FX Rates Said to Face Global Regulation in LIBOR Review

June 17, 2013
By Vlad Karpel

Foreign Exchange rates all over the globe are plunging into a dramatic transition. For decades now, foreign-exchange rate activities are among the most lenient when it comes to financial oversight. However, in the wake of the benchmark-rate manipulation scandals that were revealed starting from LIBOR, global regulators may begin overseeing currency rates.

When did this all start?

The world was shocked in July 2012 when the news surfaced that several of the world’s biggest banks have been manipulating global interest rates and fraudulently inflating or deflating prices of higher than $500 trillion worth of financial instruments.

In computing the LIBOR rate, the banks are supposed to submit the actual interest rates they are willing to pay for borrowing from other banks and the numbers are averaged out. The LIBOR supposedly reflects the general assessment of the health of the financial system and credit-worthiness of banks. Those voluminous piles of data submitted are used every day to establish benchmark rates that affect the prices of everything from credit cards to mortgages to currencies to commercial loans, to swaps.

When such issue was made public last, it was swiftly catapulted into national spotlight. Since then, it was coined as the biggest financial scandal in history. MIT professor Andrew Lo said it “dwarfs by orders of magnitude any financial scam in the history of markets.”

How do these scandals affect investors?

Try to remember your entire life in retrospect. What if someone tells you that all the things you have experienced were not real? Unimaginable, right? Plain insanity. That’s what the rate-rigging scandals are like, only more massive and pervasive since they mess with 500 trillion worth of financial instruments and they affect hundreds of millions of people across the globe.

In particular, this means that the exchange rates for USD, GBP, JPY, etc. and the interplay between them would have not really been reflective of the natural demand-supply relationship in the market. Rather, they were dictated by at least 3 to as many as 16 huge banks in the world. Thus, if you have incurred some major losses in short-term or long-term trades in the currency market, then those banks are fairly instrumental to why you lost.

What happens now?

The U.K. Financial Conduct Authority (FCA), which keeps an eye on the financial market and punishes crimes committed thereto, is currently investigating a potential manipulation in the $4.7 trillion-a-day foreign-exchange market after being contacted by a whistle-blower just this March.

Also, the International Organization of Securities Commissions (IOSCO), a Madrid-based group that irons out market rules, may propose final guidelines improving the transparency and regulation of benchmarks, including the WM/Reuters rates, as soon as July 2013.

Then, the FCA will review the guidelines and decide which particular rates to oversee, spokesman Chris Hamilton said. Martin Wheatley, the regulator’s chief executive officer, has already taken on oversight of the London interbank offered rate after his review of how the rate is set.

Last January, IOSCO made some initial recommendations including one that suggested that the rates used in “currency markets, which can be represented by specific or aggregate benchmarks,” be subject to regular audits, stricter oversight from regulators and a code of conduct for submitters. The WM/Reuters rate would be included under this definition, accordingly.

US regulators may also get involved with the on-going investigation. “The agency takes the allegations very seriously and is working with other regulators, domestically and internationally, to look into these concerns,” said Bryan Hubbard, an OCC spokesman.

What do all these events mean to investors?

When the regulation takes effect, it is expected that the behavior of FX rates will not be exactly the same as they were before. This is because the FX rates are anticipated to be more reflective of the actual demand-supply dynamics in the market, bereft of any malicious manipulation that could have been controlling the currency market for the past years.

Hence, for investors, this means that you should begin adapting to this new setup and revisit the strategies that you used to employ. Since the patterns observed in the currency market for the past years might not be applicable anymore once the regulation begins, it might be necessary to start re-observing the market again and draw out quick yet accurate analysis to execute the best possible investments in a timely manner.

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