The good news hiding in the wreckage of the FX scandal

The details of the latest multi-billion dollar settlement over concerted manipulation of the FX markets make for depressing reading. But if you look hard enough there are at least three bits of good news buried beneath the piles of ordure…

You should never underestimate the capacity of some people in the financial markets to look you in the eye while they pick your pocket. But even when you know what to expect, such behaviour still has the ability to shock.

The details of the latest scandal in the FX markets are so depressing that you almost have to look for something positive – anything – to restore your faith in human nature. And if you look hard enough among the wreckage of ethical vacuity, you can just about find some good news struggling to get out.

First, bankers and traders are rapidly running out of markets to manipulate. Having worked their way through Libor, swaps, gold and now FX, at this rate they should have exhausted their highly-developed capacity for misbehaviour by sometime around 2018 (although by then they may have gone back to the beginning).

Second, more than two years after the Libor-rigging scandal erupted and more than one hundred billion dollars of fines later, the latest FX settlement goes a long way to finally killing off the ‘few bad apples’ theory of misbehaviour.

Third, and most importantly, this could at last be the opportunity for the industry and its regulators to stop treating the repeated scandals as a series of unconnected compliance failures and start addressing them as a systemic failure in culture across the industry.

A few bad apples…or an entire orchard?

For many years, banks have tried to argue that episodic misbehaviour was the work of a few greedy individuals, and that it was unfair to tar the reputation of an entire organisation or industry by the actions of a ‘few bad apples’. Any wider ethical problems, banks said, had been dealt with by hiring thousands of compliance staff, coming up with new codes of conduct and values, and cutting pay and bonuses.

But the latest settlement is a wake-up call to anyone who still believes that might be the case. There are simply too many people working at too many firms in too many different markets manipulating too many different products over too long a period for the ‘few bad apples’ theory to stand up.

The number of traders directly implicated in the FX scandal may seem small: perhaps a dozen or two at each of the main protagonists, and maybe a few hundred across the industry. But once we add the traders from other markets and products that have been manipulated – not to mention those in markets that have yet to reveal their secrets – and then count the layers of management who might have tacitly encouraged or quietly ignored the problem, and the ranks of back office and compliance staff who turned a blind eye, and you soon have an entire orchard.

Policymakers have made it clear that they simply don’t believe that ‘a few bad apples’ are the root of the problem, and they have shifted their focus to root and branch cultural reform.

In a speech last month on the subject of fair and effective markets, Minouche Shafik, deputy governor of the Bank of England, said the argument that problems were the result of ‘a few bad apples’ is ‘no longer credible’ and that there were instead ‘deep-rooted problems in the nature of fixed income and currency markets’. A few weeks earlier, William Dudley, president of the New York Federal Reserve, said that ethical problems in banks ‘originate not with a few bad apples but with the barrel maker’, that they come from the culture of individual firms, and that ‘culture is largely shaped by the leadership of those firms’.

Dudley challenged the industry to embrace a culture-led approach that involves asking ‘what should I do?’ rather than a compliance-led ‘what can I do?’ His comments echoed those of Ignazio Angeloni, a supervisory board member at the European Central Bank, who said in September that compliance is about following the letter of the law, while ethics and culture are about following the spirit of it.

The end of the beginning

But although the excuses may be running out of steam, the scandals are not. Even if you try to find the positives under the pile of ordure, the overriding sense of the FX settlement is depressing. There is plenty more bad news and many billions of dollars of fines still to come.

More than a dozen banks are still under investigation for benchmark rigging, and regulators seem to find something nasty hiding under every stone they pick up. That FX manipulation took place not only since the financial crisis, but long after scandals such as Libor had broken – and even after the banks knew they were being investigated – suggests an underlying willingness to lie, cheat and rip-off clients in some corners that will take many years to stamp out.

Future settlements will drag down the reputation of the industry even as it tries to raise its game. Andrew Tyrie, chairman of the Treasury Committee in the UK and of the Parliamentary Commission on Banking Standards summed up the surprise of many people when he said: ‘Even as banks were telling the Parliamentary Commission on Banking Standards [in 2012 and 2013] that they had got to grips with past misconduct, their FX traders were manipulating benchmarks, sharing confidential client information and exploiting conflicts of interest’.

This highlights the disconnect between the tone from the top of the banking industry, the tone from the middle, and the actions on the front line. It will take time, commitment and persistence for changes in culture and values to filter down through many levels of management into changes in behaviour at the coalface. There is an entire generation of middle management in between, who started their careers before the crisis and have become used to behaving and being rewarded in a particular way. It will take more than a few ethics and culture seminars to change the way they think and act. But if nothing else, thanks to the FX scandal, at least the industry can start addressing the right structural problems – instead of counting how few or how many apples might have gone off.