The foreign exchange market is one of the world’s deepest and most liquid markets, with over $6.6 trillion changing hands every day. Proponents claim it can’t be manipulated. However, regulatory agencies in the US and abroad regularly clamp down on bad actors.
Let’s review how shady banks and hedge funds have conspired to manipulate the foreign exchange markets.
Minor currencies are vulnerable.
The US Department of Justice recently charged a UK hedge fund with manipulating the US Dollar to South African Rand currency pair to trigger a payment in its favor under an FX options contract.
In the days leading up to the option’s expiry, the hedge fund instructed an investment bank to place a large sell order in the hundreds of millions of dollars around the option’s exchange rate to manipulate the market exchange rate.
The order’s size was so large relative to the market liquidity that the USDZAR exchange rate moved in the desired direction. This example illustrates the extent to which prominent actors can manipulate the market in minor currency pairs.
Pricing fixing is widespread.
Importantly, this isn’t an isolated incident driven by an evil hedge fund. Time and time again, regulators have fined investment banks and brokers in the UK and abroad for illicit practices in the Forex market.
In 2019, a currency trader at a large multinational bank was sentenced for conspiring to fix exchange rates and withhold customer bids in Africa, Central, and Eastern European. Middle Eastern currencies are usually traded against the US Dollar and the Euro.
The currency trader conspired with contacts at other large banks to manipulate exchange rates by agreeing not to buy or sell at certain times or withholding customer bids. They sought to increase profits across their trading books by coordinating their actions. The trial revealed that communication took place daily through a range of channels.
EURUSD manipulation
Even the large and deep EURUSD currency pair has seen its share of market manipulation attempts.
In 2015, the United States Department of Justice Antitrust Division charged four investment banks and their traders with conspiracy in the FX market. Over several years, they’d worked together in an attempt to influence the Euro-US Dollar spot market.
Every day, the foreign exchange market experiences two major fixes: the 1.15 pm ECB fix and the 4 pm WM/Reuters fix. These fixes crystallize the historical exchange rates of a large number of currencies. The ECB fix is undertaken by the ECB itself, and the WM/Reuters one by WM/Reuters.
These fixes matter because they determine the price at which many counterparties trade. The investment banks sought to profit from this by placing large businesses in the minutes leading up to the fix in an attempt to manipulate the fixed price. The idea is that they would buy at the average price over the period but only record the final transaction at the fixed price and pocket the difference as profit.
Significantly, they conspired to remove an element of risk from their transactions by sharing their buy and sell orders ahead of time. If all their customers wanted to buy before they fixed, they would front-run those orders to drive the fixed price as high as possible. And if they had a mixed bag of buy or sell orders, they’d work together to ensure the side with the most orders could make money.
These examples illustrate that where there’s money to be made (or lost), humans will use their best efforts to reduce risk and stack the odds on their side, even if this means breaking the law. They also cast light on frailties in the foreign exchange market around minor currency pairs with lower liquidity and price fixing mechanisms in deeper currency pairs. If you suspected the markets were rigged against retail investors, you might be onto something.