Dirty F/X

24 November 2003


Foreign Exchange Traders Cuffed and Booked

Some 47 people involved in the foreign exchange market were hauled off to jail in handcuffs last week. According to an Associate Press Report, the individuals worked for JP Morgan Chase, Societe Generale, UBS Warburg Dillon Read, Dresdner Kleinwort Benson and Israel Discount Bank. Practicing lawyers, officers of publicly traded companies and a former member of the Fed's Foreign Exchange committee were also arrested. The ugly secret about FX is out -- no one is regulating it.

Unlike stocks, bonds and futures contracts, there is no real governing authority for the foreign exchange market. Anyone can buy or sell euros for dollars in the cash market (futures delivery comes under the CFTC). The reason is simple enough -- an Italian tourist with euros is entitled to come to Florida, change some euros to dollars and enjoy Miami (to the extent that dismal burg can be enjoyed). No one wants to bother regulating the $1,000 deal that tourist is making -- especially since he is usually making the deal with a bank that is already heavily regulated.

But how is that $1,000 retail deal different from a $1,000 investment? One can only tell the difference based on what the individual does with the money after the transaction. And what about the bank? Changing euros and dollars back and forth becomes a wholesale operation quite quickly with millions of both currencies involved on a daily basis. Multiply that by the number of banks in the world, through in some investment houses and some multinational corporations, and it's no surprise that the global transaction in the F/X market is worth $1.2 trillion (each day).

Moreover, since every country in the world has its own currency, international regulation is the only way to make honest trading airtight. Yet no country in the world is prepared to give up the regulation of its currency (eurozone notwithstanding -- and that stemmed from incredible synergies).

And so the lesson must be learned again and again by investors. If the broker isn't licensed, if you can't get a prospectus, and if it sounds too good to be true, walking away is a wise decision. And if it is a legitimate operation, with transparent and squeaky clean accounts, one still must watch the baskets in which one puts one's eggs.

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