Criminal charges a possibility in forex rigging scandal | Video

World Finance interviews Mark Taylor, former foreign exchange trader and Dean of Warwick Business School, on the forex rigging scandal

March 27, 2014

All eyes are on the BoE as regulators investigate the forex rigging scandal. Dean of Warwick Business School and former foreign exchange trader Mark Taylor shares his insight.

World Finance: Mark, what was your initial reaction when you heard about this scandal?

Mark Taylor: It was not a surprise! I think it’s been known for some time that there have been efforts to, not rig, but certainly affect, the 4pm fix, which is the main reference rate in the foreign exchange market, that this investigation is centred on. And as a former foreign exchange trader myself, it is part of the folklore of the market that traders do try to affect the reference rate. And in one way I suppose there is some surprise that it’s taken the Bank of England so long to investigate it.

World Finance: So how much of the blame should the BoE shoulder?

Mark Taylor: The Bank of England does have oversight of the financial markets; the London financial market is the most important foreign exchange market in the world. Most foreign exchange transactions are booked through that market. It does share some responsibility, I think that’s true.

World Finance: Let’s focus on governor Carney’s decisions of late. He’s said he’s appointing new deputy governors to the bank, he’s promised to bolster internal regulations; but do you think those changes go far enough?

Mark Taylor: I think they do in some sense, but obviously there has been a culture in the foreign exchange market and in the bank of not being forensic enough about the way the foreign exchange market conducts its business. So, letting people push through big trades just 30 seconds or 20 seconds before the reference rate is fixed in order to affect that rate, and create a situation where they can take an unfair profit from their clients? Even if there’s a whiff of that, it should have been looked at some time ago.

Mark Carney? This didn’t happen on his watch. He’s trying to change the culture of the BoE

Mark Carney has brought in two very very experienced new deputy governors: Ben Broadbent and Nemat Shafik from the International Monetary Fund, with responsibility for conducting a root and branch review of the way the bank uses market intelligence and investigates these issues. So that is a very very important issue I think, and it’s an important step forward.

It depends what will come out of that. To my mind it’s not really so much regulating the market that’s important. It’s actually taking away the incentives for people to cheat in that market. And therefore, there are one or two ways in which the 4pm reference rate is fixed, is calculated, that I would like to see change in order to take away that incentive for big traders in the market to try to influence that, and have an unfair advantage over their clients.

Mark Carney? This didn’t happen on his watch. He’s trying to change the culture of the Bank of England, so bringing in two very senior deputy governors in order to deal with that is an important step forward.

World Finance: Regulatory action is what he’s calling for, but do you think a criminal investigation against the traders who’ve been suspended is also needed?

Mark Taylor: Well I suppose one has to go back and examine exactly what are the allegations, what is it that’s being alleged? Now, there is a reference rate in the market which goes for all the major exchange rates: dollar-sterling, dollar-euro, dollar-yen. At 4pm there’s a rate that’s calculated every day by WM Reuters, a private company. And it’s calculated by taking the average exchange rate for transactions recorded by Reuters for 30 seconds before 4pm, and 30 seconds after 4pm. And that average is then called the 4pm fix.

Why that’s important is that many big institutional investors, many big clients of banks, may have lots of foreign exchange transactions going through, and they’ll just say to their bank, well, just do them at the 4pm fix. Just do them at that reference rate. So if the bank is able to affect that rate, and push it up artificially high, just for a minute or so around 4pm – they can then charge their customers a higher rate than is actually the true rate in the market.

You can put through, you know a big trade, a couple of billion dollars, 20 seconds before 4pm. That in itself is not illegal. If somebody said, why did you put through that big trade, they could say, well it’s not illegal to trade, obviously! But what is illegal is colluding. If there is evidence that banks got together, senior traders from some of the big banks got together and said you know, I’m going to put through this billion dollar trade, dollar-sterling, I’m going to buy dollars against sterling 10 seconds before 4pm. Why don’t you do the same thing, and we can both together affect the market rate?

That would certainly trigger a criminal investigation, possibly criminal charges. And that’s why important evidence to examine here is the chatroom evidence. There is some suggestion that some of these traders may have spoken to each other online in textroom chats, chatrooms at Bloomberg and Reuters. And if there is evidence recorded there of collusion deliberately to affect the market, then that is a criminal offence.

World Finance: When speaking before parliament’s treasury select committee, Carney said he had no information that suggests that anyone at the BoE condoned manipulation of the market, facilitated, or participated, in market manipulation. He also went on to to say that we have to protect the integrity of the market. But if we have the belief that traders colluded, what does that do to general market stability?

Mark Taylor: I’m sure it’s true that no one at the bank did participate or condone. I’d be very surprised if that was the case. I suppose it’s more a matter of culture. The bank should have been aware that if, you know. If you just look at the behaviour of exchange rates. Just look at what happens around 4pm: they tend to spike, or they have historically tended to jump up for 30 seconds or so around that time. So the question is then, that in itself is kind of prima facie evidence that people are trying to affect that rate.

I’m sure it’s true that no one at the bank did participate or condone. I’d be very surprised if that was the case

And I think Paul Fisher, when he was examined with governor Carney at the treasury select committee, did say something like, well it’s not the bank’s business to go out hunting down forex market riggers. Well, maybe it is. Maybe they should, where there is at least prima facie evidence of that. Where it’s part of the folklore, in a sense, of the market, that everyone knows that people are doing this. They should perhaps have investigated it, rather than seeing it as part of the culture of the market.

World Finance: How do we avoid this becoming a second Libor affair?

Mark Taylor: The Libor scandal was very important. It did strike at the perceived integrity of the financial system. And this does so similarly, it is very very worrying.
Remember the banks will be taking a profit from their institutional clients, but who are those institutional clients? They’re largely pension funds. So insofar as property is taken from pension funds, it’s taken from every one of us who have an investment, either direct or indirect, in a pension fund. And we’ll have less money to spend in our retirement! So it is vitally important to all of us.

I think just regulating the market and saying ‘you shouldn’t do this’ is very difficult, because financial markets are by their very nature large and opaque. The foreign exchange market is by definition an international global market. A $5trn a day market.

So, very very hard to regulate, because the markets will tend to find ways of circumventing that regulation. I mean, one simple way of dealing with it, or one way I personally think should be investigated, is the way the 4pm fix is conducted.
The problem with the 4pm fix is that you only have to move the exchange rate a small amount for a small period in order to affect it. So, if you can affect the average rate by a fraction of a percentage point, then that can represent millions of dollars of profit on a billion dollar trade.

I think [Carney’s] doing actually very well out of this. It depends what comes out of that investigation: the external legal investigation

Now, one simple way that ought to be investigated perhaps, is to calculate the average rate over a whole hour, rather than one minute. Because it would be very difficult in a $5trn a day financial market to affect that average over a whole hour, rather than just a minute.

Another alternative would be, if you wanted to take a short interval, you could take a minute interval, but take it a random one minute interval between 30 minutes before 4pm and 30 minutes after.

So that would then take away the incentive or the opportunity for traders to try and front-run or affect the 4pm fix. And I think that would be far more effective than just regulating against it.

World Finance: How likely do you think it is for the BoE to take your suggestion?

Mark Taylor: I don’t know; I mean they haven’t spoken to me about it. But I’m open to conversations about it, certainly!

World Finance: Now let’s talk about legacy concerns. Of course when governor Carney came into his position there was a lot of expectation placed on him. What does this whole scandal do to that expectation, and his legacy?

Mark Taylor: In a sense it wasn’t… well not in a sense, this absolutely didn’t happen on his watch. So it’s not something that, you know, he’s to be blamed for. He’s called in an external law company to investigate this, he’s appointed two new deputy governors of very very high standing in the international financial community. One ex-Goldman Sachs, one ex-International Monetary Fund, to investigate this. So I think those are very very strong and bold moves.

I think he’s doing actually very well out of this. It depends what comes out of that investigation: the external legal investigation. It depends what comes out of the internal root and branch review that Nemat Shafik will conduct. And the new measures put in place, both to shift the culture of the bank, and in order to put in place new ways of calculating the 4pm fix.

World Finance: Well I’ll be watching, thank you so much.

Mark Taylor: Thank you.