How does the fix work?
At different set points each day the cross rates for the ten major currencies (those of the G10 nations) are fixed. For example the sterling/dollar rate is fixed at 4pm using the WM Reuters rate. This is fixed using actual trades in the spot market in the minutes immediately around 4pm. Clients of the banks regularly put in orders to buy or sell currencies “at the fix rate” ahead of it being fixed.
How do the banks make money?
A bank with net client orders to buy a currency at the fix rate will make a profit if the average rate at which it buys the currency in the market is lower than the rate at which it sells to the clients. The reverse is the case for net sell orders where the bank tries to sell the currency at a higher rate than it has agreed to buy from its clients. Banks can legitimately manage their currency book to try and improve the chances of this being the case.
So what did rigging involve?
Because it is spot rate trades which lead to the fix, the groups of traders who ganged together, could manipulate their spot trades around the fix to ensure that when the fix was established their overall books were in profit.
In particular traders tried to trigger “stop losses” which were specific exchange rates clients had set to limit their potential losses. The bank has effectively taken a position by guaranteeing its client a certain rate. By triggering “stop losses” and then manipulating the fix to be at a lower level (in the case of net buying orders) the traders could guarantee that the bank made a profit.
Why did the traders collaborate with traders from other banks?
While each trading desk knew its own client book it could not see other banks’ positions. Using emails and chat rooms they could suggest to their rivals and their colleagues in other parts of the world which way they wanted the fix to move and, if that suited the majority, ensure it happened.
So who lost?
Primarily the banks’ clients who were paid worse rates for the foreign exchange transactions than were actually the true rates in the market. This could be anyone from a hedge fund taking a punt to a major corporate changing money as part of a big overseas commercial transaction.
What was in it for the traders?
They did not profit individually from the rigged markets. But if their dealing desk made consistently higher profits it was certainly reflected in their bonuses at the end of the year.