The Last Look…
Posted by Colin Lambert. Last updated: July 2, 2024
The whole sorry episode of the USD/ZAR barrier and Neil Phillips’ actions has come to an end (perhaps) with his sentencing in a New York court, however the questions for the FX market resulting from this case remain – as does the question of the inconsistency of the US legal system when dealing with FX cases.
I have absolutely no problem with the judge sentencing Neil Phillips to probation and a $1 million fine (the maximum permitted) after he was found guilty of targeting an FX option barrier on Boxing Day, but the rationale behind the decision risks signalling to the market that poor behaviour is OK, if the “victim” is big enough – and that is a concern.
The judge in the Phillips case explained away his leniency by noting that the victim was Morgan Stanley, a professional counterparty that could have taken other measures to protect itself from the risk from the USD/ZAR barrier option it had written. At face value there is nothing wrong with that, it was a trade between two professional counterparties – but that begs the question, why wasn’t the same criteria used in the Mark Johnson case?
In the latter, HSBC dealt with a registered advisor from Rothschild, who was advising Cairn Energy. In the case with Phillips, Morgan Stanley paid out $20 million on the triggering of the barrier (it had offered to buy it back in the previous days for $13 million), Cairn Energy, under advice from a professional may have received poor execution of its order (but not as poor as it would have been had the bank tried to buy the two yards-plus in the one-minute window!)
The real concern is however, that the sentencing judge may have signalled it’s OK to trigger barriers, especially if the counterparty is a major bank. Phillips argued that “barrier chasing” was normal in the FX market and that Morgan Stanley would have been buying to defend the barrier. Factually that is correct, the court records show that MS bought over half a yard of USD/ZAR related to the option, it’s just that Phillips sold more. That does not make it normal, or even acceptable, practice in the market though -not least because of the motivation behind both parties’ trades.
The bank was at least partly, if not entirely, hedging its risk, whereas Phillips was selling for what reason? His chats make it perfectly clear he was targeting the barrier, and that is intent, and that is against the principles of the FX Global Code (there is an explicit example in the appendix for just this scenario). Now, thanks to the jury’s decision, it is also against the law.
The bottom line is he sold over $700 million in USD/ZAR…on Boxing Day morning in Singapore. You don’t take a punt of that size at that time of the day and with liquidity what it is, you do it with the express intent of earning the $20 million pay out. As far as I can tell, the evidence was produced that Phillips explicitly instructed Nomura (the executing bank) to take out the 12.50 level, but no chats were presented showing Morgan Stanley explicitly defended the level by over-buying (and the bank would have had the records had it done so).
Sas noted, some people I have discussed this with have suggested that the sentencing means that triggering barriers is OK if the counterparty is a bank, but I don’t agree – the counterparty should be irrelevant. Equally, we should not lose sight of the fact that this was a sentencing, the judgement remains the same – Phillips has been found guilty of market manipulation.
One of the ambitions of the Code’s creators was to keep the lawyers at arm’s length, but it never hurts to have a legal decision back your voluntary principles
Reports suggest that his legal team are considering an appeal based upon jurisdiction – that the deal was insufficiently related to US markets, but that would, I suggest, be folly. The Johnson case highlights how the US Department of Justice has succeeded in bringing US laws into play for offshore trading, and the Phillips deal involved the US dollar (as did the Cairn deal) and two US institutions in the prime broker and option writer. Of course, that is only folly if the US legal decision making is consistent, not something we can guarantee.
The good news in all of this for the industry is that a practice frowned upon by the FX Global Code has been found to be illegal in the US. This is a pat on the back for the creators of the Code and the Global FX Committee, because their judgement has been ratified in the most important arena. I know one of the ambitions of the Code’s creators was to keep the lawyers at arm’s length, but it never hurts to have a legal decision back your voluntary principles.
This case has highlighted a controversial area in FX markets, but it has also provided some clarification – deliberately and overtly target barriers and you will, in all likelihood, be found out and punished. There are some who observe that Glen Point wasn’t a popular client due to its trading practices – it wouldn’t be the first hedge fund to sit in that camp – and that word got out about this trading because of this dislike. There is no way of knowing if that is the case, but now the courts have had their say, I would think twice about running a barrier even if I were the most popular client in the world.
