A couple of people have been talking to me in very excited tones about how the latest accusations of front running are yet another nail in the coffin of the traditional FX market. None of them, as far as I am aware, have any particular interest in the model changing, rather they are expressing an honest view, but I have to say – as I did at the time – that I think they are barking up the wrong tree.
Yes, it doesn’t look good that the US Department of Justice has (yet again) chat messages and phone recordings that appear to indicate wrongdoing on the part of a bank trader – in this case former Barclays US FX trading head Robert Bogucki – but I have to reiterate again that these are alleged actions that took place several years ago, when the FX market was a different place.
Changes have taken place in the intervening period, not least the launch of the Global Code, and I suspect the traditional sell side is not necessarily a happy place for a trader at the moment (nor will it improve in the near future), but the fact that we have another looming case about misconduct should not deflect from the great steps the market has taken in recent years.
One person suggested to me that the DoJ’s case will fall apart, mainly because it was a victimless crime, and again, I am not sure I can agree, nor do I wish to pre-empt the legal procedures.
It was actually me that put the idea in that person’s head that it was a victimless crime because I was trying to check some numbers I had pulled together regarding the deal! Those numbers were rough and may be some way out, although my acquaintance didn’t seem to think so.
Hewlett Packard’s purchase of Autonomy has been a nightmare from the outset and in some ways the DoJ’s action fits perfectly into a tale that could qualify for disaster story of the decade. There have been countless legal cases around the original deal amidst claims the target had misrepresented its accounts and HP had not been honest with shareholders. Those legal actions are still ongoing so the end is yet to be written, but if the story is told, the FX hedging may actually turn out to be one of the bright points.
I say this because I was running some numbers and checking some price action as best I could and at the time HP bought the options Cable was around the 1.6200 mark. It is unlikely they bought at the money but let’s assume they did. They apparently decided in early September not to exercise the options and instead buy the six yards of sterling in the cash markets.
A source tells me they started buying towards the end of the month, just before they actually offloaded the options back to Barclays. If that is the case then Cable was trading in a volatile fashion between 1.5325 and 1.5725 for about a week at the end of September 2011.
Although the dollar was giving up gains in that week, sterling definitely outperformed the market, rising against the euro and yen, which suggests there may have been some additional buying. Let’s assume again that HP was the buyer and that at worse they got them at 1.5600 average (it was probably a great deal better) then that is $360 million in revenue saving.
Of course the option would be worth significantly less thanks to the Cable drop, but it is also noteworthy that vol rose by over 2% at the same time and time decay was probably limited.
All in all, the deal would have been revenue positive for HP it strikes me…none of which make is OK to say it’s a victimless crime, because if the traders did bang vol down 1% in a day that’s still likely to be a significant amount of money, probably in the region of $15-20 million.
To go back to the original point, however, I don’t see how issues such as this change the modern FX market. These events happened in a time when banks were still encouraging their traders to assume risk and targets were there to be hit – nowadays it seems to me the targets are set in fees and market share (which are faux fees it could be argued).
Just about every institution now ring fences their order management business so the risk is a breaking down of the internal walls, not a trader deliberately front running an order.
Looking at the Bogucki allegations, as I believe was the case with Johnson and several other legal actions brought, if he is found to have lied to the client then he’s facing an unpleasant outcome – for this seems to be the hook upon which the US authorities most comfortably hang people. The front running aspect of the allegations are only likely to be important to HP, because if it follows the pattern established by some other (typically non-corporate) firms then it will see a guilty verdict as an opportunity to investigate any restitution available to it.
In other words, the lawyers are going to continue to get rich at the expense of the FX market for a lot longer, and that’s what depresses me, not an unlikely change of market structure.