THE BANK CURRENCY TRADING SCANDAL AND ITS IMPLICATIONS EXPLAINED

WHAT HAVE THE BANKS BEEN UP TO…?

Last week Wednesday, 15th February 2017, the South African Competition Commission decided to prosecute 3 local banks (ABSA, Investec, Standard Bank) and 14 international banks (see endnote)  for collusion in price fixing and market allocation in trading involving the South African rand.

The Commission has evidence that these banks colluded on setting the prices at which they would trade the rand vs. the dollar and on taking turns to do large volumes of business.  The Commission intends to fine these banks 10% of their annual turnover.

HOW DID THE BANKS ACTUALLY MANAGE TO DO THIS?

Foreign exchange is by far the largest market in the world. Over US$ 5,000,000,000,000 (five trillion!!!) worth of currencies is traded each day. There is no one magical computer system that runs this market. Although you can log onto a website and see a single number for buying and selling currencies, behind this there is very complex network of banks, dealers and other intermediaries. At the end of the line there is usually a human being [“forex trader”] sitting on the trading floor of a large investment bank who decides at what prices their bank will offer to buy and sell a particular currency. For hedge funds and other investors that trade huge amounts of currencies, this usually involves picking up the phone and speaking directly to a trader (or their salesperson). The important thing is that this process is supposed to be competitive. If Investec are willing to sell you dollars slightly more cheaply than ABSA, then you are going to do business with Investec.

The single number for the rand dollar exchange rate that you hear on the radio is also misleading. The price in rands at which a bank will sell you one US dollar is higher than the number of rands that they will give you if you sell that dollar back to them. If you instantaneously buy and sell one US dollar, it will cost you a few percent. This is how banks make money.  The prices at which banks buy and sell are called the “bid” and the “offer” and the difference between them is called the “bid-offer spread”. It is important to realise that in forex trading banks shouldn’t care if the rand goes up or down because they really make money off the bid-offer spread. The wider the spread, the more money they make. Currencies where there is a high volume of trading (aka “lots of liquidity”), usually have small bid-offer spreads, BUT, if a trader can collude with his mates to artificially increase the size of the spread, he can make more money on each trade.

When you watch a movie like Wall Street the people you see sitting behind a bunch of computer screens staring at zillions of graphs and numbers aren’t getting that data from Moneyweb. There are two main providers of data, Bloomberg (owned by former New York Mayor, Michael Bloomberg) and Reuters. In the London bond market, we used Bloomberg. Bloomberg comes with a chat function where you can send private messages and create groups. It's a bit like WhatsApp, except that it's private and access can cost you tens of thousands of dollars per year. According to the Competition Commission, traders at the implicated banks were using Bloomberg chats to coordinate bid offer prices and decide whose turn it was to do a big block of trades.

DID THE BANKS COLLUDE TO TANK THE RAND..?

No. The Competition Commission accuses the traders of fixing the price of the rand in both directions (weaker and stronger). Also, as I have explained above, the banks make their money by colluding on the bid-ask spread. So, yes, if you traded forex you probably paid a tiny amount more that you should have. But, if you really want to get the best prices for forex, you are much better off speaking to a private dealing desk like our friends at Currency Partners. In reality the only way one person can wipe 5% off the value of a currency is by firing a finance minister.

WHAT IS ALL OF THE FUSS ABOUT…

Daylight Robbery - The Star headline 16th February 2017

Inside the rand scam - Sunday Times billboard 19th February 2017

Greedy traders and market manipulation is not unique to South Africa. Since 2008, 20 banks have paid more than US$ 235 billion in fines in the United States. The South African economy is worth around US$350bn, so think for a moment how massive those fines are. However, it is now absolutely infuriating that a small group of individuals were motivated by pure greed to mess around with a key part of our economy for their personal benefit. In my opinion, the traders involved belong on the same list as the Eskom officials whose greed and incompetence contributed to load shedding (based on the Dentons report) and the Gupta Family (based on the State of Capture Report). It is absolutely correct that the Competition Commission adheres to international best practice and prosecutes individuals and companies that are involved in anti-competitive practices. But; there are also a couple of things about the reaction to the scandal that make me uneasy...

“This is a heist by the banks against poor people in South Africa…”  - ANC spokesperson, Zizi Kodwa

Businessman Hamza Farooqui, who is in a bid to buy Habib Overseas Bank in a joint venture with Gupta associate Salim Essa, said it would be a "disgrace" if the South African Reserve Bank denied them a banking licence, while allowing Standard Bank and Absa to keep theirs. - Business Day

“The findings of the Commission (put into question) the credibility, trust and independence of these institutions and whether they can still be trusted to act independently” - Zizi Kodwa again, (emphasis is ours)

The current head of the Competition Commission has been at the organisation for over 10 years, the illegal activity that the Commission has found has been happening since 2007 and the investigation itself has been running since April 2015. It is therefore “interesting” that the charges are being laid now, when President Zuma is under pressure, explosive reports about state owned enterprises are being leaked to the press and the economy is growing at a snail’s pace. The announcement also comes quickly after President Zuma’s State of the Nation Address, where he introduced a program of ‘Radical Economic Transformation”. The problem is that the last time Mr Zuma tried to radically transform the economy, by firing Finance Minister Nene, he did R500 billion worth of damage.

ANC spokesperson, Zizi Kodwa, makes liberal use of the term “banks” as though the entire South African financial sector is rotten to the core. However, it is important to note that only two of the big four retail banks are implicated (ABSA and Standard). There is no mention of FNB or Nedbank and certainly not Capitec. In Investec’s case, the accusations are also directed against the activities of a single individual. Despite the bank’s failings, it is sensationalism to call the actions of these rogue traders a “heist against the poor”.

However, looking at the broader financial landscape, the simple truth is that South African banks just aren’t doing enough to help grow the economy.  Around 75% of small firm credit applications are rejected, and only a tiny number of firms that try to raise private equity funding succeed. But; the current scandal, the dodgy Bancorp bailout and the structural inadequacies of the big banks not reasons to threaten the independence of the financial sector. My firm, Louw and Company, exists because of the massive gap in the market for financing growing businesses. We have financed over 30 transactions in the last 6 months and are growing rapidly. Instead of threatening the private sector, the government should be doing more to encourage and support new entrants… now that would be radical!

DR ANDREW LOUW CFA

(Sources: SA Competition Commission, Bank for International Settlements, Fin24, International Business Times, Business Day, Times Live, IOL, FinMark Trust  and… the lessons learned during 8 freezing London winters!)

* International Banks: BNP Paribas, JP Morgan, Standard New York, HSBC, Standard Chartered, Credit Suisse, Commerzbank, Australia and New Zealand Banking Group, Nomura, Macquarie and Barclays.

MARKETS

LOCAL

The rand is performing well, spending time below the 13 to the US$ level, mainly on the back of dollar weakness (Bloomberg, Business Day).

SA’s unemployment rate dipped to 26.5% in 4Q16. But… if you include people who would like to work, but stopped looking, the rate is actually 35.6% (8.9m people that would like to work, but can’t) . 235,000 jobs were created, of these ⅔ were by the private sector. Services, transport and manufacturing sectors created jobs. There were job losses in mining and construction. Youth unemployment (15-34 years old) is 37.1% (Business Day)

There was a slight dip in inflation. Consumer price inflation 6.6% (annual basis) was in January, down from 6.8% in December (Fin24).

INTERNATIONAL

Global stocks hit a record high on Wednesday for the first time since 2015, driven by hopes for faster economic growth (FT). US Consumer inflation jumped from 2.1% to 2.5%, which is the highest level in more than seven years (Business Day). US Fed Chair, Janet Yellen, said in her testimony to congress that she thought that the US central bank could cause a recession if it waited too long to raise rates… which is a little strange (Business Insider).

 

Andrew LouwComment