Goldman Sachs under investigation for Forex manipulation

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Goldman Sachs is the latest Forex trading bank to be added to the list of banks being investigated for rigging of Forex rates used to price other derivatives, and for benchmarking purposes, known as the WM/Reuters rates.  However the investigation against Goldman Sachs also includes commodities, options, and technology systems.  Bloomberg reports:

Goldman Sachs Group Inc. (GS), the world’s most profitable securities firm before the financial crisis, said it’s under investigation by regulators probing the potential manipulation of foreign-exchange rates. Currencies and commodities were added to a list of financial products and related activities that are subject to investigation, according to a regulatory filing published by the New York-based company today. The filing also added options trading and technology systems and controls to the list. Investigators are looking at the firm’s “trading activities and communications in connection with the establishment of benchmark rates,” Goldman Sachs said in the filing. The company “is cooperating with all such regulatory investigations and reviews.” At least eight banks including Citigroup Inc. (C) and JPMorgan Chase & Co. (JPM) have said they’re being investigated by authorities examining the $5.3 trillion-a-day foreign-exchange market and are cooperating. Citigroup, JPMorgan and Barclays Plc (BARC) have suspended or put on leave some of their most senior currency traders amid the inquiry. No one has been accused of wrongdoing. The U.S. Federal Reserve is examining legal and regulatory exemptions that have allowed banks including Goldman Sachs to trade and own raw materials such as oil, coal and metals, a person with knowledge of the matter said last month.

Investment banks and other Wall Street institutions have come under much pressure since the financial crisis of 2008.  What is interesting about this case is that the interbank Forex market is unregulated per se, it’s an over the counter market where banks trade with each other according to their own rules. By seeing client order flow, banks have an unfair advantage into the market. One example is bank A sees a big order coming through, let’s say to sell 1 Billion Euro.  Bank A calls his friend at Bank B and tells him about the order.  Bank B then places a smaller order for their own book, knowing the price will move when the 1 Billion order hits the market (and may have to be split up in multiple orders).  It’s very difficult to prove such activities without seeing the communications between Bank A and Bank B, which may be revealed during the course of this investigation.  Also it will be interesting to see what legal grounds are taken against the banks. In the stock market, insider trading has been illegal for a long time.  But there isn’t any specific regulation specifically forbidding banks profiting from information which they have ahead of other market participants.  Lawmakers may consider making a Forex specific law, but then it would be questionable how this could be enforced in jurisdictions which are not G8 friendly.  Also since Forex is not traded on an exchange, but OTC, this also complicates the enforcement of any potential regulation forbidding such activities. The WM/Reuters rates are used widely to price other instruments, derivatives, and for accounting purposes.  Clients who lost money because of these banks activities essentially front running orders and manipulating the price, clearly have a claim against the banks.  But what’s not clear is what form this claim may take and how it will be prevented from happening in the future.

Further Reading

http://www.bloomberg.com/news/print/2013-11-07/goldman-sachs-is-under-investigation-in-currency-probe.html

http://www.bloomberg.com/news/2013-10-30/rbs-said-to-review-currency-trading-practices-amid-global-probe.html

http://www.businessweek.com/news/2013-11-06/lloyds-opens-internal-probe-into-potential-currency-manipulation

http://uk.reuters.com/article/2013/10/30/uk-rbs-forex-idUKBRE99T0OA20131030

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