The Last Look…
The US legal system time and again likes to prove it doesn’t have a decent handle on how the FX market works, relying too heavily on how stock markets operate for their understanding, and this creates grey areas that parties on all sides can exploit. The sad thing is, there is a very simple solution to this issue that would effectively clarify everyone’s thoughts and actions – and into the bargain probably make some of these cases go away.
I raise the issue because lawyers for Glen Point Capital co-founder Neil Phillips have filed to have the charges brought against him for alleged FX market manipulation dismissed. The arguments against the US government’s case focus in on a few specific areas – and that is the intent of a defence, of course, to create doubt over a prosecution.
Some of the arguments are familiar to long term watchers (should that be sufferers?) of the US legal system’s attempts to grapple with the FX market structure – inevitably there is an argument that FX trades do not come in scope of the Commodity Exchange Act (CEA) as cited by the prosecution, just as there is a jurisdictional challenge because the trading took place offshore and lacks a “direct and significant connection” to the US.
History suggests that the presence of the US dollar in the transaction is good enough for US courts to allow jurisdiction, as for whether FX is part of the CEA, well I’ll leave that to better legal minds, but the defence claims, “…the government asks this court to extend the CEA to an FX market that Congress decided it should not reach, for trading activity no court has ever held to be a crime. And the government does so in a case where the alleged conduct happened entirely abroad, beyond the reach of the CEA, a statute with only limited application to foreign conduct under specific circumstances that are not present here.”
The defence does make quite a bit of the prosecution’s allegation that Glen Point “defrauded the counterparties to that option by not telling them about its spot market trades”, pointing out, quite rightly I would suggest, that there was no requirement to do so. If I recall correctly, the CFTC charges noted that Glen Point didn’t tell their prime broker (my italics) of the trades, rather than the counterparties to the trade – but again, there is no reason for them to do so. As the defence states, “Glen Point had no duty to report how the Barrier Event occurred, but rather whether it occurred.” (original italics)
I am not sure how the legal niceties play out, but surely this whole issue is one of intent? The prosecution states Phillips and Glen Point created an “artificial move” through its trading on December 26 at the Singapore open, but the defence responds – again credibly – by pointing out the trades were executed in the open market, with willing counterparties. The fact, as I have pointed out before, that it took $725 million to get USD/ZAR lower at probably the least liquid time of the year, suggests there was some hefty buying interest on the way down, which in turn suggests there was a good two-way market. I certainly don’t think that amount of buying, at that time of year, takes place without some intent, so on both sides of the trade there seems to have been motivation.
The challenge for the defence, and it obviously doesn’t go there in its documents, lies in the communications between Glen Point and Nomura Singapore, the executing bank. These make it clear there is a target in mind for the hedge fund, and the bank salesperson makes the point when escalating their concerns (as per an internal review cited by CFTC), that the fund “probably had a barrier or something” in play.
If the defence could find similar communications from a counterparty discussing protecting a level, then they may have something – the chances of that happening are probably beyond minimal, so the intent aspect still looks, to an informed outsider at least, to favour the prosecution.
Legal teams are paid to drive certain points home when prosecuting, and casting doubt when defending, which is all well and good. The challenge with so many cases, especially in the US where the chase after alleged FX malfeasants has been more aggressive, is the language betrays a lack of knowledge of the FX market structure, which increases the grey areas and extends these trials for a lot longer than could be the case.
The accusations around notifications in one such example – there is no requirement to report trades in spot FX markets, it would be a nightmare for any repository to handle, but there are reporting rules in place for FX options. So, the initial transaction has to be reported, but not spot trades in the same pair, again because it would be a logistical nightmare, let alone legal.
By recognising the FX Global Code for what it is – a set of guidelines that participants on all sides of the industry have recognised as best practice – lawyers would have an accessible guide to what is, and what is not, viewed as acceptable.
The defence also talks of the prosecution’s argument that Phillips was defrauding “investors in the spot FX market” by creating a false market. I am not sure how this can be proved, because, as noted, the market may have been deliberately pushed to a level at which an option could be triggered by one counterparty, but this may have benefitted some “investors in the spot FX market” as well as harmed others. When you trade in a market it can go one of two ways – up or down – and you make or lose accordingly. By extension of this logic, does the market impact from a hedge fund taking a very large position in, for example, USD/HUF, create the same problem?
In my example obviously the hedge fund in question is taking on market risk, and the defence argues, correctly, that Phillips was also taking on risk by selling USD/ZAR on December 26. He was, but the fact that the fund stood to gain more by hitting a certain level was certainly a consideration and part of any calculations that may or may not have taken place at Glen Point.
I mentioned at the top a simple solution to problems like this – and it is actually the second time this week it has come up. If the US authorities would acknowledge that their understanding of the FX market structure is, to be polite, sub-optimal, they would then, perhaps, be more open to outside guidance and help? By recognising the FX Global Code for what it is – a set of guidelines that participants on all sides of the industry have recognised as best practice – lawyers would have an accessible guide to what is, and what is not, viewed as acceptable. There will be legal niceties, inevitably, but the bedrock of any case would be in place and save a lot of work as people with minimal knowledge of the market argue over points that those with knowledge (and the Code) would solve in a matter of minutes.
By endorsing the Code as the UK’s FCA and Australia’s ASIC have done, US authorities would be stating that any case brought by them will guided by the Code’s Principles and as such, a lot of confusion and complex and unnecessary language will disappear. I noted last week when writing about the Mizuho fine by the CFTC, that the bank was not adhering to the Code’s Principles by failing to disclose its pre-hedging actions.
In the case of Glen Point I will await the machinations of the US legal system, but would reiterate the core concept on “intent”. Further to this, in Annex 1 of the FX Global Code (page 58), an example supporting Principle 12 “Market Participants should not request transactions, create orders, or provide prices with the intent of disrupting market functioning or hindering price discovery” goes as follows:
A hedge fund is long an exotic Euro put. The currency has been weakening towards the option’s knock-in level during the New York session. Knowing that liquidity will be lower during the Asian session, due to a major holiday, and intending to knock in the option, the hedge fund leaves a large Euro Stop Loss sell order for the Asian open with bank A at a price just above the knock-in level. At the same time, the hedge fund leaves a limit buy order with bank B for the same amount of Euros but at a level just below the knock-in level. Neither bank A nor bank B is aware that the hedge fund is long the exotic Euro put.
The Code adds, “Market Participants should not request transactions or create orders with the intention of creating artificial price movements. In this example, the hedge fund has sought to profit (to knock-in the option) by leaving orders designed to cause artificial price movements inconsistent with prevailing market conditions.”
The passage comes with a clear Red ‘X’ alongside, making perfectly clear that this action is unacceptable and not best practice. If – and it remains an ‘if’ – Phillips and Glen Point did this, then the judge or jury’s deliberations would be made much simpler and the opportunities afforded by ambiguous language generated by a lack of real understanding as to how the FX market works, would be minimised.
All it takes is for certain US authorities to recognise that FX is a global market, with a different structure and that fair and balanced guidance is available…oh and then adopt that guidance.