ACI – The Financial Markets Association (ACI FMA) has filed an Amicus Briefon behalf of former HSBC FX trading head Mark Johnson, who is appealing his conviction and sentencing earlier this yearfor several wire fraud offences.
In the Amicus ACI says that if the US government’s “Illogical” position is allowed to stand, and the conviction is not overturned, bank dealers are unlikely to operate in the face of potential criminal sanctions simply for transparently and fairly hedging the uncompensated risk of “colossal loss” to their shareholders.
“They are far more likely to simply stop accepting significant principal risk transfer and offer to fill transactions like the Cairn order exclusively on an agency or “at best” basis,” it states. “Put simply, the less banks are incentivised to take the risk of accepting transfers of client exposure on a principal basis – or indeed the more they are penalised for doing so – the less they will support or originate liquidity. Risk tolerance and liquidity go hand in hand, and should this reticence become widespread, the implications to FX and related OTC markets is manifest.
“If permitted to stand, the conviction not only represents an individual injustice, but will have a chilling market-wide impact upon FX liquidity providers, likely resulting in greater damage to market end users – the very class of person the US government presumably sought to protect in the instant prosecution,” it adds.
The Amicus further argues that (while stressing that ACI applauds enforcement and criminal prosecution where appropriate) based upon the facts taken exclusively from the government’s case together with defense evidence that remains undisputed as recited in Johnson’s brief, itbelieves that Johnson’s wire fraud and conspiracy conviction “stands in opposition to (i) law and regulation specifically applicable to FX, (ii) nearly universal terms of industry standard master agreements, and (iii) established market-wide standards, custom and practice now embodied in specific provisions of the BIS Global Code of Conduct”.
The Amicus recognises that the Global Code presently carries no power of law in the US and had in any case not yet been implemented at the time of Johnson’s complained-of conduct. It adds, though, that the Global Code, together with the widely accepted ACI Model Code upon which is it largely based, represent the result of a nearly 50-year effort of central banks and market participants to consolidate and codify ethical standards and global custom and practice between banks and their FX customers.
It adds that Johnson cannot plausibly have been unaware of these standards and practices. Furthermore it adds that Johnson’s conviction, if permitted to stand, would represent “an unanticipated and sudden lowering of the bar in disregard of universally recognised standards of dealer conduct and longstanding banking custom and practice with respect to FX risk transfer”.
It continues, “The attendant uncertainty threatens a near-term and substantial chilling of FX liquidity as bank dealers become less willing to face unpredictable personal legal peril in addition to the market risks they are trained to manage. As liquidity diminishes, FX end users – like Cairn – will pay the price in higher transaction costs and more volatile markets.”
The Amicus also highlights jurisdictional concerns that “weigh heavily” upon ACI’s global membership and exacerbate the unintended public policy consequences of Johnson’s conviction, which, it argues, is likely to lead banks to avoid the risk of similar action being taken against them by the closing of their US dealing operations, driving jobs and business offshore.
Pertinently, the Amicus highlights how conduct rules promulgated and endorsed by the Financial Stability Board (FSB) and global central banks (including the Federal Reserve Bank), that are embodied in the ACI Model Code and Global Code, provide far more than tacit acceptance of HSBC’s method of handling of the fix order.
These current versions embody closely similar language from prior codes in effect at the time of Johnson’s complained-of conduct and embody decades old banking custom and practice. “Under the facts and circumstances demonstrated in this case, such codes specifically approve pre-hedging and transacting before a fix in the execution of a fix order,” it states.
Taking issue with the government’s witness testimony, the Amicus says it “could not disagree more” with the argument that banks engaging in large fix transactions like the one at issue do not intend to manage their risk and make money, but instead view such fix transactions as “loss leaders”.
“While some banks make the decision to price certain smaller deals at a loss for relationship or other strategic purposes, simple mathematics shows the absurdity of the government’s assertion with respect to the Cairn transaction,” it states. “Pursuant to the Mandate Letter HSBC agreed to buy up to USD 4 billion worth of pounds either at the fix rate, or as a full risk transfer at a 100-pip spread below prevailing market rates.
“Clearly, given the premium required by its full risk transfer alternative, the bank intended to make some money on the transaction: perhaps as much as 100 pips – approximately $26 million in clear profit – had they covered the maximum amount immediately at or near the prevailing market rate,” it continues. “While not without some risk, this alternative gave the bank a reasonably comfortable 100-pip “buffer” if markets began to move against it before it covered its exposure. Under the fix order alternative on the other hand, if, as the government expert suggests, HSBC was willing to accept the full amount at an unknown price to be fixed two hours in the future, without hedging any portion of that exposure in advance, the potential “colossal loss” from such a “crap shoot” (to use the government expert’s own terms) would have been indeterminate.
“Two hours is a long time in a volatile market, during which a multitude of factors might arise to cause precipitous and illiquid price moves, especially late in the trading day,” it further adds. “It is simply illogical to suggest any purpose behind HSBC’s two-hour head start window other than to permit the bank to pre-hedge at least some of its risk.”
Johnson’s appeal process has started with the filing of documents in the US Second Circuit Court of Appeals.