Shakespeare's often misquoted suggestion, "first kill all the lawyers", still sells very successfully on mugs and T-shirts. It is likely that had he referred to bankers instead, merchandise sales would currently be at least as successful. The recent fine levied on five banks in respect of manipulation of spot FX rates has added fuel to the fire of public disapproval of banks and some of their behaviour. One of the most commonly perceived inadequacies of the authorities' response to this and other similar scandals has been a lack of individual accountability for the wrongdoing reported.
The notion of individual accountability covers a number of possibilities. It might refer to the accountability of the individual traders involved, or of their superiors who took no action to curb their activities. It could refer to criminal liability or to accountability to the regulator.
The FCA's and PRA's joint Consultation Paper "Strengthening accountability in banking: a new framework for individuals" states that public confidence in the banking system has been undermined by unclear or confused individual accountability. The new regime it proposes is designed to ensure greater accountability of individuals not only to the regulators but to their firms.
The new regime (yet to be announced in final form) is, of course, too late to affect FX manipulation. However, the issues surrounding the foreign exchange market may provide a useful prism through which to view the proposed new senior managers regime and accompanying changes.
In a subsequent article, we will consider how changes to the regulation of the market, rather than of the individuals who operate in it, might affect the type of behaviour identified by the FCA.
Foreign exchange manipulation - how was it done?
The spot rates investigated by regulators were those for the so-called G10 currencies as published by the European Central Bank (ECB) and WM Reuters at 13:15 and 16:00 respectively. The objective of the traders manipulating the "fix" was to ensure that the spot rate at which their banks would buy or sell currency to customers pursuant to existing orders was either higher or lower than the average at which the bank had bought or sold that day. The example given by the FCA in its Final Notices is that if the bank had net orders to sell currency to its customers, it would profit if the spot rate at which it did so was higher than the rate at which it had bought currency in the market that day.
This was achieved by traders forming groups in chat rooms in order to share information about their net positions (and occasionally confidential information about orders placed by specific clients), and then manoeuvring the individual positions of those within the group. So, for example, all the net buy orders within the group might be consolidated in the hands of just one trader who would execute a succession of large buys at just over the best available rate in the run-up to the fix, with the result that the spot price for that currency (which would determine the rate at which the bank then sold to its customers) would be artificially high.
The regulatory response
The fines levied by the FCA were for breaches of Principle 3 which requires firms to "take reasonable care to organise and control [their] affairs responsibly and effectively, with adequate risk management systems." The foreign exchange market is, of course, largely currently unregulated, and there were therefore no rules specific to the type of behaviour which had occurred.
The Final Notices published by the FCA are strikingly similar in content as regards the risk management model in place at the five banks, and its failure. All of them operated a "three lines of defence" model: the relevant business area's management being the first line of defence, with support from control functions such as Compliance, Risk and Legal (the second line of defence) and Internal Audit (the third line of defence).