Fixing FX rates – Fixing broken markets

June 18, 2013 Categories: Investment Strategy

Russell Investments Wire - Fixing FX rates

Last week on The Wire, Sorca Kelly-Scholte commented on Professor John Kay’s stance on “broken markets” by stating that:

“The alignment of incentives along the chain is, at best, patchy, particularly around transactional services such as currency trading or managing portfolio transitions. Savers are not always well equipped, or well-represented by their agents, to control these issues effectively. The agents themselves may have conflicting commercial interests, or may lack the scale or expertise required for effective control.”


On the same day a report by Bloomberg came out which alleged corruption and price fixing in the currency markets. The Bloomberg report claims major investment banks have been routinely rigging the primary currency benchmark rate, WM/Reuters 4pm London fix, to profit off clients. Lawsuits in the United States and media attention have identified hidden FX costs when currency trades were executed on a principal basis. While Russell has written extensively on this issue, we have also been researching point-in-time trading for our clients and have concluded that there is a better way to trade currency.

At several million transactions a day, currency trading accounts for a significant portion of the overall trading that occurs across markets, yet still remains a neglected risk for some investors and is largely unregulated, with very little transparency into trade prices and sizes. To solve the lack of transparency, benchmarks have been created, such as the WM 4pm London fix, at which trades can be posted in order to confirm and compare the prices received. The creation of currency benchmarks also allows for standardised portfolio benchmarking and global index calculations.

While trading at these benchmarks times is understandably attractive for cleanliness of reporting and to confirm that one has received the market rate, research shows that trading at specific points in time does not generally result in optimal outcomes for investors and can carry significant regret risk. Russell research shows that trading at WM has a higher price dispersion and higher volatility, hence is more costly, than trading on a volume-weighted basis (see graph below.) Similarly, Morgan Stanley research on the topic concluded that investors that trade an MSCI World portfolio at the WM London 4pm fix could suffer up to 500bps of annualised tracking error compared to a volume-weighted approach.

Russell Investments - GBP graph
Source: Russell, Bloomberg, WM Markets


Some investors may not be concerned with these inefficiencies and may claim that over time, currency trading “washes out”, but the news that there are banks that are actively manipulating the WM fixing rate and reportedly making profits off the pitfalls in the benchmarking point must mean that investors are losing out. Tolerating excessive risks should only be justifiable if feasible alternatives do not exist, but in terms of currency trading, that is not the case. Firms exist that provide agency execution services and who can benchmark trades to any point of the day with time-stamped trades to prove best execution and avoid being victimised by these types of market manipulations. We believe that this series of allegations serves as a very clear reminder of the importance of effective implementation management in the portfolio management process.

For more information, please see our Russell Research Viewpoint, “Does Trading at the Fix fix FX?” (DuCharme, May 2013)

Yacine Zerizef – Portfolio Manager, Implementation Services, EMEA

Russell Investments Wire - Yacine Zerizef

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