On Wednesday 20 July 2016 Mark Johnson, HSBC’s global head of foreign exchange trading, was arrested and a few hours later charged with fraud. His bail was set at $1 million. One of his colleagues, Stuart Scott, was previously charged also.

These charges do not relate to the foreign exchange (“FX”) manipulation that resulted in fines being levied against five banks by the UK and US regulators. The HSBC charges relate to a single trade valued at $3.5 billion. The two individuals are alleged to have used insider knowledge of a customer’s trade in order to benefit from their knowledge. As noted, they are charged with fraud. The trade in question occurred in 2011, and has been the subject of a three-year investigation by the US Department of Justice.

It is also notable that he was arrested and then charged in an exceptionally short period. That suggests that the regulators had a substantial amount of evidence and did not need to question Mr Johnson.

What Did They Do?

They are alleged to have known that a client of theirs was going to trade an extremely large currency transaction in one trade on one day. Armed with this knowledge, they acquired GB Pound sterling in substantial amounts. When the client’s huge trade went through the price of sterling rose, they sold their holdings to HSBC and made a very tidy profit. That is fraud (if proven to be true). This is known as “front running” in the industry.

Using knowledge such as this for personal gain is a very serious crime, if proven to be true. It is unlikely they will be at trial in any period less than a year.

What Difference Does It Make?

FX trading is big business. FX mortgage, FX loans and FX derivatives account for c. $350 trillion in trades a day. That is compared with $5.3 trillion of actual cash currency trades that goes through the system each day.

As such, any artificial movement of the system or, as is alleged here, using knowledge of seriously large trades to make personal trades (and thus profits) is unfair and moves from being unfair to being criminal.

As noted, the actual cash in the system is miniscule compared with the “on paper” trades that are made every day. If someone within that system is manipulating it in order to make personal gains the regulators will usually clamp down very hard on them.

We cannot suggest that they did this, only that they are charged with this. It seems ridiculous that the most senior FX trader at HSBC would be so stupid as to be seen buying currency in large sums ahead of trading what was likely one of the largest trades that day is simply unfathomably stupid. As such, I would expect that this issue is not as cut and dry as it may at first appear. No doubt HSBC and the two individuals will be pumping serious sums of money into the best legal representation money can buy. The story will unfold over the next year to two years. Longer if there are appeals.

What Was The Other FX Fines For?

The charges yesterday relates to alleged unlawful use of confidential information. When the UK and US regulators fined banks for FX manipulation it related to another form of manipulation, but on a much, much larger scale.

In those scenarios traders and brokers would be in contact and arrange for substantial trades to be aligned so as to move rates up or down (depending on the trades they wanted to impact) and used confidential customer information in order to create larger profits or minimise losses by ensuring that when the Fixes occurred that day they set higher or lower as required.

There are two fixes each day (the 1:15 p.m. European Central Bank fix and the 4:00 p.m. World Markets/Reuters fix.). Each day at 1.15 pm and 4:00 pm the average price of currency is calculated. The averaged, weighted number created is then used for a variety of foreign exchange products, including derivatives and cash currency exchanges.

Five banks were found to have participated. It is odd that so far no brokers have been fined, despite that the manipulation could only have happened through collusion with brokers. You can read about how this sophisticated crime occurred HERE and HERE and HERE.

Will We See More?

It seems almost a certainty that individuals will be charged. However, if the FCA wishes to charge individual traders and/or brokers, they must do so within three years of first becoming aware of the issue. That is likely to be a time frame that is fast approaching, if it has not already passed.

The Serious Fraud Office and department of Justice in the US are not constrained in the same way. Despite the very thorough investigation under taken by the UK and US regulators, the Serious Fraud Squad in the UK would have to re-start the investigation themselves. I would therefore expect UK charges not to be brought for a while. But it is undoubtedly going to happen. In the issue of LIBOR the Serious Fraud Squad took their time, and now the “Master puppeteer” of LIBOR manipulation, Tom Hayes, was jailed for 14 years (reduced to 11 years on appeal). Expect the same for FX manipulation.