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By Jamie McGeever and Carmel Crimmins
LONDON, March 7 (Reuters) - In July 2006, during lunch at anupmarket restaurant overlooking the sprawling Smithfield meatmarket in the City of London, Bank of England officials andsenior bank dealers discussed evidence of potential manipulationof the foreign exchange market. People at the lunch said theattempts to move the market meant the process of establishingofficial prices - known as "fixing" - was becoming "increasinglyfraught".
It was two years before the issue was discussed again,according to minutes from the meetings, released after a Reutersfreedom of information request, and seven years before theFinancial Conduct Authority (FCA), Britain's financialregulator, kicked off a global investigation and banks startedto suspend or layoff traders.
The FCA probe focuses on whether traders used advanceknowledge of customer orders to try and manipulate benchmarkforeign exchange rates for their own gain, and is a blow to the"hands off" approach to regulating the world's largest financialmarket.
The fact that Bank of England officials knew about possiblemanipulation and seemingly did not act, raises questions for one of the world's most powerful central banks. A central bankemployee has been suspended and an internal probe launched intoallegations its staff condoned or were aware of market rigging.
The Bank said that an internal review had so far found noevidence that its staff colluded in any manipulation or sharedconfidential client information.
British lawmakers will next week question Bank of Englandboss Mark Carney, and other officials about their oversight ofcurrency trading in London, the global hub for foreign exchange(FX).
Regulators have compared the alleged manipulation to therigging of benchmark interest rates, or Libor, two years ago.Back then, Barclays released an email written by itsthen chief executive, Bob Diamond, that appeared to suggest PaulTucker, the former deputy governor of the Bank of England, hadknown that Barclays was submitting artificially low rates to theLibor-setting process during the financial crisis.
Tucker later told a parliamentary committee that he did notknow or approve of the "low-balling" of Libor submissions.
Of course, much has changed in the six years between thatLondon lunch and now. Back then, "financial centres wereinclined to avoid excessive over-burdening of financialinstitutions in order to keep their centres competitive," saidLorenzo Bini Smaghi, a former member of the executive board andgoverning council at the European Central Bank. Now "thependulum has changed from light touch to much more intrusiveregulation."
But the latest scandal underscores that even in the newworld of regulation and supervision that followed the 2007-08financial crisis, the market for foreign exchange, with dailyvolumes of $5.3 trillion, remains one of the least regulatedanywhere.
TRANSPARENT AND FLUID
Operating 24 hours a day, across all time zones, the foreignexchange market - unlike that for shares or commodities - doesnot have a centralised location for trading. Participants dealdirectly with one another either over the phone orelectronically.
Various financial centres have developed voluntary codes ofconduct for FX trading but they are not legally binding. In FX,unlike on the stock market, short-selling or betting on a fallin the price of an asset is virtually unrestricted.
This arrangement has worked on many levels. Despite themarket's size, foreign exchange trading is really a cashtransaction between two counterparties that does not create thesort of systemic risks seen in other markets, such as creditderivatives, which blew up in 2008.
The ease of buying and selling foreign exchange has boostedglobal growth, helping to smooth the path of internationaltrade. Daily foreign exchange volumes have trebled since 1998,according to data from the Bank for International Settlements.
"The FX market is the world's biggest fruit and vegetablestore," said Jim O'Neill, a former chief currency economist atGoldman Sachs and currently visiting Research Fellow atBruegel, a Brussels-based think tank.
"It is the most transparent and liquid market on the planet."
"FOR SAFEKEEPING"
Some 40 percent of all FX trades take place in London. TheBritish capital's heritage as the centre of a vast, tradingempire, along with its English language and time zone betweenAsia and America make it a natural venue for FX dealing.
The Bank of England does not have formal regulatoryoversight of the FX market. The FCA is in charge of monitoringmarkets for misconduct such as insider trading and collusion.But the BoE does maintain close relations with senior foreignexchange dealers to ensure it knows what is going on in themarket and to fulfill its remit to uphold financial stability.
The Bank has chaired an industry committee made up ofdealers, brokers and corporate treasurers since 1973. On theinitiative of Bank of England chief dealer Martin Mallett, itcreated a smaller group in 2005 made up of senior dealers.
This sub-group, chaired by Mallett, held its inauguralmeeting at Imperial City, a Chinese restaurant close to the Bankof England, according to the minutes released this week.
It continued to meet in a series of eateries, including anArgentinian steak house, until late 2007 when banks' officeswere used instead.
After 2006, concerns over manipulation around the fixingwere only raised again in meetings in 2008 and April 2012.
The meeting in April 2012 is now critical to the whole saga.It was held at the offices of French bank BNP Paribas as the UK media exposed electronic messages showing how traderscolluded with each other to rig the Libor market. Traders toldMallett that currency dealers were using chat rooms to poolinformation before benchmark FX rates were fixed.
A source familiar with the investigation said that Malletttold senior dealers at that meeting not to take notes and not toexpect minutes about that part of the debate. Mallett could notbe reached for comment. The Bank of England has said it hasreviewed emails, minutes and other documents as part of itsinternal review into the FX allegations. It declined furthercomment.
At least one trader has filed his own personal account ofthe meeting with Britain's Financial Conduct Authority (FCA),"for safekeeping," according to a person who has seen the notes.The FCA has declined to comment.
CENTRAL BANK INTERVENTION
The scandal has the potential to shake up the way theforeign exchange market operates.
The fluid nature of FX markets suits governments and centralbanks which want the freedom to intervene in order to supporttheir currencies. Many traders argue that itself amounts tomarket manipulation.
The lack of regulation also makes the foreign exchangemarket susceptible to abuse from private traders. During the1980s and 1990s, there were instances of traders and brokerstrying to collude to manipulate the price of certain currencypairings.
Traders expect the latest scandal to accelerate the trendtowards more trading on electronic platforms and push moredealing on to exchanges.
Official attitudes towards market misconduct have hardenedsince taxpayers had to pour trillions into saving the globalfinancial system. Banks themselves have been quick to react tothe FX probe, suspending or dismissing 24 traders, handing overreams of data to regulators and cracking down on the use ofonline chat rooms, where groups of traders allegedly hatchedplans to rig rates using names such as "The Cartel", accordingto sources familiar with the matter.
No one has been charged with any wrongdoing, but banks knowthe trouble they could face. The international investigationinto Libor manipulation saw 10 financial firms fined $6 billionand 13 individuals charged.
Martin Wheatley, chief executive of Britain's financialwatchdog, said last month that the allegations in the FX probewere "every bit as bad" as Libor, but warned that it wouldlikely be next year before he is able to publish the findings ofhis review.
