In a fix

The stringent £1.1 billion fine imposed on five banks, including big names such as UBS, HSBC and Royal Bank of Scotland, by the UK financial services regulator raises further worries about the extent to which financial benchmarks are being manipulated. A major problem is that many financial benchmarks are designed in a manner that allows a few large players to influence them with ease. This was the conclusion in the scandal involving the London Inter-bank Offer Rate as well as the investigations into the fixing of the benchmark for physical gold prices — the London Gold Fixing. The emergence of yet another scandal on similar lines shows that global regulators need to act fast to ensure that the trust of the public in the financial markets is not eroded any further. The currency benchmark involved in this scam, also known as the WM/Reuters benchmark rate, is widely used by funds and other money managers to determine the value of their foreign currency denominated assets. The benchmark rates of the local currency in each country is also influenced by this rate.

The WM/Reuters benchmark rate is determined by the buy and sell transaction executed by foreign exchange traders in the interbank market in the 60-second window on either side of 4 pm. The benchmark rates for 21 currencies are fixed based on the average price of transactions in this period. The lack of transparency in the interbank foreign exchange market wherein clients call their banks to place an order, which is not publicly disclosed, enabled a group of traders located in the US, the UK and Switzerland to compare their outstanding orders and to collude to move the benchmark to serve their interest. The extremely small period that determines the ‘fixing’ rate and the fact that the computation and dissemination of the benchmark was left to non-government entities are two factors that facilitated this operation.

The Reserve Bank of India has taken proactive measures to review and bring about changes in the Indian benchmarks for interest rates and currencies after the Libor scandal was revealed. The computation of the main currency benchmark in India, the RBI reference rate, has been so designed that it cannot be easily manipulated. The rate is fixed based on transactions in any five-minute window between 11.45 am and 12.15 pm. The trades are chosen from a random group of banks. That the central bank is involved in setting this benchmark adds weight to the reference rate. While the credibility of the currency benchmark in the country is not a concern, the manner in which interbank currency transactions are conducted needs looking into. Outstanding orders in the interbank forex market are not publicly disseminated; as a result, more favourable rates and transaction costs are quoted for larger customers and there is a possibility of dealers front-running large orders to increase their bank’s treasury income. The forex fixing scandal should be a wake up call for the RBI to take note of this.

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