Around the world, investigators are trying to find out if the largely unregulated foreign exchange market was manipulated. Even before the investigations 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 rumored flows has long been a way of life in foreign exchange, 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 rumors 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 foreign exchange chatter will mute the impact of client orders, since fewer people will be able to jump on the bandwagon of rumored flows.
Because of the heightened sensitivity about fairness to clients, even more currency business is likely to be done on electronic trading platforms: humans can be accused of mishandling such information, machines can’t. Three-quarters of global foreign exchange trading volume is already processed electronically, according to financial research firm Greenwich Associates. It is 28 percent for the currency options part of the market. Because banks get higher margins on options than on spot trading, foreign exchange profits will be squeezed if “electronification†makes inroads in that part of the market.
It looks like regulators will take some time to decide whether the foreign exchange 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.
Swaha Pattanaik is a markets columnist at Reuters Breakingviews. For more independent commentary and analysis, visit breakingviews.com.
