Around the world, investigators are trying to find out if the largely unregulated foreign exchange market was manipulated. Even before the probes are completed, the pace of change will pick up in the $5 trillion-a-day market, in both what moves currencies and the way business is done.
Regulators are investigating whether some traders profited from knowledge of how clients wanted to trade around the time that widely-used benchmark prices were set. Chatter about rumoured flows has long been a way of life in FX, and not just at benchmark-setting minutes.
The economic logic for talking is simple and strong, as a 2013 Bank for International Settlements working paper shows. Knowledge of customer order flows, particularly from asset managers, has “a significant economic value for a dealer.” Dealers’ gains are amplified as the market concentrates.
The investigations have awakened the traders’ employers. Several banks have curbed the use of online chatrooms, long used to swap rumours and nuggets of information. And the traders, after more than 20 of them have been suspended or fired, are being far more circumspect about what they share. Muffling the echo chamber of FX chatter will mute the impact of client orders, since fewer people will be able to jump on the bandwagon of rumoured flows.
The heightened sensitivity about fairness to clients will probably see even more FX business done on electronic trading platforms: humans can be accused of mishandling such information, machines can’t. Three-quarters of global FX trading volume is already processed electronically, according to financial research firm Greenwich Associates. It’s 28 percent for the currency options part of the market. Since banks get higher margins on options than on spot trading, FX profits will be squeezed if “electronification” makes inroads in that part of the market.
It looks like regulators will take some time to decide if the FX rates were manipulated and what to do about it. Currency markets, always quick to anticipate news, won’t wait for the final results. They will start adjusting to the new environment before it’s unveiled.