Ethical Machines? Foreign Exchange Trading Collusion Violations Hasten Transition to Electronic Market

Sure, that will solve all those pesky human problems: just replace the humans with machines and there will never ever be another financial scandal.

Persistent allegations of collusion and self-dealing in the foreign exchange markets is causing the banking entities that manage the trading of global currencies to consider replacing all those unreliable humanoids with an electronic system. No greed, no drinking, no sex, no bad behavior a la 'Wolf of Wall Street.'

That's the theory, anyway.

Electronic trading already makes up a significant percentage of all financial trading, including foreign exchange. Banks and other financial institutions are concerned that increased regulatory scrutiny will reduce margins even further than will algorithmic or computerized trading so are open to increasing the amount done between machines rather than by voice between humans.

In the annals of technological advancement and human redundancy, there have been many factors cited for the replacement of humans with machines: cost, speed, productivity and quality being but a few of them. But this may be the first time in history that ethics has been the primary driver of computerization.

There are a number of issues that need to be addressed, such as the fact that this will probably hasten the market dominance of only the largest banks, contributing to the 'too big to fail,' risk already extant.

There is also, that one little detail that no one has yet figured out how to regulate: all those electronic platforms are designed, programmed and managed by humans who are, history and psychology suggests, probably not unaware of their increased power and the opportunity it presents. JL

Daniel Schafer and Delphine Strauss report in the Financial Times:

Allegations that foreign exchange traders have colluded to rig a crucial currency benchmark has prompted top bankers in recent months to hasten a more than decade long move onto electronic trading platforms.

Tired of headlines about alleged trader misbehaviour, investment banking executives are accelerating longstanding efforts to save costs and become technology leaders by replacing humans with computers.

“Electronic trading is compliant by its very nature,” the head of trading at a top-ten global investment bank says. “If I have a business that is 100 per cent electronic I am a lot less nervous about conduct,” the head of another large investment bank adds.

Regulators in the US, Europe and Asia are investigating allegations that voice spot traders, who make prices and buy and sell currencies over the phone, have shared information about client orders with rivals to manipulate markets.

The probes have so far triggered the suspension, placing on leave or firing of 22 forex traders and prompted calls for strict rules in the so far mostly unregulated, largest financial market in the world. The Financial Stability Board, a group of global regulators, is working on proposals for changing forex benchmarks, while politicians including German government ministers have argued currencies trading should be forced on to regulated exchanges.

Banks, fearing a move towards exchanges as it would further reduce margins and the value of costly investments into their own trading platforms, are stepping up a push away from archaic voice trading structures that are at the centre of the probes.
“Pretty soon, voice desks will be much smaller and e-platforms a lot bigger,” a consultant to the industry says.

The irony is that it is happening in the one area of the “Ficc” trading of fixed income, currencies and commodities products that has been the first to embrace electronic platforms in the late 1990s. Banks such as Citigroup and Deutsche Bank invested early in forex trading platforms enabling them to expand their dominant positions in currency trading.

Within a decade, online trading and programmed algorithms have become a significant force in forex trading. Across all products, electronic trading volume moved from single-digits in the early 2000s to 74 per cent last year, according to Greenwich Associates, a research company.
Yet despite this, the spot market has kept large elements of voice trading. About 35 per cent of volume in the global $2tn a day spot market – where currencies directly change hands and traders take risks as market makers – is still done over the phone, according to Bank for International Settlements data.
Bankers claim this is mostly driven by client demand. “Some asset managers and hedge funds are telling their banks either you take those very large orders [through your voice trading desks] or we don’t give you any other business,” one trader says. “There is nothing better than listening to a human voice and getting a picture of the anxiety of the market,” a hedge fund manager confirms.
Yet the rise of machine-driven trading in the past decade has taken its toll on the power of top voice traders. “Fifteen years ago the market was controlled by the senior traders and brokers – their ability to control and manipulate prices is already significantly diminished,” a fund manager says.
Traders say the “equitisation” of forex trading – bringing more orders on to electronic platforms just like in stock trading – will probably foster the market dominance of the largest operators.

Four banks – Deutsche, Citi, Barclays and UBS – share half of the overall currencies market and in etrading, their dominance is even more marked according to data from the Euromoney FX Survey.

Smaller rivals including Royal Bank of Scotland and BNP Paribas have caught up in recent years, nibbling away at the big fours’ market share in electronic trading. But industry experts predict operators such as RBS – about to drastically shrink its investment bank further – will rethink costly investments into electronic trading.

“Electronic trading will reconcentrate towards the platforms of the largest players after a few years in which they have ceded market share to a chasing pack,” says Ian Green, head of Eco Financial Technology, and formerly Credit Suisse’s global head of ecommerce for fixed income, currencies and commodities.

But it is also set to push down profitability. The lack of transparency around large orders executed by traders directly with clients over the phone traditionally helped banks to make huge profits in voice trading. If such orders are being broken down into smaller pieces through an electronic platform, there is less scope to make money.

There will always be humans involved so there will always be scope to game the system - Former forex trader

The drive towards electronic trading comes as foreign exchange and other areas of Ficc trading – which has long been investment banks’ main cash cow – are already under heavy pressure from stricter capital rules, falling revenues, a move to low-margin exchanges and centrally cleared trading and a restricted ability to trade with the bank’s own money.
More computerised trading does not mean fewer people. Etrading requires about a third more – albeit lower paid – sales and trading staff than voice trading not least because algorithms have to be constantly kept up to date, recruiters say.
Bank managers are also misinformed if they think it will eliminate fully the risk of human wrongdoing.
Etraders say some colleagues have been codifying electronic platforms so that they can move prices to the detriment of clients. There even is talk that some are tracking movements of a clients’ mouse on trading screens to be able to react when it hovers over the “bid” button.
“There will always be humans involved so there will always be scope to game the system,” a former forex trader says.