The big banks had a fine time on Wednesday – as in they had to pay $4.3 billion worth of fines to financial regulators in the United States, the United Kingdom and Switzerland.
Traders at several big banks – including UBS, JPMorgan Chase and Citigroup – manipulated foreign exchange rates over a five-year period starting in 2008. Essentially, they banded together to get rich at the expense of their clients.
Foreign exchange, or forex, is by far the biggest market in the world in terms of the amount of money that changes hands. According to Carol Osler, a professor at the Brandeis University International Business School, forex is “easily 10 or 20 or 30 times bigger than any other single market you could imagine.”
Every day, more than $5 trillion moves through the market.
“Trading is literally 24/almost-7,” Osler says. “Over the weekends, very little happens, but there is trading almost any time you want to trade.”
Companies trade currencies to import and export products, and to buy and sell bonds. Banks want to be sure they have enough yen or euros to buy or sell something at a moment’s notice.Because currency trading happens all the time, there is no closing price.
“There was a need for some sort of formal price that institutions could use to value their portfolios,” Osler says.
And so the “fix” was born.
“They had to find an arbitrary time to grab off a rate, and they just decided to do it at 4 p.m.,” says Kathryn Dominguez, a University of Michigan professor of public policy and economics.
Every day, for one minute around 4 p.m. London time, Reuters takes the average exchange rate and that becomes the “fix.”
According to Darrell Duffie, who teaches finance at the Stanford Graduate School of Business, if you are buying and selling currencies, sometimes you do it in real time, “but sometimes you tell the bank, well, never mind giving me a price now, I’ll just pay whatever the 4 p.m. fixing price is.”
And because of that, currency dealers had an easy time colluding to drive that price up or down. Brandeis’ Carol Osler says that, in private chat rooms, traders told each other how much they had to buy and sell to move the price.
“The dealers are thinking, ‘Well, gosh, if almost all of us are going to be buying, then we know the price is going to go up,’” Osler says. “Well, it would be helpful to know what is going on with everyone else.”
When they announced the fines, regulators called on banks to change their corporate culture – and left the door open for criminal prosecution.