# A Fixed Game? Institutional Corruption Charges Taint Global Markets—Again.

by Gregg Fields

Is the fix in? If it's 4 p.m. in London, and you're talking about foreign exchange trading, the answer is a definite "maybe."

Actually, the hour of 4 p.m. London time has long been a fixture in international finance. It's a pivotal moment when exchange rates between currencies are set. Based on the trading around that time, the price of a dollar versus the euro, for instance, can climb or fall, depending on demand. It was historically known as the 4 p.m. fix. The most commonly used exchange rates are distributed by a joint venture called WM/Reuters.

In theory, the price is a simple function of supply and demand among the handful of global financial institutions that dominate this gigantic market. More than $5 trillion in currency trading occurs daily, according to a survey conducted last April by the the Bank for International Settlements. That's a 35 percent increase since 2010, the BIS said. And with such huge volumes, even the slightest move in a currency's value can mean giant profits for some traders, and their institutions. Therein lies the problem—and a large, growing scandal with significant implications related to the study of institutional corruption. Regulatory bodies around the world are now examining some suspiciously convenient price swings that have occurred around the 4 p.m. fix. In a scandal reminiscent of last year's rate-rigging improprieties surrounding the London Interbank Offered Rate, or Libor, regulators now are questioning the institutional integrity on which the 4 p.m. fix is purportedly based. Some reports contend a whistleblower alerted regulators in the U.S., U.K. and Switzerland as early as 2011, to little avail. Last June, Britain's Financial Conduct Authority, somewhat vaguely, said it was "aware of allegations" of currency rigging, according to Bloomberg. The story broke open in October when FINMA, the Swiss markets regulator, disclosed it was "conducting investigations into several Swiss financial institutions in connection with possible manipulation of foreign exchange markets." Swiss officials made it clear that the alleged transgressions went far beyond the Alps, however. "FINMA is coordinating closely with authorities in other countries as multiple banks around the world are potentially implicated," it said. Soon after, the U.K.'s FCA disclosed: "We can confirm that we are conducting investigations alongside several other agencies into a number of firms relating to trading on the foreign exchange (forex) market." Late last year, in a rare interview on an open case, U.S. Attorney General Eric Holder Jr. hinted to the New York Times that proof of rate manipulation had already been found. "The manipulation we've seen so far may just be the tip of the iceberg," Holder said. "We've recognized that this is potentially an extremely consequential investigation." The Audacity of Opacity The forex case bears some striking similarities to other recent financial scandals, including those that figured centrally in the economic collapse of 2008. And it brings renewed scrutiny to practices that, upon close examination, share unsettling likenesses with the systems and influences that produce the institutional corruption that is the focus of the Edmond J. Safra Center for Ethics. Among the parallels: There is compelling evidence of lax to no regulation. As a lively headline in the Daily Mail put it last June: "Wild West currency market hit by latest fixing scandal." There is also a clear corporate culture driven by short-termismhuge profits in this case can be earned in a matter of seconds. As Malcolm Salter, business professor emeritus at Harvard and senior faculty advisor at the Edmond J. Safra Center for Ethics, has argued, "short-termism also invites institutional corruption." Institutional corruption, in Salter's view, "refers to institutionally supported behavior that, while not necessarily unlawful, erodes public trust and undermines a company's legitimate processes, core values, and capacity to achieve espoused goals." Finally, there is an almost complete lack of transparency in forex. When it comes to how exchange rates are set, mum's the word. A client doesn't have any independent way of knowing, for instance, if the price is good or bad relative to what others are paying. "If traders were then given the carrot of a massive bonus and a way of fudging the figures to get there, where is the stick that keeps them in line?" Andre Spicer, a professor of organizational behavior at City University London, wrote last October. "Often, there isn't one." Troubling Numbers A quick tutorial on how this opaque system works is in order. The reality is that currencies are traded around the world 24 hours a day. However, the United Kingdom is the dominant player, with a 41 percent market share, followed by the U.S. with 19 percent, according to the BIS. In Asia, the dominant centers are Singapore, Japan and Hong Kong. The U.S. dollar is on one side of currency exchanges 87 percent of the time, according to the BIS. Prices change throughout the day. But shopping for the best deal is daunting. So over time the London 4 p.m. fix became a de facto benchmark. The 4 p.m. fix is based on trading that occurs in a 60-second window around that time. The recent allegations are that traders skewed the 4 p.m. figures to serve their own interests, potentially at the expense of clients, which can include entities like pensions and mutual funds. When trading runs to the trillions of dollars a day, a slight change can make a big difference. Bloomberg, for instance, took a sample trade of$1 billion Canadian into U.S. currency on June 28 of last year. The trader would have received $5.4 million less if the transaction used the WM/Reuters rate, rather than the spot rate available 20 minutes before the 4 p.m. window. How can such a huge market be manipulated by such a small number of traders? One example is a process, not exclusive to foreign exchange, known as "banging the close." In banging the close, traders place a blizzard of orders around the time benchmarks are set, skewing prices. Regulators have apparently noted that price spikes around 4 p.m. have often evaporated soon after a new benchmark price was set. Other reports, including coverage in the Financial Times, say investigators are looking at old-fashioned collusion. Traders are in theory competitors. But reportedly some shared strategies via text message groups and chatrooms, with nicknames like "the cartel," and "the bandits club." No question, foreign exchange trading is a cluba quite exclusive one. Deutsche Bank and Citigroup are the world's largest currency traders, with roughly 15 percent of the market each, according to a 2013 survey by Euromoney Institutional Investor. Barclays and Switzerland's UBS had roughly 10 percent each. Libor 2.0? If the allegations have a familiar ring, it's because we have seen this pattern before. In testimony to Parliament earlier this month, Martin Wheatley, who heads the FCA, acknowledged the allegations "are every bit as bad" as with Libor. Libor is, in theory, the rate at which banks borrow from one another. The problem was that banks self-reported the Libor, manipulating it to serve their own interests. There, social injury includes the fact that trillions of dollars in consumer borrowing, including home equity loans in the U.S., are priced against the Libor benchmark. Libor and similar benchmarks "have been readily and pervasively rigged," Gary Gensler, then-chairman of the Commodity Futures Trading Commission, noted last year. In December, the European Union fined a group of banks that included Citigroup and JPMorgan Chase$2.3 billion for manipulative behavior that went back several years.

(A number of Libor traders have been charged, and press reports in England contend that further indictments are in the pipeline. The Libor scandal and its links to institutional corruption was examined in an Edmond J. Safra Center for Ethics working paper last June, authored by Justin O'Brien, director of the Centre for Law, Markets & Regulation at the University of New South Wales.)

Separately, foreign exchange trading bears some clear parallels to the market in derivatives, which played a central role in the economic meltdown in 2008. As with derivatives, foreign exchange isn't conducted in a central market like with stocks. It's driven by private transactions, away from the glare of transparency.

"The foreign exchange market is unregulated, opaque and controlled by a small tight-knit group of traders who have little commitment to their employers," noted Spicer, the organizational behavior professor at City University London. "If the allegations are true, these are the networks that provided the social infrastructure for rate fixing."

Social infrastructure, in this context, can be viewed as a subculture of sorts. In this case, the social infrastructure could include not just the traders and their institutions but also the regulators who turned a blind eye. Cumulatively, strategic and systemic influences such as these often manifest as institutional corruption, Lawrence Lessig, director of the Edmond J. Safra Center for Ethics, wrote in a recent article for the Journal of Law, Medicine and Ethics.

Burning Issues

Unfortunately, one of the primary casualties of institutional corruption is a decline in public trust, as well as the trustworthiness of vital societal institutions, Lessig added. It's particularly relevant in this case, in the midst of efforts to restore public confidence through reforms mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Looking ahead, the investigations into foreign exchange markets are continuing. Although resignations and early retirements on foreign exchange desks seem unusually high lately, it should be noted that no charges have been brought.

Nevertheless, the sad reality is that, when it comes to global finance, in recent years the smoke of scandal has inevitably signaled the subsequent discovery of the fires of institutional corruption.