RBI moves to curb ‘short-changing’ of clients, price rigging

The Reserve Bank of India (RBI) is pushing banks to embrace a new code of conduct that is aimed at curbing price manipulations and minimising trades that short-change clients in the foreign exchange and bond markets.

The triggers for the code are the recent short-squeeze in the local government securities market that brought to the fore an element of collusion till now unseen among high-street Indian banks and, on a different plane, the initiatives of the Bank for Inter national Settlements (BIS) which is trying to instill best practices that would make the forex market more open, fair and liquid. The Basel, Switzerland, headquartered BIS – often described as the central bank for central banks – fosters co-operation among monetary policy markers across markets.

“About 10 days ago, RBI met banks to discuss the code for the forex market. It has also asked Fimmda (the association of banks and bond houses dealing in the money marker) to prepare a code for the bond market. Banks may have to later pursue with the industry bodies and about a dozen large corporates to nudge them in accepting the code,” a senior banker told ET.

One of the rules in such a code could prohibit a company buying or selling foreign currency from holding back the entire order. “Say, a company buying $100 million should abstain from ‘spraying the market’ by placing $10 million with 10 banks. The argument is that in such a case it is not sharing the full information with the market,” said the treasury head of a large bank.

The short-squeeze in the government securities — happening twice since early March — rattled several MNC banks as well as RBI.

It was unleashed when large local banks entered into tacit understanding to hold back supply of securities after some banks went short in the most liquid 10-year bond.

A short seller borrows security on the anonymous online platform with the expectation that the borrowing cost would be less than what it gains from buying the security at a cheaper price later. According to banking circles, some of the large state-owned banks colluded to take on the short-sellers whom they felt were trying to unsettle the pricing — as the 10-year government bond serves as a benchmark for pricing of a range of other securities.

However, the collusive behaviour did not go down well with the regulator which sent a stinker to all banks reminding them that such actions spoil the integrity of the market.

“While the industry is aware that it’s unethical, there are no guidelines or regulations that specifically ban such collusions. FEDAI (the Foreign Exchange Dealers’ Association of India) has been asked by the regulator to work on a code. The question is how to monitor whether banks are following the code. Such codes are voluntary. One can hope that if the regulator and the industry give them due importance, these would evolve as accepted rules of the game,” said a trader.

There could be a slew of practices that the code would lay down as unacceptable. These could be buying extra and pushing up price before putting through a client’s order; sharing information and colluding with other institutions in the market, misselling products that are inappropriate for a client, holding back information, entering intro trades to disrupt the market, and fixing higher than normal mark-ups in the execution of an order from a client, among others.

But it’s felt that such codes can bring about a change only if they are also accepted by other market participants such as asset managers, brokers, highfrequency traders, insurers, and Sebi registered offshore funds.