Article: December 2013 Structured Finance/Antitrust Update

Major Banks Face New Antitrust Investigations and Civil Suits. On the heels of the investigations into manipulation of LIBOR and price-fixing in the aluminum markets, the world’s largest banking institutions now face new inquiries from domestic and international antitrust regulators into allegations of manipulation of the foreign currency exchange (“FX”) market. These investigations have raised the possibility of a new wave of lawsuits. Two class action suits alleging antitrust violations based on FX manipulation and collusive conduct have already been filed, and additional class actions and/or individual suits are likely to follow.

The currency exchange market is a $5.3-trillion-a-day market—the largest in the financial system. Companies, investors, portfolio managers, and stock index compilers, among others, use exchange-rate benchmarks—snapshots of traded currency rates calculated on a half-hourly or a hourly basis using sample data from a minute-long period starting thirty seconds before the half-hour/hour mark—as a transparent and auditable way of buying and selling currencies. The most popular benchmark, called the WM/Reuters rate or the “London fix,” runs at 4 p.m. London time on each trading day. Roughly 1% to 2% of overall global foreign exchange transactions are conducted at this “fix.” The foreign exchange market is largely opaque and almost entirely unregulated, with four banks dominating the market and trading around the “London fix”: Deutsche Bank AG (15.2%), Citigroup Inc. (14.9%), Barclays Plc (10.2%) and UBS AG (10.1%). Collectively, these banks have a market share greater than fifty percent.

On June 12, 2013, Bloomberg News published an exclusive report, citing five confidential dealers, that traders “at some of the world’s biggest banks manipulated foreign-exchange rates used to set the value of trillions of dollars of investments.” Since then, the Financial Conduct Authority of the United Kingdom, the Swiss Financial Market Supervisory Authority, and Joaquin Almunia of the European Commission’s competition group have announced investigations into the practices by major banks. On October 9, 2013, the Swiss Finance Minister claimed at a briefing on the investigation that it is “a fact that currency manipulations have been committed.” The U.S. Commodity Futures Trading Commission has also been reviewing potential violations of the law with respect to currency markets, and the U.S. Department of Justice has opened a criminal investigation into manipulation of the foreign exchange market.

The investigations focus on allegations that traders at major banks such as Deutsche Bank AG, Citigroup Inc., Barclays Plc, Goldman Sachs, HSBC, JPMorgan, Standard Chartered, UBS AG, and Royal Bank of Scotland have been conspiring to manipulate the WM/Reuters foreign-exchange benchmark rate that is fixed at 4 p.m. in London. Countless transactions executed by these banks are tied to this benchmark rate, and traders are alleged to have frequently “front-run” their clients’ transactions to make a profit. It has been reported that, by conspiring to manipulate the benchmark, these banks ensure they always win these “front-running bets,” costing their clients millions if not more.

To ensure that their front-running is successful, and to maximize their profits at their clients’ expense, traders have allegedly conspired to artificially influence the benchmark rate in one direction. According to confidential sources, traders at rival banks send instant messages to each other on a routine basis when respective client orders match up enough to allow for rate-setting. This group of traders was known by various monikers, including “The Cartel.” Two sources reportedly told Bloomberg News that traders “would share details of orders with brokers and counterparts at banks through instant messages to align their strategies” and “to glean information about impending trades to improve their chances of getting the desired move in the benchmark.” By concentrating orders in the moments before and during the 60-second benchmark window, traders can push the rate up or down, a process known as “banging the close.” To maximize these profits, dealers reportedly buy or sell client orders in installments during the 60-second window to exert the most pressure possible on the published rate. Since the rate 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. Given the size of the FX market, even minor movements in the benchmark rate can mean millions of dollars in profits for traders with inside knowledge.

Quantitative studies of the foreign exchange market appear to confirm the anecdotal accounts of traders. In the 30 minutes preceding the “London fix” at 4 p.m., certain currencies regularly experience significant price spikes followed by quick reversals after calculation of the benchmark. Data regarding the number of times spikes of at least 0.2 percent occurred in the 30 minutes before the 4 p.m. benchmark on the last working day of each month from July 2011 through June 2013 suggest that collusion has occurred.

Two class actions alleging illegal antitrust conspiracies have recently been filed in U.S. District Court for the Southern District of New York. The first is brought by Haverhill Retirement System, a retirement fund for public sector employees, and alleges that a class of investors that entered into foreign currency trades directly with the Defendant banks was harmed by the Defendants’ manipulation of FX rates. The complaint defines the class to include “all persons who traded foreign currency directly with a Defendant in the United States between August 1, 2005 and the present which transaction was settled on the basis of WM/Reuters Rates.” Similarly, a second class action brought by a Korean company, Simmtech Co. Ltd., includes substantively identical factual allegations, but defines the class to include all persons in the Republic of Korea who entered into foreign currency transactions directly with a defendant, which transaction was settled on the basis of WM/Reuters Rates. Both complaints assert causes of action for violation of Section 1 of the Sherman Act; the Simmtech complaint also includes two state law claims, for violation of New York General Business Law, §§ 340 and 349.

Given the size of the FX market and the ongoing investigations, additional class action and individual lawsuits are expected.