I guess we’ll get this out of the way early – I am pretty sure I have dealt on a fake price at more than one stage in my career. I don’t think I did it that much in the spot markets, although given the books some of the voice brokers used to run it wouldn’t surprise me, but I am confident that quite a decent percentage of the (relatively few) FX swap trades I executed were on “kite” prices.
I mention this because last week, after an interminable investigation that may have lasted almost nine years, the CFTC has charged TFS-Icap and two senior managers at the firm with “flying prices” and “printing trades” in FX options markets.
The “printing” of fake trades is a problem because the broking market was, and is, the primary source of price discovery in these markets, therefore dealers may have ended up making wrong prices with the subsequent P&L impact. When it comes to “flying prices” I am less sure of the seriousness of the action, because the market has its own way of regulating such behaviour.
There is also the question of the language used. My own trading in FX swaps was normally the result of the forward desk being at lunch – they tended to like a good feed on that desk, especially if it was paid for by someone else! Because there was not a huge amount of direct dealing between banks there was no need to worry about making another bank a price, but every now and again a customer would require something and so the spot gorilla was suddenly out of his depth!
At this stage I turned to the brokers – I had one or two good friends who were FX forwards brokers – and asked them where the market was. Often the price I was given was prefixed with “I think it’s…” and to me that is not a firm price, it is an indicative quote based upon the broker’s understanding of the market. So far so good.
Sometimes, however – especially if I went back looking for a dealing price, having dealt with the customer (as a spot dealer you learned early on NEVER to give the forward desk a position in their own asset class, they would moan and complain about it for days) I would be told the same price without the preamble. I would deal and the immortal line would follow, “back with the name”!
Whenever you heard that from a broker you knew there was no firm price behind it, they either thought it was the right price and would find a counterparty easily, or they had an arbitrage through other products to get the deal done (occasionally they knew the counterparty name wouldn’t pass the credit test).
The thing is, I had – and have, no problem with that. I trusted the brokers – and the vast majority of them were trustworthy – and more to the point, if they let me down they knew that not only would there be no more business from me, but I would also encourage my forward desk colleagues to make them the last broker they would deal with (and somehow, at one time I did find myself in charge of spot, forwards and options!)
If there is one thing left in this world that is purely relationship-driven, it is the voice broker/voice trader partnership, so messing with that was always risky and the brokers knew that.
All of which makes some of the allegations in the CFTC’s charges against TFS-Icap, its former CEO Ian Dibb and former head of emerging markets broking Jeremy Woolfenden all the more astounding because if proven, they took it to a whole new level, with the Commission claiming that of 25,000 prices quoted by brokers via voice, instant message and Volbroker channels, the “vast majority” were fake.
Obviously there is a real difference between the experience I have described above in FX swaps, and FX options, for in the former there was likely to be a price in a tenor close to the requested price which the broker could use if they got desperate, before finding someone to trade the basis risk away. There was also, as I have inferred, opportunity for hedging out through other products such as futures – in FX options that is not the case.
That said, however, if such a huge percentage of trades were fake then how on earth did the brokers get away with it for so long without being found out? I get they used the infamous “double hit” excuse (or the other trader was away from the desk therefore the price was “stale”) but even that should have worn thin after a while and traders would have looked elsewhere. It’s like a smart order router using a last look platform above a firm liquidity venue when the amounts on offer are the same – it’s illogical and won’t go on for long.
Reading the CFTC’s Compliant it seems obvious that one manager of the Latam EM FX options desk was aware of this, he was cited as saying the practice would undermine the firm’s credibility and risk it losing money (for his pains he was dismissed a short time after – and if ever there was an unfair dismissal case waiting to happen that is it).
Obviously, if there was this level of flying prices then the bank traders either didn’t notice or didn’t care – and I do think there is an element of people relying too much on what is on a screen without thinking carefully enough about where that information has come from, it’s a potential weakness in the hybrid model. The problem is, however, that in products requiring a degree of negotiation (and FX swaps are more complex in this matter than options) then how do you go to a fully-automated CLOB?
That the brokers were able to apparently publish fake trades reiterates the issue with the hybrid model. Allegedly they created three IDs, in the name of TFS offices in New York, London and Frankfurt, and simply traded with each other. That is impossible to spot as a trader looking at a screen, but would someone deliberately programme a pricing engine build such a thing? Given the time it would take they would have plenty of time for thought and, hopefully, they wouldn’t, but if they did, it is likely they will be found out very quickly and would suffer the consequences of making such a deliberate decision. In the hybrid world, the lower risk of discovery means such activity is more likely to be undertaken and, as is alleged in this case, it was led from the top, so it takes a brave broker to refuse to comply.
What really surprises me is the use of a bank name for fake trades. The bank in question did not apparently know about it – the CFTC alleges that the brokers used it because the firm didn’t trade Latam EM options and therefore wouldn’t spot the activity. Again, though, how long before that bank is asked why they keep dropping trades? Actually, quite some time, because the over-reaction by banks to issues elsewhere in the FX business (chat rooms) means that traders were not allowed to talk to each other! So the bank concerned could have some serious reputational issues that it doesn’t even know about.
Given my current campaign to raise responsibility levels in FX markets I could argue that the dealers should have known where the market was, and not relied upon their brokers so much, but that would be wrong. In this case the pricing was credible, the alleged scheme difficult to spot so even if a trader did follow the Global Code’s recommendations and ask questions, they wouldn’t know what to ask, beyond, “why am I getting dropped on these prices?” (and often the brokers would find a match later in the day).
During my session at Forex Network Chicago with Bob Savage from CC Track about pre-hedging and front running, he made a very pertinent observation – “you can’t regulate morality”. If the CFTC’s allegations are proven then this was purely and simply a case of a business head deliberately waking up to commit a misdemeanour and coercing those working for him to follow suit (with different levels of enthusiasm no doubt).
If that is the case, then it should not be seen as an endemic problem, although I have to accept that if other investigations follow and similar allegations are proven then the inter-dealer broker industry has a real problem. There is a significant segment of the industry that wants greater automation in products that remain the domain of the voice brokers and they will be given more fuel for their arguments.
Personally I agree we need more automation, but I also accept the need for negotiation in certain products – and for that reason, we have to hope that what we have here is an isolated case. That is the hope…my experience from a different era makes me fear it may be something else.