Holding Bankers to Account by Oonagh McDonald;

Author:Oonagh McDonald;
Language: eng
Format: epub
Publisher: Manchester University Press

Part II: A decade or more of change in the foreign exchange market

Chapter 6

A rapidly changing foreign exchange market

This chapter is designed to show how much the foreign exchange market has changed over the years. The days of noisy currency trading floors where dealers shouted at each other have long gone, replaced by computers and people tapping at keyboards or talking quietly to each other. When did the foreign exchange market start to change and why does this matter?

A different market begins to emerge

As with LIBOR, there are suggestions that rigging or manipulating the foreign exchange (FX) market began in 2005. To look for explanations, it is worth beginning with the changing structure of the foreign exchange market during the 2000s. Interpreting these changes might provide an explanation as to why attempts to manipulate the market became not only possible but also financially worthwhile from the point of view of the traders.

Changes began with the extensive use of computers in FX from 2000 onwards. Networks principally connected brokers to banks but a number of competing companies allowed their FX customers to see prices from many banks simultaneously and, through these multi-dealer platforms, they could see a blended rate on one screen, such as a bid from Deutsche Bank and an offer from UBS. Although the percentage of flows transacted through these APIs (application programme interfaces) was only about 5% at first, it was the beginning of much more dramatic changes.

In his interesting account of his life as a banker, Kevin Rodgers explains the impact of two changes which occurred in 2005. The first step was taken by Barclays, which involved an additional decimal point, which hardly seemed an earth-shattering move. Barclays used its computer system to quote, for example, the US dollar rate as 1.32783, whereas everyone else would be quoting 1.3278; this enabled Barclays to undercut other banks. If one bank quoted prices with 3 pips (as they are called), the only way the bank could go to a narrower spread would be to go to 2 pips, a 33% reduction. But Barclays could go to 2.9 pips (a tighter spread, at only 3%). That could mean for other banks the loss of customers with large sums to change into another currency, such as major companies operating in more than one country.

Rodgers and his team at Deutsche Bank noticed a change in the behaviour of one large American fund and eventually discovered that it was engaged in ‘latency arbitrage’:

Its computers would constantly monitor the market, wait for a large order or information release to move prices on EBS [Electronic Broking Services] or elsewhere. Then its computers would ‘look’ around the prices shown by its banking counterparties and deal on any rate that was too slow to respond. Deutsche Bank’s ARM, its computer system, was programmed to alter prices in this event in a fraction of a second, but the fund was faster.1

He also explains why the American fund turned away from latency to ‘relative value’. By observing the bids

Download

Copyright Disclaimer:
This site does not store any files on its server. We only index and link to content provided by other sites. Please contact the content providers to delete copyright contents if any and email us, we'll remove relevant links or contents immediately.