In the wake of the recent LIBOR rigging scandal, financial authorities have begun calling for stricter regulation of currency rates… and it looks as though the campaign is really starting to gain traction!
In fact, as early as next month, Madrid-based International Organization of Securities Commissions (IOSCO) is expected to present its final proposal on a set of guidelines to help improve transparency in the forex markets. The group is composed of the securities commissions of various countries and exists to regulate securities and futures markets.
This actually isn’t the first time IOSCO suggested stricter regulation. Back in January, it proposed that currency rates should be monitored more heavily by regulators and subjected to regular audits.
And why not? As we learned from the School of Pipsology, the forex market is the largest financial market, but it’s also one of the least regulated markets in the world.
Bear in mind that forex trading doesn’t take place within a central exchange. Unlike in trading stocks or futures, transactions are made over-the-counter. And this is precisely why forex regulation is so difficult.
It’s true that there are industry watchdogs (e.g. the CFTC and NFA in the U.S. and FSA in the U.K.) that monitor local activity, but their powers are limited. In the U.S. forex trading is merely grouped together with futures in terms of regulation. While these regulatory agencies can help verify if a forex firm is legitimate or reliable, it really can’t do much to address potential currency rate rigging.
Word through the grapevine is that the regulatory holes in the forex industry have resulted in rate manipulation by a group of traders. Apparently, some traders colluded with their counterparts at other forex firms in order to move the WM/Reuters forex rates in their favor. Whistleblowers claim that this rate rigging practice has been going on for the past decade.
The WM/Reuters rates are published regularly and are used by asset managers to compute for the value of their holdings, particularly of stocks and bonds denominated in various currencies. These include 160 currencies whose exchange rates that are set based on the volume of trades rather than bank estimates.
Should retail traders like you and I be alarmed? Well, some industry experts say that there’s no reason to panic because forex rate manipulation is difficult to pull off. After all, exchange rate manipulators would have to commit a considerably large amount of capital in order to actually move the markets.
Unlike LIBOR, which is based on rate estimates submitted by banks, currency prices are based on supply and demand factors. WIth that, analysts cautioned that rate manipulation could still be possible in less liquid currency pairs, as the low volume of trade activity could be impacted by a large position.
In this regard, financial regulators who are investigating the rate rigging matter are being urged to force WM/Reuters to open their books and show the calculations for the forex rates they publish. Another place to start would be to take a closer look at how exchange rates of less liquid pairs are determined. Proving that exchange rates are largely determined by supply and demand could help maintain credibility in the forex industry.