Britain’s chancellor George Osborne outlined on Thursday tougher penalties for banks rigging the foreign exchange markets but in the FX futures markets the same banks who are being punished have the perfect opportunity to clean up their act.
Osborne said in his Mansion House speech that he plans to extend laws introduced in the aftermath of the Libor fixing scandal to include foreign exchange, commodities and fixed income markets.
The chancellor said he wants to impose tougher penalties on firms and individuals found to have colluded to rig these key benchmark rates and, to this end, has set up a review to be conducted by the Treasury, the Bank of England and the Financial Conduct Authority.
The message is clear – the government is coming down hard on the banks for their continual misdemeanours and these firms need to be brought into line and be seen to be brought into line.
The banks then seem to be in for another torrid time and the fines that could come for FX rigging are said to outweigh those already imposed for Libor-fixing, which are already running in the several billions.
The multi-trillion dollar FX business is effectively the last great unregulated market for the banks.
For this reason, they will also be loath to see the authorities getting tough because this vast global industry still yields decent returns at a time when some of their other top-earners, in the over-the-counter markets for example, have been regulated virtually out of existence.
Banks, however, are going to have to wake up and smell the coffee.
Foreign exchange futures are traded on public exchanges in the US, where CME Group is the main venue, and in Asia, where various groups list these products.
But in Europe currency derivatives are still traded like the underlying spot FX market, namely bilaterally in the over-the-counter market.
This leaves them at the mercy of the banks, of which a handful of global firms dominate FX trading in Europe.
This could be set to change however.
Prop traders are hopeful that the recent launch of 30 FX futures by CME Europe and the launch next month of six currency futures on German exchange Eurex could be the start of a process that sees the control of FX derivatives wrested from the banks.
The launches make sense as these products are well-established in the US and Asia but it is likely these contracts will not be wholeheartedly supported by the banks, in the early days at least, because the status quo is simply too lucrative for them.
It is possible that these contracts will start out supported by market-makers, prop firms and some of the smaller banks less reliant on FX for profit, while the big banks could watch from the side lines.
If things go well, however, and there is sufficient liquidity and tighter spreads in these markets, the big banks will have to consider coming in at some stage, though that could take a few years.
The banks may feel inclined to resist the advent of a European listed FX contract. But if these contracts don’t take off for commercial reasons and the market remains opaque, it is very possible the regulators will come in and force FX swaps into the light, just as interest rate swaps have been forced on to exchanges and swap execution facilities in the US.
Banks complain a lot about the constant flow of draconian regulation but, in this case, European firms have a choice. They can decide between accepting they have done wrong, falling into line with regulatory best practice and saving the regulators the hassle of having to draft all this stuff into law, or they can do nothing.
It is a choice, however, they should make mindful of the fact that if they don’t do it willingly now, they will be forced to do it later.