Banks like to tell the world how much they respect and value their clients. In its literature, the UK-based global institution HSBC says that its customers are “at the heart of everything we do”.
That may be the marketing patter, but a recently launched criminal case in New York puts a rather different spin on these words. Two senior executives in the bank’s foreign exchange division have been charged with fraud for allegedly front-running an unusually large customer order, making millions of pounds of profit at a client’s expense.
It is the latest in a series of allegations that have painted both HSBC and the broader industry as predatory - and all too willing to abuse the customer’s confidence if opportunity and the chance for profit present themselves.
HSBC has just emerged from a civil suit in which it paid $614m for abusing foreign exchange benchmarks, one of its many regulatory settlements in recent years. Given the bank actually investigated the foreign exchange trade in question as part of that process and found no wrongdoing, the case will revive doubts about its culture and controls. HSBC has yet to lay to rest these concerns.
The case revolves around a $3.5bn mandate won in 2011 by two top traders, Mark Johnson and Stuart Scott, buying sterling on behalf of a British company, Cairn Energy.
Despite signing covenants restricting their use of that information, they bought sterling ahead of the transaction, earning HSBC $3m in proprietary profits on top of the $5m it received for executing the deal.
True, that in itself was not foul play. Foreign exchange is a vast market: the sterling-dollar trade alone turns over $500bn a day. Traders do not stop buying currencies because of the possibility of a big client order. But the nub of the allegation is that the executives encouraged Cairn to structure the deal in ways that would maximise the profit on these proprietary trades.
Clients buy foreign exchange from a bank at a benchmark rate set at various times of the day known as “fixes”. The bankers allegedly persuaded Cairn to deal at a fix they knew to be less liquid, and hence one where trading activity was likely to result in a spike in the exchange rate - to the client’s disadvantage. They then allegedly dealt aggressively ahead of the fix to push up the rate, even discussing in a phone call how high they could go “before the victim company would ‘squeal’”. When Cairn queried the resulting price surge, the prosecutors claim HSBC falsely blamed trading by a Russian bank.
Unlike equity markets, foreign exchange trading is lightly regulated. Large wholesale clients are understandably deemed capable of standing up for their own interests. But this also puts an onus on the bankers to treat clients fairly and not exploit the lack of prescriptive rules.
The case will heighten investors’ anxiety about its knock-on consequences for HSBC’s still tangled regulatory exposure. The bank is working through a complex deferred criminal settlement to do with money laundering offences. It also reflects poorly on Stuart Gulliver, who ran the investment banking unit before taking over as chief executive in 2011. Culture, after all, comes from the top.
More broadly, the whole banking industry should take a long hard look at the incentives it dangles before traders.
Wholesale markets can only function if there is trust between participants. The markets business is suffering, as this week’s results from Goldman Sachs and Morgan Stanley demonstrated.
If banks want this to recover, their marketing promises to clients and market practices must be more convincingly aligned.
