Market Manipulation

Last week regulators from the US, Britain, and Switzerland announced fines of $4.25 billion against several major financial institutions for conspiring to manipulate the foreign exchange markets. Simultaneous with the settlement announcements, the CFTC published select transcripts detailing chat room evidence of the manipulations.

The transcripts are rough reading, especially if you aren’t a text-happy teenager well versed in financial slang and impervious to foul language. But because they afford critical background for our story, we’ve decided to translate a short excerpt from one chat into clearer, safe-for-work English. The excerpt comes from three traders discussing how they could manipulate the 4 pm WM fixing for GBP-USD (often referred to as “cable” by FX traders), selling large amounts just before the fixing to drive the rate down.

  • Trader 1 (70 minutes until fix): it’s early but I am selling cable at the fix
  • Trader 2 (35 minutes until fix): do you have much to trade at the fix?
  • Trader 1 (35 minutes until fix): I’m selling cable 130 mm. Hopefully a few more get the same way and “we can team whack it.”
  • Trader 2 (32 minutes until fix): I’ll do some digging.
  • Trader 1 (24 minutes until fix): I’m selling cable 170 mm at the fix.
  • Trader 2 (24 minutes until fix): We’re selling cable 40 mm.
  • Trader 3 (22 minutes until fix): We’re selling cable at the fix. It’s a good amount.

  • Trader 2 (35 seconds after fix): “Well done gents”
  • Trader 1 (2 minutes after fix): “hooray nice team work”
  • Trader 3 (2 minutes after fix): “nice one mate”

What stood out to us most was the use of the phrase “nice team work.” In fact, the “team work” euphemistically described in this instance was actually collusion, working together to move the price by trading collectively disclosed client orders just before the fix. As a result, they increased the chances that the GBP-USD fixing would be lower than would otherwise have been possible had they not shared their own order book with each other. Traders don’t often divulge ahead of time that they will take a specific large position (otherwise they would get front-run), but in this case they had the benefit of asymmetric information and collusion; namely, they knew that they and the other traders would be selling GBP and buying USD in large amounts just seconds before 4 pm, and that other large traders would not be buying.

Here’s our best guess at how it worked: if a trader had a client with a sell GBP order, he could find out from other colluding traders that they would be selling (and as importantly, not buying). Moments before the fixing at 1.5750, the colluding traders would sell large amounts of GBP into the spot market; the exchange rate would decline from the selling pressure and at 4 pm, the fixing would set at 1.5730. The trader would then fill the client order at the fixing, capturing the profit between where he actually sold and where he bought back at the fixing. This strategy was not without risk: if other non-colluding traders had larger buy orders prior to the fixing, the fixing could end up higher than where the trader sold and he would have incurred a loss. But by knowing the sizes of other significant market sell orders and the lack of buy orders, the trader greatly enhanced his chances of making money and reduced his risk of loss.

We wish to clarify that we don’t wish to impugn the integrity of financial institutions as a whole, or indeed of any FX traders beyond those specifically implicated. In the normal course of business, when traders guarantee the fixing as the exchange rate they will provide to a client, they need to trade out of that risk at some point and appropriately might make money doing so. In the cited cases, however, it appears the colluding traders obtained an extra level of profit at the expense of their clients.

Even after these nine-figure settlements, any firm getting trades done at daily fixing rates still runs the risk of being manipulated. As we have written in these pages previously, prices revert 100% of the time after the WM fixing, but the reversion is four times as large on month-end days! The result of rate manipulation is real economic loss – as shown in the example above, if rates were driven down twenty ticks on the GBP-USD rate just before you sold 20 million pounds, you’d lose 40,000 dollars on just one trade.

At Chatham, we too believe in nice teamwork, but predicated on different key attributes:

  • promoting transparency rather than promulgating information asymmetry: We want you to know exactly what you are paying and what you are getting on every transaction.
  • market expertise rather than market manipulation: We pay attention to all of the key times when markets are likely to experience key fluctuations, such as fixing times or economic announcements. We also know how to structure and execute transactions for minimal price slippage.
  • collaboration with an independent advisor rather than collusion among market makers: We seek to understand exactly what your key risk management exposures and objectives are, and to lay out clearly your available alternatives and important considerations.

We love it when clients view us as members of their team, sitting down the hall in their risk management group. And whether we are performing actual trade execution at market levels for our clients or merely producing transaction cost analysis to demonstrate how much money is being given up through sub-optimal execution, we would welcome the chance to add economic value to your organization – especially in a way that would make us all sincerely say: “Hooray nice team work!”

Call 610.925.3120 or email us.