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2014-08-26 05:34:36
The money-spinners await their fate
Aug 23rd 2014
A CITY worker looking for a quiet place to nap nowadays could do worse than
head for his bank s foreign-exchange (FX) trading floor. Once noisy with
activity as gesticulating dealers moved around billions of dollars, euros and
yen, it is more likely now to be an oasis of calm. Bankers are plain bored.
The FX market has been exceptionally quiet, moaned currency analysts at
Citigroup recently. In fact, it s been so quiet that there was almost no point
in writing this report.
The summertime torpor disguises existential angst. Regulators across the world
are probing the role of banks in currency trading, apparently convinced it is
the latest financial market to have been fiddled. Around 30 bank staff,
including many trading-floor bosses, have been suspended or fired. Hefty fines
seem inevitable. Worse, reforms may tear the heart out of the FX market as it
is presently constituted. Banks, which make money by offering to buy or sell
currencies from or to their clients, could go from being central actors to bit
players. The future of a business which used to reap annual revenues of $20
billion is at stake.
Not that such bounty is attainable these days anyway, given the placid state of
the market. Currency-trading volumes have slumped. That is largely because the
world s big central banks have replaced yo-yo-ing interest rates which in turn
determine the levels of their currency with a uniform near-zero level since the
financial crisis (see chart 1). The upshot is that floating exchange rates have
seldom been so stable: volatility has plunged to its lowest level in two
decades (see chart 2).
As a result, once-keen users of banks FX services have learned to do without
them. Multinationals that might once have tried to hedge their foreign-currency
exposures now opt to live with the risk, assuming that exchange-rate movements
will remain within a limited range. Financial firms, which make up over 90% of
trading volumes, have also pared back. Hedge funds that wager on currencies
have shrunk or left the market in recent years. And banks, whose traders
sometimes also bet on market moves, are no longer keen to do so. Appetite for
risk is non-existent: This is not a time to try something clever in FX, says
a trading boss in London.
Volatility will eventually come back British holidaygoers may have noticed the
value of the pound rising and falling this week as the world s biggest
economies recover and interest rates move around more. But the tidy profits
once made by banks may not. Much of the market for major currency pairs, such
as dollar-euro or pound-yen, is now conducted electronically. Anyone wanting to
exchange less than $100m is unlikely even to speak to a human being these days.
The spreads on trades (the difference between the price at which banks buy and
sell currencies) have become vanishingly thin. Even the profits to be made on
making markets in more obscure emerging-market currencies, where spreads were
once wider, have evaporated. High-frequency traders are moving in, too,
hobbling banks.
But the big worry is what regulators are likely to say and do. Although they
have yet to detail their case against banks, their investigations are focusing
on whether FX traders bilked clients by fiddling widely-used daily benchmarks.
There is nothing sophisticated about the alleged fraud: clients looking to buy
or sell FX from bank trading desks agreed to price currency deals at the price
prevailing at 4pm London time, regardless of when the order was placed. Bankers
soon found they could bend that price in their favour, and they did. Worse,
they appear to have colluded in order to execute the scam. The transcripts of
online chat rooms they used, dubbed the Cartel and the Bandits Club , are
likely to amuse neither bank compliance officers nor regulators.
Much of the errant behaviour happened after banks promised to clean up, having
been caught tampering with LIBOR, an interest rate used to peg contracts worth
trillions of dollars. Their most plausible defence is that some watchdogs knew
about the way the market actually worked, including the collusion. The Bank of
England, which oversees the world s biggest FX centre in London, has suspended
an employee.
The fines for the currency fiddle could reach $26 billion globally, according
to KBW, a bank. Cheated clients might sue for compensation, too. Many complain
the market is no longer fit for purpose. The more powerful among them,
including giant institutional investors and asset managers, might egg on
regulators who want to change the way currencies are traded. The Financial
Stability Board, a committee of global supervisors, has floated the idea of a
global utility that would match supply and demand of currencies. Whatever that
means and few know for sure it sounds like a way of sidelining bankers. More
details are expected in time for a meeting of G20 leaders in November.
Banks think a fine-tuning of the FX market and a stern reminder to traders
not to be crooked would suffice. Some are paring back their currency
activities, worried about profits being squashed between fixed costs and
shrinking revenues down to $13 billion this year, thinks Morgan Stanley, a
bank. Those that remain may find it a harder environment to thrive in.