By Dr. Daniel Hall
13th November 2014
 

The FX Market background

Before I delve into the meat of yesterday’s news, whereby the Financial Conduct Authority (FCA) imposed their largest ever fine across the banking industry, I thought it would help to provide a snippet of background information about the Foreign Exchange (FX) market so you can understand the context of the fine and why the announcement is such a big deal.

The FX market is one of the largest and most liquid markets in the world with a daily average turnover of $5.3 trillion, 40% of which takes place in London – so you can see why the UK regulator is particularly concerned with this issue.

Part of the FX market is the spot FX market that uses “fixes” or benchmarks to establish the relative value of two currencies (spot FX). These fixes are used by a range of (and numerous) financial and non-financial companies (located and operating across the globe) for a variety of purposes such as managing currency risk or valuing assets and liabilities – so when you hear the regulator talk about “systemic issues”, “integrity” and “undermining of confidence in the UK financial system”, you can see why this is a pretty serious issue.

Finally, G10 currencies are the most widely-used and liquid currencies – so we are not talking niche, contained or immaterial here either.

So what banks were fined, what went wrong and what does this all mean?

The Enforcement Action

The FCA announced its enforcement action in the way of a series of fines across 5 banks amounting to just over £1.1 billion. In order of fine size (rounded up), there are:

  • UBS: £234 million
  • Citibank: £226 million
  • JP Morgan Chase: £222 million
  • RBS: £217 million
  • HSBC Bank: £216 million

These banks were fined for failing to control their G10 spot FX trading operations. Interestingly, each of these banks received a 30% discount on the fine for effectively settling the bill early (good corporate citizens).

Barclays, the other bank implicated, won’t benefit from this early discount as they are not just dealing with an investigation into their G10 spot trading business, but also under investigation for “wider FX business areas”. You can see why it makes sense now for Barclays to set aside £500 million in Q3 2014 to settle ‘currency issues’.

In short, just when you thought the banks had learnt their lessons from the LIBOR rigging scandal, they are hit with bigger fines.

The Remediation Programme

In addition to this enforcement action, the FCA also announced that it was launching an industry-wide remediation programme, or ‘corrective’ programme for the banks.

The purpose of a remediation programme is to ensure that the banks address the cause of these failings and drive up standards across the market.

According to the FCA, “the remediation programme will require firms to review their systems and controls and policies and procedures in relation to their spot FX business to ensure that they are of a sufficiently high standard to effectively manage the risks faced by the business. The work at each firm will depend on a number of factors, for example, the size of the firm and its market share and impact, the remedial work already undertaken, and the role the firm plays in the market”.

What went wrong?

Ineffective controls in the banks’ G10 spot FX trading operations resulted in a series of misdemeanours including:

  • Banks sharing information about client’s activities (breach of confidentiality)
  • Attempted manipulation of the spot rates through conversations between FX traders
  • Triggering client ‘stop-loss’ orders
  • Collusion between traders of banks

In essence, a bunch of FX traders, with special code names such as “the players”, “the 3 musketeers”, “the 1 team, 1 dream” “the bandits club”, “the Cartel” and “a co-operative” went into special chat rooms and shared coded information about client activity. Such activity led to the banks putting their own interest above that of the client, other participants and the wider UK financial system; or banks’ profiting at the expense of everyone and everything else.

What does this mean?

The message the FCA is sending out is pretty clear.

It does not tolerate this kind of bank conduct especially that which puts market integrity or the wider UK financial system at risk.

Senior management at banks will need to take responsibility for putting things right.

Banks will need to deliver a real and lasting change to the culture of the trading floor.

But what does this really mean for the claims management industry?

Its early days yet, but the team at All Square are keeping one eye on how the “remediation programme” pans out. The FCA indicated that the review will extend beyond the G10 spot FX market to other areas of FX such as FX Emerging Markets, FX Sales, derivatives and structured products referencing FX rates and precious metals (gold, silver, platinum etc).

Just when you thought the current s.166 FCA IRHP Review programme was coming to an end….