It’s an all-too-familiar scenario: after an altercation between a civilian and a police officer, the department receives a complaint alleging officer misconduct or excessive use of force. The officer in question responds that the situation required that level of force. But without witnesses or a serendipitously placed security camera, it’s generally impossible to know for certain who is telling the truth, and mistrust between the citizenry and the officers sworn to protect them can fester.
Given a number of complaints against his police officers, the Rialto, California police chief decided on a novel approach; he equipped half of the force with miniaturized video cameras to record their interactions with civilians. Although the police officers initially expressed misgivings, the program’s results were unmistakable – complaints against police officers fell by 88%, and police officers were 60% less likely to use force in their interactions with the community.
Why did the use of force drop so dramatically? When police officers knew that their choice to intervene forcibly would be audited later, they were much more likely to opt for a different approach. And why did the volume of complaints against police officers drop even faster? Certainly part of the decline in complaints came because the use of force itself fell, but there were also cases where individuals came to the police station to file a complaint and then backed out. In these cases, after the police supervisor showed them video of the incident in question, they realized that their allegations did not fit the facts as captured on video and left without filing any paperwork.
For Rialto, California, the state of public-police interaction has changed dramatically. People spend a lot less time being forcibly subdued by police officers, who are now much more willing to consider other means of dealing with a tense situation. The police force doesn’t suffer the reputational risk of facing numerous unsubstantiated accusations of misconduct, now that would-be complaint filers first watch the video of the interaction at the police station. Even the ACLU, usually no fan of police-run cameras, approves the concept: “When it comes to the citizenry watching the government, we like that,” says a senior policy analyst cited in the New York Times. In short, the injection of greater transparency into police-civilian interactions seems to have benefited everyone.
Of course, transparency can also prove to be a huge boon to financial market participants. Consider the recent scandals connected to LIBOR and ISDAfix interest rate settings, where there is growing evidence that bank trading desks worked with rate-setting desks to manipulate fixings in a way that would profit their derivative positions. Although the methodologies for setting both are publicly known, they are not impervious to exploitation by large market-makers. For LIBOR, contributors merely needed to submit rates that were not consistent with their true borrowing costs, altering the average. For ISDAfix, swaption traders could tell their rate-swap counterparts to order as many interest-rate swaps as possible right before 16.00 London time, pushing ISDAfix up or down to the desired level.
What can be done to bring greater transparency to rate fixings, so heavily relied upon by pension funds and many companies to hedge their risks? After all, Michael Melvin and John Prins have shown that:
1. Trading volume in currencies dramatically spikes around 16.00 London time (also the time of the WM currency fixings) on month-end dates, and is even more pronounced on quarter- end days and year-end days. This volume spike comports with major trading activity to “bang the close,” or manipulate the rate immediately before it gets set. If a company has ordered a large trade for a certain day at the WM Fixing rate, it will be traded at a manipulated rate, not one that has naturally occurred at that time. Also, the period-end dates represent the height of fixing activity related to rebalancing passively managed hedges, so those are especially vulnerable to being transacted at very volatile rates.
2. 70% of the sharp movement in currency rates in the run-up to the WM fixing on month- end dates gets reversed during the course of the next day’s trading. These substantial market moves are not being driven by market fundamentals, since the rates retrace their courses as soon as the fixing gets set. Prices revert 100% of the time after the WM fixing, but the reversion is four times as large on month-end days. Naturally, since so many pension funds with passive strategies rebalance at period ends, the rate fixings will be under the highest level of pressure on those dates.
The deep irony of these facts is that the English word “fix” does not just mean “to set or establish”; it also means “to influence an outcome by improper means.” If you are relying on a predetermined-time rate fixing for your interest rate or currency derivatives, please know that they have been shown to be subject to profound spikes not related to any change in underlying fundamentals. If rates run up twenty ticks on the EUR-USD exchange right before you sell 20 million dollars at the fixing rate, you will lose more than 30 thousand dollars on the fixed rate versus the non-manipulated rate.
This is why a growing number of funds look to Chatham for actively re-balancing their portfolios at market rates, rather than putting in orders to trade at a “fixed” rate – we know about and generally aim to avoid peak volatility times for trading. It’s also why we’ve built a post-trade monitoring service to help measure the quality of trade execution (whether performed by you or outsourced). If you’re looking to inject more transparency into your interest rate or currency trades, give us a call or send us an email – because corrective action is needed when the fix is in!