As the world’s largest and least regulated financial market, and with close to $5.3 trillion dollars being traded each day – the foreign exchange market seems primed for manipulation. Just in the last 48 hours the investigation into alleged abuse has broadened to Switzerland, Hong Kong and New Zealand and is keeping regulators across the globe scrambling for answers.
The stakes are high. Foreign exchange (FX) rates are used everyday to set benchmarks that help companies value their assets and portfolios, enabling the flow of good and services from country to country. If there was a loss of confidence in this system, our global, national and local economies could be adversely affected for years to come.
So, how can a handful of foreign exchange dealers at eight global banks manipulate such an important and visible market? It starts off with the fact that although the foreign exchange market is thought of as an exchange, it really isn’t. Unlike the equity markets where there is an actual exchange, banks place FX orders and conduct trades amongst themselves to actually set the FX rate. This is called the interbank market from which all FX rates are derived from (such as benchmark, commercial and consumer FX rates). Every time a deal is done on the interbank market (between banks) for a specific currency, the rate is set. So when a bunch of dealers (traders) start to place orders and conduct deals in a coordinated way, they can change (or move) the market. Moving the market based on order volume and direction isn’t necessarily illegal (this happens naturally with large and legitimate orders), but timing the orders, quantity and direction so a specific rate is set, well this is highly illegal, and is the basis for today’s regulatory action.
A class-action lawsuit filed in the US yesterday, as reported by the WSJ, accuses the banks of communicating “with one another, including in chat rooms, via instant messages, and by emails, to carry out their conspiracy,” and for rigging foreign-exchange rates as far back as January 2003, the lawsuit said. With so much on the line, banks need to ensure that their employees are not colluding with others, coordinating how and when they place orders to design a system where they can control any market, especially the FX market. Although there are policies, procedures and surveillance systems in place that are supposed to stop abuses such as these, they are clearly ineffective when dealing with employees who have the skills to manipulate the system.
Then what’s the solution? If you’re going to catch these highly motivated, intelligent individuals and deter future unethical activities, you need technology that learns and gets smarter as it monitors and analyzes how these people communicate, coordinate and collude. Digital Reasoning’s technology monitors and understands every email, chat and any other form of electronic communication to reduce the time of detection and reduce the overall cost of investigating suspicious individuals.
Digital Reasoning’s machine learning platform, Synthesys®, is smart enough to know when employees are talking about deals, orders, trades and rates and will quickly expose employees that are intentionally trying to conceal their deal related conversions, while revealing others that are manipulating orders with “bad actors” in order to move the market or effect a rate. Synthesys also reveals previously unknown relationships, which help banks, understand who’s communicating to whom, in addition to what they’re discussing. Understanding relationships in addition to activities often helps to expose people who are trying to avoid detection.
Whether it’s FX, Libor, benchmark, trading, conduct or ethical risks, Digital Reasoning has the technology and experience to help banks, regulators and examiners safeguard our financial infrastructure.
Contact us today to learn more about how we can enhance your surveillance systems and comply with regulatory requirements.