Forex hit the headlines once again in late July, after the arrest of HSBC global head of forex cash trading (Mark Johnson) at JFK airport in New York.   The US Department of Justice alleges that Mr Johnson (and Stuart Scott, who was HSBC’s head of forex cash trading for Europe, the Middle East and Africa until 2014) used a technique called “ramping” when arranging for Cairn Energy to purchase $3.5 billion in sterling. This means that the bank is said to have purchased the sterling for HSBC’s owns accounts, caused the price of sterling to jump, and resold it to Cairn at higher prices.

Accusations of misconduct in FX trading are sadly nothing new. But here the Cairn trade had already been scrutinised and given the all clear. In 2013 HSBC had engaged a law firm to conduct an investigation into its currency trading, including this trade. Such internal investigations are common in the financial services sector, and the regulator often relies heavily upon their findings to supplement its own work (although the regulator will generally “test” the evidence and conclusions). In this instance no breaches of the bank’s internal code of conduct were found.

The incident raises again the question whether the reliance on internal investigations into market manipulation scandals can continue, or, whether there will be pressure on regulators to insist upon independent external investigations in the future.

Forex rigging – a recap

The issues with FX manipulation arose in part because the FX market is unregulated, and as such there are no specific rules governing it. The absence of a physical FX marketplace also lends itself to the potential for rigging. Trading takes place on electronic systems, operated by large banks – and approximately 40% of the world’s dealing goes through London.  Currency prices fluctuate based on supply and demand, and in response to economic news.

To help with valuing multi-currency assets and liabilities, daily spot FX benchmarks (known as “fixes”) are determined. Until recently, the main fixes were calculated by Reuters based upon currency trades which took place between 30 seconds before and 30 seconds after 4pm GMT.  Because the fix was based such a short period, traders were able to collaborate and place aggressive orders during the one minute window to distort the fix.   Traders also shared confidential information regarding their clients’ activities to enable fixes to be manipulated. In 2014, the FCA fined five banks a collective of £1.1 billion for their roles in G10 spot FX manipulation.  Since then the fix window has been lengthened to five minutes, making it harder to manipulate.

Changes to the conduct of investigations?

Once it began to emerge that market rigging may have taken place, the banks involved all conducted their own internal investigations. The findings of those internal investigations were passed to the FCA and other authorities.

In 2014, the FCA announced a remediation programme, which required firms to “review their systems and controls and policies and procedures in relation to their spot FX business to ensure that they are of sufficiently high standard to effectively manage the risks faced by the business”.   Senior managers were asked to confirm that such action had been taken, with the focus being on clear accountability for the specific issues which the FCA had highlighted as requiring change.  Despite the advantages of a remediation programme, this still put the emphasis on firms to ensure their own compliance and accountability, with limited external checks.

In 2015 Jamie Symington – Director in Enforcement (Wholesale, Unauthorised Business and Intelligence) at the FCA – highlighted the perceived benefits of allowing firms to conduct their own investigations: an understanding of their own business enabling them quickly to investigate, establish the facts and remediate.  But Mr Symington noted that, in circumstances where the FCA may be considering taking enforcement action, it must consider whether an internal investigation will help or hinder the FCA’s investigation.  The FCA is alive to the fact that firms will have their own interests in mind when an investigation is being conducted.

If incidents like Mr Johnson’s arrest, some three years after an internal investigation found no fault, continue to arise, there is clearly a risk that regulators will think again about the way in which investigations in the financial services sector are conducted. That may ultimately entail fully independent, external investigations, either by skilled persons appointed under section 166 of FSMA or by some other bespoke procedure. Such a move would undoubtedly make investigations more costly and cumbersome to run, and as such more of a burden for the firms under investigation. The Johnson case certainly highlights once more the need for firms asking regulators to rely on internal investigations to ensure they are conducted by genuinely independent external professionals in a robust manner that will withstand scrutiny. Otherwise firms face the risk that scrutiny may be brought to bear in the US courts.