Currency Spikes at 4 P.M. in London Provide
Rigging Clues
In the space of 20 minutes on the last Friday in
June, the value of the U.S. dollar jumped 0.57 percent against
its Canadian counterpart, the biggest move in a month. Within an hour,
two-thirds of that gain had melted
away.
The same pattern -- a sudden surge minutes
before 4 p.m. in London on the last trading day of the month,
followed by a quick reversal -- occurred 31 percent of the time across 14
currency pairs over two years,
according to data compiled by Bloomberg. For the most frequently traded pairs,
such as euro-dollar, it
happened about half the time, the data show.
The recurring spikes take place at the same time
financial benchmarks known as the WM/Reuters (TRI)
rates are set based on those trades. Now
fund managers and scholars say the patterns look like an attempt
by currency dealers to manipulate the rates, distorting the value of trillions
of dollars of investments in
funds that track global indexes. Bloomberg News reported in June
that dealers shared information and used
client orders to move the rates to boost trading profit. The U.K.
Financial Conduct Authority is reviewing the
allegations, a spokesman said.
“We see enormous spikes,” said Michael DuCharme,
head of foreign exchange at Seattle-based Russell Investments,
which traded $420 billion of foreign currency last year for its own funds and
institutional investors. “Then, shortly
after 4 p.m., it just reverts back to what seems to have been the market rate.
It adds to the suspicion that things
aren’t right.”
Global Probes
Authorities around the world are investigating
the abuse of financial benchmarks by large banks that play a central
role in setting them.
Barclays Plc (BARC), Royal Bank
of Scotland Group Plc and UBS AG (UBSN) were fined a combined $2.5 billion
for rigging the London interbank offered rate, or Libor, used to price $300
trillion of securities from student loans
to mortgages. More than a dozen banks have been subpoenaed by the U.S.
Commodity Futures Trading Commission
over allegations traders worked with brokers at ICAP Plc (IAP) to manipulate
ISDAfix, a benchmark used in interest
-rate derivatives. ICAP Chief Executive Officer Michael Spencer said in May
that an internal probe found no evidence of
wrongdoing.
Investors and consultants
interviewed by Bloomberg News say dealers at banks, which dominate the $4.7
trillion-a-day
currency market, may be executing a large number of trades over a short period
to move the rate to their advantage,
a practice known as banging the close. Because the 4 p.m. benchmark determines how much
profit dealers make on the
positions they’ve taken in the preceding hour, there’s an incentive to
influence the rate, DuCharme said. Dealers say they have
to trade during the window to meet client demand and minimize their own risk.
Currency Patterns
“There are some patterns in currencies that are
very similar to what I have seen in other markets, such as the way the
price-fixings’
effects disappear so often by the following day,” said Rosa Abrantes-Metz, a
professor at New York University’s Stern School of
Business, whose August 2008 paper, “Libor Manipulation?,” helped trigger
the probe into the rigging of benchmark interest rates.
“You also see large price moves at a time of day when volume of trading is high
and hence the market is very liquid. If I were a
regulator, it’s certainly something I would consider taking a look at.”
WM/Reuters rates, which determine what many
pension funds and money managers pay for their foreign exchange, are published
hourly for 160 currencies and half-hourly for the 21 most-traded. The
benchmarks are the median of all trades in a minute-long
period starting 30 seconds before the beginning of each half-hour. Rates for
less-widely traded currencies are based on quotes
during a two-minute window.
London Close
Benchmark providers such as FTSE Group and MSCI
Inc. base daily valuations of indexes spanning different currencies on the
4 p.m. WM/Reuters rates, known as the London close.
Index funds, which track global indexes such as the MSCI World Index, also
trade at the rates to reduce tracking error, or the drag
on funds’ performance relative to the securities they follow caused by currency
fluctuations.
The data are collected and distributed by World
Markets Co., a unit of Boston-based State Street Corp. (STT), and Thomson
Reuters Corp. Bloomberg LP, the parent company of Bloomberg News, competes with
Thomson Reuters and ICAP in providing
news and information as well as currency-trading systems.
Reuters and World Markets referred requests for
comment to State Street. Noreen Shah, a spokeswoman for the custody bank in
London, said in an e-mail that the rates are derived from actual trades and the
benchmark is calculated anonymously, with multiple
review processes to monitor the quality of the data.
“WM supports efforts by the industry to
determine and address any alleged disruptive behavior by market participants
and we
welcome further discussions on these issues and what preventative measures can
be adopted,” Shah said.
Opaque Market
The foreign-exchange market
is one of the least regulated and most opaque in the financial system. It’s also
concentrated,
with four banks accounting for more than half of all trading, according to a
May survey by Euromoney Institutional Investor Plc.
Deutsche Bank AG (DBK) is No. 1 with a 15
percent share, followed by Citigroup
Inc. (C) with almost 15 percent and
London-based Barclays and Switzerland’s
UBS, which both have 10 percent.
All four banks declined to comment.
Because they receive clients’ orders in advance
of the close, and some traders discuss orders with counterparts at other firms,
banks have an insight into the future direction of rates, five dealers
interviewed in June said. That allows them to maximize profits
on their clients’ orders and sometimes make their own additional bets,
according to the dealers, who asked not to be identified
because the practice is controversial.
‘Incredibly Large’
Even small distortions in foreign-exchange rates
can cost investors hundreds of millions of dollars a year, eating into
returns
for savers and retirees, said James Cochrane, director of analytics at New
York-based Investment Technology Group Inc., which
advises companies and investors on executing trades.
“What started out as a simple benchmarking tool
has become something incredibly large, and there’s no regulatory body looking
after it,” said Cochrane, a former foreign-exchange salesman at Deutsche Bank
who has worked at Thomson Reuters. “Every
basis
point is worth a tremendous amount of money.”
An investor seeking to change
1 billion Canadian dollars ($950 million) into U.S. currency on June 28 would
have received
$5.4 million less had the trade been made at the WM/Reuters rate instead of the
spot rate 20 minutes before the 4 p.m. window.
“Funds that consistently trade using the
WM/Reuters fix are basically trading against themselves, and their portfolio is
taking a hit,” Cochrane said.
FCA Complaint
One of Europe’s largest money managers, who
invests on behalf of pension holders and savers, has complained to the FCA,
alleging
the rate is being manipulated, said a person with knowledge of the matter who
asked that neither he nor the firm be identified because
he wasn’t authorized to speak publicly.
The regulator sent requests for information to
four banks, including Frankfurt-based Deutsche Bank and New York-based
Citigroup, according to a person with knowledge of the matter. Chris Hamilton,
a spokesman for the FCA, declined to comment, as did
spokesmen for Deutsche Bank and Citigroup.
Bloomberg News counted how many times spikes of
at least 0.2 percent occurred in the 30 minutes before 4 p.m. for 14 currency
pairs on the last working day of each month from July 2011 through June 2013.
To qualify, the move had to be one of the three
biggest of the day and have reversed by at least half within four hours, to
exclude any longer-lasting movements.
The sample was made up of currency pairs ranging
from the most liquid, such as euro-dollar, to less-widely traded ones such as
the
euro to the Polish zloty.
Pounds, Kronor
End-of-month spikes of at least 0.2 percent were
more prevalent for some pairs, the data show. They occurred about half the time
in the exchange rates for U.S. dollars and British pounds and for euros and
Swedish kronor. In other pairs, including dollar-Brazilian
real and euro-Swiss franc, the moves occurred about twice a year on average.
Such spikes should be expected at the end of the
month because of a correlation between equities and foreign exchange, said two
foreign-exchange traders who asked not to be identified because they weren’t
authorized to speak publicly on behalf of their firms.
A large proportion of trading at that time is generated by index funds, which
buy and sell stocks or bonds to match an underlying
basket of securities, the traders said.
Banks that have agreed to
make transactions for funds at the 4 p.m. WM/Reuters close need to push through
the bulk of their trades
during the window where possible to minimize losses from market movements, the
traders said. That leads to a surge in trading
volume, which can intensify any moves.
Index Funds
For 10 major currency pairs, the minutes
surrounding the 4 p.m. London close are the busiest for trading at the end of
the month,
quarter and year, according to Michael Melvin and John Prins at BlackRock Inc.
who examined trading data from the Reuters and Electronic Broking Services
trading platforms from May 2, 2005, to March 12, 2010.
Reuters and ICAP, which owns
EBS, declined to provide data on intraday trading volumes for this article.
Index funds, which manage $3.6 trillion
according to Morningstar Inc., typically
place the bulk of their orders with banks on the
last day of the month as they adjust rolling currency hedges to reflect
relative movements between equity indexes in different
countries and invest inflows from customers over the previous 30 days. Most
requests are placed in the hour preceding the 4 p.m.
London window, and banks agree to trade at the benchmark rate, regardless of
later price moves.
Opposite Effect
“Since the major fix-market-making banks know
their fixing orders in advance of 4 p.m., they can ‘pre-position’ or take
positions
for themselves prior to the attempt to move prices in their favor,” Melvin and
Prins wrote in “Equity Hedging and Exchange Rates
at the London 4 P.M. Fix,” an update of a report for a 2011 Munich conference. “The large market-makers are adept at trading
in advance of the fix to push prices in their favor so that the fixing trades
are profitable on average.”
Recurring price spikes,
particularly during busy times such as the end of the month, can indicate
market manipulation and possibly collusion, according to Abrantes-Metz.
“If the volume of trading is high, each trade
has less importance in the overall market and is less likely to impact the
final price,”
said Abrantes-Metz, who’s also a principal at Chicago-based Global Economics
Group Inc. and a World Bank consultant. “That’s
exactly the opposite of what we’re seeing here. That could be a signal of a
problem in this market.”
‘Massive Trades’
U.S. regulators have
sanctioned firms for banging the close in other markets. The CFTC fined
hedge-fund firm Moore
Capital Management LP $25 million in April 2010 for attempting to manipulate
the settlement price of platinum and palladium
futures. The regulator ordered Dutch trading firm Optiver BV to pay $14
million in April 2012 for trying to move oil prices by
executing a large number of trades at the end of the day.
Melvin, head of currency and fixed-income
research at BlackRock’s global markets strategies group in San Francisco, and
Prins,
a vice president in the group, said that because banks could lose money if the
market moves against them, their profit may be
viewed as compensation for the risk they assume. Both declined to comment
beyond their report.
“Part of the problem is it’s
all concentrated over a 60-second window, which gives such an opportunity to bang
through
massive trades,” said Mark Taylor, dean of the Warwick Business School in
Coventry, England, and a former managing director
at New York-based BlackRock.
World Markets, the administrator of the
benchmark, could extend the periods during which the rates are set to 10
minutes or use
randomly selected 60-second windows each day, said Taylor, who began his career
as a currency trader in London.
‘Fiduciary Duty’
Trading at the highly volatile 4 p.m. close
instead of at a daily weighted average could erase 5 percentage points of
performance
annually for a fund tracking the MSCI World Index, according to a May 2010
report by Paul Aston, then an analyst at Morgan
Stanley. (MS) For an asset manager trading $10 billion of currencies, that
equates to $500 million that would otherwise be in the
hands of investors. Aston, now at TD Securities Inc. in New York, declined to
comment.
Fund managers rarely complain about getting a
bad deal because they’re assessed on their ability to track an index rather
than
minimize trading costs, according to consultants hired by companies and
investors to help execute trades efficiently.
“Where possible,
I would always advise clients not to trade at the fix -- but minimizing
tracking error is so important to them,”
said Russell’s DuCharme. “That doesn’t seem to be the right attitude to take
when you have a fiduciary duty to seek the best
execution for pension holders.”
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