Price fixing

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) presents the concept of Price Fixing.

Definition

Price fixing refers to an agreement between two or more participants operating in a market to collude and set the prices of an asset to serve their interest. In financial markets, price fixing refers to a form of market manipulation where the manipulators rig asset prices by inflating or deflating them to benefit from such practices. The main markets where price fixing takes place are for the following assets: interest rates, currencies and commodities.

The price fixing practice works in contradiction to the free and fair financial market forces and hampers public confidence in the markets. The asset prices should be decided by the natural market forces of supply and demand. Price fixing is banned and deemed illegal across global financial markets and stringent regulations.

In the United States of America, several laws have been implemented including the Sherman Act of 1890, which prohibits any form of price fixing or collusion among financial institutions to fix asset prices. The market manipulation tactic of price fixing comes with severe civil and criminal liabilities along with heavy penalties (see the example of the Libor scandal below).

Mechanisms

Price fixing can take different forms: collusion among market participants and window dressing.

Collusion among market participants

In such a form of price fixing, the market participants operating on the same side of a market often collude to set the buying or selling prices of an asset to manipulate the asset prices and serve their personal interest.

Window dressing

It is often carried out to give an artificial appearance to assets offered by certain companies, done by window dressing their creditworthiness and inflating the demand for the financial products offered.

Examples of price fixing

The Libor Scandal

Price fixing came to light when the Libor scandal was uncovered in 2012.

What is Libor?

Libor (London Inter-Bank Offered Rate) is a benchmark interest rate that is decided on the basis of the average inter-bank unsecured borrowing rates over a short-term period ranging from 1 day to 1 year. It is computed on a daily basis by the ICE Benchmark Committee working under Intercontinental Exchange, which is the overseeing body for Libor. Every day, at 11:00 AM, major banks from all across the world submit their borrowing interest to the ICE Benchmark Committee.

The Libor rate is used worldwide by major financial institutions to determine interest rates for different loans (for corporations to finance their investments and operational activities, for individuals to finance their consumption and the acquisition of their home, students to finance their studies, etc.) and the flows of financial derivatives.

How the Libor is calculated on a daily basis?
As seen in the picture, 18 major banks from all across the world sends their estimated unsecured borrowing rates on a daily basis at 11 AM to the ICE Benchmark Committee.

The committee then ranks the rates in a top to down order and eliminates the top and bottom 25% of the outliers from the list. The remaining rates are then averaged out and a five decimal Libor figure is issued at 11:55 AM on a daily basis. The committee issues the Libor in 5 currencies and with 7 different maturities, thus issuing a total of 35 different rates. The three-month US Libor is generally termed as the current Libor rate.

What happened?

A pool of banks colluded to artificially inflate or deflate the Libor rate over a couple of decades. The traders working at these banks submitted higher or lower rates to the ICE Benchmark Committee than they actually paid for unsecured short-term borrowings to manipulate the Libor on a daily basis. The price fixing was carried out to benefit traders and banks who traded financial derivatives to make profits by artificially inflating or deflating the Libor, which was the reference rate for such instruments.

The Libor scandal was unearthed in 2012 when a series of international investigation uncovered the price-fixing activities that were carried out by banks that formed a major part of the group of banks submitting their borrowing rates.

The Libor is used worldwide and the price fixing impacted millions of honest people around the globe, who took loans on inflated fixed Libor, and companies, which held derivative contracts.

The investigation led to fines amounting to $9 billion for the major banks that were involved in the scandal including Citi Bank, Barclays, JP Morgan Chase, Deutsche Bank and Royal Bank of Scotland. Many individual brokers and traders working for these banks were also sued by the regulatory bodies and charged with severe punishments and fines.

Related posts on the SimTrade blog

   ▶ Akshit GUPTA Securities and Exchange Commission

   ▶ Akshit GUPTA Price fixing

   ▶ Akshit GUPTA Corner

To know more about price fixing

The links mentioned below provides a comprehensive picture of how price fixing works in the financial markets and also provides a deeper view of the different scandals that happened using price fixing manipulation and shook the world.

About the Libor scandal

Wikipedia Libor Scandal

About the author

Article written in December 2020 by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

Market manipulation

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022). presents the concept of market manipulation.

Definition

Market manipulation refers to a deliberate attempt made by a person or a group of people to artificially inflate or deflate the price of stocks, commodities or currencies, and hamper the free and fair operations of the financial markets. It is a type of market abuse which is done to ensure personal profits and gains. The person doing market manipulation has the intent to influence the prices of the stocks, commodities or currencies in his favor.

Market manipulation is banned in almost all the developed financial markets around the globe including USA (under Section 9.a.2 of the Securities Exchange Act of 1934) and the European Union (under the Article 12 of Market Abuse Regulations on insider trading and market manipulation). With the rising complexity and trade volumes in the financial markets today, it is becoming increasingly difficult for market regulators to catch the culprits who practice market manipulation. However, the laws for market manipulation are very strict and often comes with severe repercussions which involves both civil as well as criminal liabilities for the person or group involved.

Forms of market manipulations

Market manipulation can take different forms. Some of the most common types of market manipulation activities involve:

False information

The rise of technology and digital media in the recent years has spiked up the amount and reach of false or fake news that circulates in the market on a regular basis. The false news that is circulated to benefit certain investors or companies leads to market manipulation and comes with severe repercussions for the culprits.

Pump and dump

This is one of the most common form of market manipulation which involves inflating the prices of a lesser known company such as a microcap or a nanocap company by circulating misleading information and dumping the stocks once the prices of such companies has risen. The manipulator (or promoter) of such schemes has the intention to create artificial demand for such stocks and thereby generate quick profits.

Insider trading

This form of market manipulation involves an insider (a person related to the company or any of its employee with access to sensitive information) who uses non-public confidential information about a company, and generates profits or avoid losses by executing trades in the market based on such information.

Spoofing

In this form of market manipulation, a trader places large volume of buy or sell orders
without the intention of executing them. The orders are placed to attract the attention of other investors who would try to bet in the stock seeing the large order in the trading book. Such acts are usually carried out using high frequency algorithms and help the trader to manipulate the market in his favor.

Cornering

In cornering, an investor or a group of investors buy significantly large volume of commodities or shares in order to sway the market in their favor and create a monopoly by controlling the prices and the supply for the asset.

Wash trading

In this form of market manipulation, a trader or a group of traders continuously buy and sell securities within themselves to hype up the trade volumes for such assets. This attracts the attention of other market participants and creates a false illusion about the asset and helps in increasing the demand.

Bear raiding

The traders who enter long positions in the market, sometimes use stop loss orders to protect their position from a significant price decline (risk management). Bear raiding involves selling large quantities of stocks of a company thereby decreasing its stock price. This downward trend in the stock price usually triggers the stop loss orders of traders with long positions, and further decreases the stock price in mechanical way.

Examples of market manipulation

WorldCom (2002)

A formerly world-renowned telecommunications company came under the scanner of U.S. financial regulators in early 2000s. The company was charged for manipulating their financial books by showing high profits and thereby manipulating the stock prices for the company. The ‘Book Cooking’ fraud done by WorldCom amounted to $3.8 billion. After the charges were proved, the company had to bear severe repercussions and eventually filed for bankruptcy in July 2002.

JP Morgan Chase (2020)

Many investors filed a case against JP Morgan Chase for manipulating the prices for the silver futures and US Treasury markets, and harming the interests of honest investors by artificially lowering down the prices of these securities. The bank made huge profits over the years and recently agreed to such charges and paid a penalty amounting to $920 million to settle the investigation carried by market regulators and law enforcement authorities. The manipulation involved ‘spoofing’ carried out by employees at J.P. Morgan Chase, many of whom are now facing criminal proceedings.

Related posts on the SimTrade blog

   ▶ Akshit GUPTA Securities and Exchange Commission

   ▶ Akshit GUPTA Price fixing

   ▶ Akshit GUPTA Corner

About the author

Article written in December 2020 by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).