An employee counts a stack of U.S. one hundred dollar bills inside a currency exchange center in Mexico City. Photographer: Susana Gonzalez/Bloomberg
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.
Fund managers and scholars say the volatile forex trading patterns look like an attempt by currency dealers to manipulate rates -AFP
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.”
- Contributed by
Bloomberg, Liam Vaughan & Gavin Finch -
Aug 28, 2013
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