First it was Libor, then currencies, then commodities. Now the market manipulation game extends to a vehicle known as ISDA fix that is used as a benchmark for pricing only trillions of dollars of worth of transactions.
Dodd-Frank reformed Wall Street, right?
Bloomberg reports, Swaps Probe Finds Banks Manipulated Rate at Expense of Retirees,
U.S. investigators have uncovered evidence that banks reaped millions of dollars in trading profits at the expense of companies and pension funds by manipulating a benchmark for interest-rate derivatives.
Recorded telephone calls and e-mails reviewed by the Commodity Futures Trading Commission show that traders at Wall Street banks instructed ICAP Plc brokers in Jersey City, New Jersey, to buy or sell as many interest-rate swaps as necessary to move the benchmark rate, known as ISDAfix, to a predetermined level, according to a person with knowledge of the matter.
By rigging the measure, the banks stood to profit on separate derivatives trades they had with clients who were seeking to hedge against moves in interest rates. Banks sought to change the value of the swaps because the ISDAfix rate sets prices for the other derivatives, which are used by firms from the California Public Employees’ Retirement System to Pacific Investment Management Co., said the person, who asked not to be identified because the details aren’t public.
That may run afoul of the 2010 Dodd-Frank Act, which bars traders from intentionally interfering with the “orderly execution” of transactions that determine settlement prices.
The phone calls and e-mails emerging since Bloomberg News first reported in April on the rigging of ISDAfix add to growing evidence that banks have gained financially by distorting key financial gauges in world markets on everything from interest rates to currencies to commodities.
The revelations show the manipulation of the London interbank offered rate, or Libor, a benchmark for $300 trillion of securities, may be the tip of the iceberg. The Libor probe has so far led to fines of about $2.5 billion against Barclays Plc (BARC), UBS AG (UBSN) and Royal Bank of Scotland Group Plc. (RBS)
While the indexes under scrutiny are little known to the public, their influence extends to trillions of dollars in securities and derivatives. Britain’s markets regulator is looking into the currency market, where $4.7 trillion is exchanged each day, after Bloomberg News reported in June that traders have manipulated key rates for more than a decade.
As part of the ISDAfix investigation, the CFTC has interviewed more than a dozen traders and brokers since May at Barclays and ICAP, both based in London, and New York-based Citigroup Inc., and plans to talk with people at 13 other banks as it sifts through 1 million e-mails, the person said. Barclays gave the CFTC recorded phone calls, the person said.
Companies, pension funds and investment firms from Calpers, the largest U.S. pension, to Newport Beach, California-based Pimco, manager of the world’s biggest mutual fund, use the kind of derivatives at the heart of the ISDAfix probe to hedge against losses or to speculate on interest-rate fluctuations.
“ISDAfix, more obscure than Libor, has the potential to affect more people’s lives” because it’s used by pension funds to hedge portfolio risks and by most companies or users of fixed-income derivatives, said Jack Chen, a financial consultant in New York who has written about the swaps benchmark and Libor for SFC Associates, a financial consulting firm specializing in litigation matters.
“In three years, ISDAfix will be the bigger story and could be potentially bigger than Libor in terms of damages,” he said.
Representatives from Calpers and Pimco didn’t immediately respond to requests for comment.
ISDAfix is used to value derivatives trades known as swaptions, which are options on rate swaps. The contracts give the holder the right to swap a fixed- for a floating-rate obligation at some future point at a predetermined level. The amount of derivatives underlying swaptions contracts outstanding as of July 26 totaled $29.5 trillion, according to the Depository Trust & Clearing Corp.
ISDAfix rates also help determine everything from borrowing costs on bonds that finance skyscrapers to interest on annuities. The benchmark, set in five currencies, is used to price euro-denominated corporate bonds and $550 billion of securities tied to commercial real estate. Fluctuations help determine the performance of structured notes bought by wealthy individuals.
What can be said? Why does Wall Street engage in this sort of manipulative activity? Because they can.
I am reminded of what a close friend on the street once shared with me. After a scandal in rigging the US Treasury market in the early ’90s, he said, “if they took the phones and computer systems out of here and replaced them with sewing machines, the Feds would shut the place down.”
I think that simple but true statement still holds.