The “London Fix”

How seven big banks secretly manipulated the global currency markets

Just how exactly did foreign currency traders at Barclays, Citigroup, Credit Suisse, Deutsche Bank, JPMorgan, RBS and UBS secretly rig global exchange rates for almost a decade?  FX is, after all, the largest financial market in the world with $5.3 trillion in trading volume a day.

Currently being investigated by regulators in the US, UK, Switzerland, Hong Kong and Singapore, those seven banks are now also the subjects of an anti-trust class action filed late last year in New York federal court on behalf of thousands of their FX customers.  The claimants contend they were victimized by the banks’ collusive manipulations of closing prices on spot trades.  Spot trades are those that settle in cash for immediate delivery and constitute almost half of the FX market.1

iStock_000033833624SmallClosing prices on FX spot trades are used to value trillions of dollars of index funds and derivative contracts and serve as the globally-accepted currency benchmarks for market indices, portfolio valuations and investment performance measurement.   The spot closing rates of 160 currencies are determined daily by WM/Reuters2 at 4pm (GMT) in what is known as the “London fix.”3

The class action complaint against the banks accuses them of trading ahead of their customers (“front-running”) and then collectively engaging in a manipulative practice called “banging the close” which enabled them to capture proprietary profits at the expense of their customers.

“Banging the Close”

FX traders typically offset every customer order with an equal and opposite proprietary trade in order to avoid overnight market risk4.  They are still exposed, however, to the risk of price differences between their intra-day offsetting trades and the closing spot rates applicable to their customer orders.  In FX, which is traded over-the-counter and not on exchanges, the closing spot rates are not based on the last trades of the day, but are the median prices of all the trades reported by FX dealers to WM/Reuters from 30 seconds before to 30 seconds after its 4pm “London fix.”

When their client orders matched up enough to allow for rate-rigging, the traders then executed their offsetting proprietary trades during the 60-second window around the 4pm “fix”

FX traders at the defendant banks allegedly compared their customer order flows on a routine basis in chat rooms or through instant messaging5.  When their client orders matched up enough to allow for rate-rigging, the traders then executed their offsetting proprietary trades during the 60-second window around the 4pm “fix” so as to raise or lower the closing spot rates to their collective advantage.  This end-of-day price manipulation is colorfully known as “banging the close.”6

In “banging the close” of the spot market, the FX traders made money for their banks at the expense of their customers.  For example, if the colluding group had net orders to sell ¥100 billion on a given day, they would collectively sell ¥100 billion in the spot market from their own inventories (or short) during the 60-second window and, in so doing, drive down the spot closing price that day.  They would then buy the ¥100 billion from their customers – still within the 60-second window – at the lower spot price, reaping an easy profit for themselves and flattening their positions (or covering) for the day.  Their customers, meanwhile, got whacked.

No single bank could have manipulated the closing price of currencies in this way because of the sheer size of the FX market.  Governments even struggle to affect the spot prices of their currencies.  If a bank tried to influence a closing spot rate in one direction, other banks could just as well be moving it in another.  In other words, there would have to be collusion among the major dealers to pull off a large-scale manipulation of FX rates.

In this case, the seven defendant banks represented over 60% of FX trading and were therefore capable of effectively “banging the close” and taking money out of the pockets of their customers and putting it into their own.  It’s no wonder, then, that this chatty little group of FXers smugly dubbed themselves “The Bandits’ Club.”7

1 The balance of FX trading is in swaps, forwards and options.

2 World Markets Co. (WM), a subsidiary of State Street Bank, administers the “London fix” in conjunction with Thomson Reuters.

3 London is the center of FX trading, accounting for 41% of all transactions. New York is second with 19% and Singapore third with 6%.

4 Referred to in the industry as maintaining a “flat book.”

5 Some of the traders being investigated reportedly had details of each other’s customer orders on their desktop screens.

6 On certain days, this tactic apparently resulted in currency price deviations of as much as 1% from the days’ averages.

7 Given their heady market power, they also liked to refer to themselves as “The Cartel.”

  • Christo

    1) This is not the only way the FX market was being manipulated.

    2) FX liquidity varies over time and every day, there are opportunities to move the market with relatively small trades and orders, especially magnetic stops.

  • Stephen Bornstein

    What are ‘magnetic stops’?

  • Saeed Amen (@thalesians)

    I’ve done some work on 4pm FX, the main conclusion was that market makers face risk by offering a guaranteed price (so it can’t be a free service). It was featured in WSJ a few days ago at http://blogs.wsj.com/moneybeat/2014/03/11/a-reminder-of-why-the-fx-fix-exists/ (also has link to my paper).