Starting in 2008, the American media and financial regulators began to investigate the idea that Libor, the London inter-bank lending rate, might be under manipulation by a bank or cartel of banks. More investigators joined in the international investigation and by 2012, the Libor scandal became the largest ever such scandal in the history of financial markets. Now, a new scandal is brewing that threatens to be as large as Libor manipulation.
The foreign exchange markets are for the most part outside the regulatory authority of national regulators. This, coupled with the fact that foreign exchange is the largest market in the world as well as one of the most volatile, means that collusion and manipulation of forex has the potential to be extremely lucrative. That is exactly what many regulators are now investigating.
Allegations have surfaced that many foreign exchange traders working on behalf of banks have collaborated to share client information and intentionally manipulate benchmark exchange rates. This collaboration lets institutional traders get an edge over their competitors and make money at the expense of their clients. However, the link between traders and clients also makes it easier to pinpoint the injured parties in this kind of collusion, which in turn makes prosecution and regulation easier.
There are several factors that contribute to the ease of collusion in forex. The first is that the forex market is dominated by just a few large banks. Four banks account for half of the entire forex market. This makes it far easier for their traders to collude than if the traders worked for many smaller banks. Secondly, the foreign exchange market is not exchange-traded. That means trades do not take place on a public exchange. Traders and brokers arrange trades over the phone. Nobody outside the transaction will be directly aware of it. That lets traders conceal collusive activity and cover their tracks. They don’t need to worry about regulators or overseers trawling through public data, looking for suspicious trades. A similar problem exacerbated the 2008 crisis- the mortgage-backed securities that detonated on the balance sheets of many banks were not publicly traded on an exchange, so there was no public knowledge of their prices or transaction history.
The last major factor is the “Wild West” nature of the forex market. Because it is built on international exchanges, no regulatory body is solely responsible for regulating it, the way the Securities and Exchange Commission is responsible for regulating stocks and bonds in the United States. Forex in general is not under as close scrutiny as the other major financial markets. Obviously, lax oversight opens to the door to abuses.
The forex investigations are still in the early stages, so it is not yet possible to draw solid conclusions about the size of the scandal. The allegations, however, are significant, asserting that major traders have manipulated rates and shared client information for years. The investigation centers around online chatrooms where traders allegedly gathered for collusion.
Thus far, the banks themselves have cooperated with authorities in terms of surrendering information, having learned in the Libor scandal that it is usually cheaper and easier to cooperate rather than conceal wrongdoing. Assigning blame to traders, and then to supervisors who may or may not have been aware of the traders’ illicit activity, is a difficult line to establish for investigators, but the size and scope of the forex market, as well as of the allegations, means that even if the evidence takes a long time to examine in detail, the known size of the scandal is likely to increase.
The potential for this scandal to eclipse the Libor scandal is based on the sheer size of the forex market- a much larger number of traders have the potential to be involved, compared to the Libor scandal. With investigators from multiple national governments, the facts in this story will begin to become clear in the coming months. Don’t be surprised to see multiple banks removing highly placed traders and executives from their rosters as the investigation uncovers more details about who knew what and when. Whether or not the forex scandal will rival the Libor scandal in size remains to be seen, but one thing is for sure- the full breadth of the forex corruption has yet to be revealed.