Monday, July 13, 2015

Algorithms “may have been used for Forex manipulation” | Not rogue traders this time

Note: This commentary is from the archives, as your OmiCronFX commentator is on holidays. It was first published in December 2014

According to Bloomberg, the New York State Department of Financial Services has found evidence “…that Barclay’s PLC and Deutsche Bank AG may have used algorithms on their trading platforms to manipulate foreign exchange rates”. This is in the context of on ongoing investigation into the manipulation of such things as currency spreads, bank pricing benchmarks and the placing of trades to take unfair advantage of the settlement process in use for Forex trading that takes place each day.

These alleged manipulations wind up overcharging less sophisticated bank customers, mainly those who need to engage in currency exchange in the course of their normal businesses, which would not necessarily include Forex trading per se (Forex traders are very sensitive to spreads and the necessity to have buy and sell orders marched up independently of the broker, as opposed to being aggregated so that the broker or bank winds up as the only effective counterparty to such transactions).

Large fines have been imposed by regulators in a number of jurisdictions on well-known banking names as a result of such practices.

The possible use of algorithms to carry out activities of the sort being investigated is of supreme interest to us, given that OmiCronFX uses such tools to enable the successful operation of its Forex trading strategies. Anything that might give algorithms a bad name, no matter in what part of the Forex supply chain they are abused, is to be deplored. Our response has to be to use an analogy with the Internet – while there are many people who misuse this amazing resource, calls for its curtailment on these grounds are irrational and counterproductive. After all, bad people were using the telephone to further their nefarious ends shortly after it was invented.

Rogue traders no longer to blame

As far as a the regulators are concerned, the use of algorithms for manipulation constitutes evidence that belies the assertion by the banks concerned that it is rogue individuals who are responsible for the unfair activities. The thinking is that the embedding of manipulatory algorithmic routines within the systems at the banks would require official sanction from the very top of the management structure, thereby making it a systemic problem. This is a little ironic, given the quote from a high-ranking member of the UK’s Financial Conduct Authority (FCA), given here:

“Ultimately, the events of the past few years — from the crisis itself, to PPI, to Libor — can be laid at the feet of individuals.” From: “Enforcement and Credible Deterrence in the FCA”, Tracey McDermott, director of enforcement and financial crime, the Financial Conduct Authority, at the Thomson Reuters Compliance and Risk Summit, June 18, 2013

The Bloomberg story can be accessed here.

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