To maximize profit, dealers would buy or sell client orders in installments during the 60-second window to exert the most pressure possible on the published rate, three traders said. Because the benchmark is based on the median of transactions during the period, placing a number of smaller trades could have a greater impact than one big deal, one dealer said.
Traders would share details of orders with brokers and counterparts at banks through instant messages to align their strategies, two of them said. They also would seek to glean information about impending trades to improve their chances of getting the desired move in the benchmark, they said.
The tactic is most effective with less-widely traded currencies, the traders said. It could still backfire if another dealer with a larger position bets in the other direction or if market-moving news breaks during the 60-second window, one of them said.
A former dealer characterized it as a risky strategy that he only attempted when he had a high degree of knowledge of other banks’ positions and a particularly large client order. Typically, that would need to exceed 200 million euros to have a chance of moving the rate, two of the traders estimated.
Because the market is so large and competitive, it would be difficult for traders to influence rates, said Andy Naranjo, a finance professor at the University of Florida in Gainesville who specializes in foreign-exchange markets.
“I’m skeptical of the ability of traders to manipulate the major currencies in a meaningful way given the massive size of this market,” Naranjo said. “Governments themselves often have a difficult time moving foreign-exchange markets through their interventions, yet they have the additional ability to create fiat money and alter both monetary and fiscal policies.”
Some fund managers say they prefer to use the WM/Reuters rates even if they can be rigged because it’s more convenient and often cheaper than seeking quotes from individual banks, according to two investors. Dealers who agree to trade at the benchmark rate offer a service by taking on the risk that the market moves against them between the time the order is placed and the fix, they said.
Bloomberg News contacted foreign-exchange traders and investors after some market participants expressed concern that the WM/Reuters rates were vulnerable to manipulation. The traders and investors said they expected their market would be the next to be scrutinized.
In attempting to rig Libor, traders at Barclays, Royal Bank of Scotland Group Plc and UBS misstated their firms’ cost of borrowing and colluded with counterparts at other banks to profit from bets on derivatives, regulators found.
Libor is one of at least three benchmarks under investigation. The European Commission is probing companies including Royal Dutch Shell Plc, BP Plc and Platts, an oil- pricing and news agency, for potential manipulation of the $3.4 trillion-a-year crude-oil market. The firms have said they are cooperating with the probe. U.S. regulators are investigating the ISDAfix rate, the benchmark used for the swaps market.
While U.K. regulators require dealers to act with integrity and avoid conflicts, there are no specific rules or agencies governing spot foreign-exchange trading in Britain or the U.S. That may make it harder to bring prosecutions for market abuse, according to Srivastava, the Baker & McKenzie partner.
Spot foreign-exchange transactions aren’t considered financial instruments in the same way as stocks and bonds. They fall outside the European Union’s Markets in Financial Instruments Directive, or Mifid, which requires dealers to take all reasonable steps to ensure the best possible results for their clients. They’re also exempt from the Dodd-Frank Act, which seeks to regulate over-the-counterderivatives in the U.S.
“Just because Mifid doesn’t apply, the spot FX market shouldn’t be a free-for-all for banks,” said Ash Saluja, a partner at CMS Cameron McKenna LLP in London. “Whenever you have a client relationship, there is a duty there.”
Sixteen of the largest banks, including Barclays, JPMorgan Chase & Co. and Deutsche Bank, signed a voluntary code of conduct for foreign-exchange and money-market dealers in 2001 that was later included as an annex to guidelines issued by the Bank of England in November 2011.
The BOE’s Non-Investment Products Code, which some banks use in contracts with clients, states “caution should be taken so that customers’ interests are not exploited when financial intermediaries trade for their own accounts.” It also says that “manipulative practices by banks with each other or with clients constitute unacceptable trading behavior.”
That only goes so far, according to Saluja.
“The thing about the code is it is a voluntary code,” the lawyer said. “It may be that compliance with that has almost been seen as optional.”