is that financial industry is not competitive, not only in US, but pretty much all around the globe. Huge regulatory pressure surely hampers competition.
Recently decided to open a bank account with another bank so I can shop around for time deposit rates. The form is 29 pages, almost all to satisfy regulatory requirements.
The price of one of my medications just tripled (to over $1000/year) due to the limited number of government approved suppliers, one of which bought the products from
the other and then shut the cheaper competing product down.
> We're from the government and we're here to help ... the industry who captured us
Maybe read up on countries with proper healthcare systems. The problem you describe is very much a US problem. I'm very happy with the healthcare system of my over regulated and bureaucratic country (the Netherlands): everyone pays insurance starting from less than a $100 a month (but if you don't have enough income the Government will give you the money to pay for it) and as such everyone receives healthcare without crazy bills (assuming you take medication for a medical condition).
As a more practical example: I travel to Asia a lot and as such I wanted to get some shots for tropical viruses we don't have in our country (yellow fever, rabies, etc - note that we do think vaccinations are good). I got around 10 shots in total, I think the bill was ~1200 euro (~$1500). I forwarded the bill to my insurance company and they paid it back 100% no questions asked (note that the shots I got were not mandatory and I wasn't sick, just wanted to prepare for traveling).