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Russia: New System Created To Prevent Manipulation Of Ruble Exchange Rate

Washington, 15 October 1998 (RFE/RL) -- About a week after the Russia government on August 17th stopped supporting the ruble at six to the dollar and allowed it to depreciate to as low as 20 to the dollar, there were two days that the ruble's exchange rate almost mysteriously recovered.

It only recovered, experts say, because several of Russia's largest banks were able to manipulate the exchange rate so as to reflect a much higher value for the ruble than was actually occurring on the market. The banks did it, the experts say, because they had issued specialized financial instruments called forward options contracts with western banks and investors. Those contracts were denominated in dollars and the sudden drop in the ruble would have meant the Russian banks owed hundreds of millions more dollars than they had expected.

By manipulating the rate, they were able to save a fortune.

Of course, on the other side of those contract deals were dozens of western financial institutions, mostly banks, which had taken the contracts to help them protect against any sudden, unexpected devaluation of the ruble.

The manipulation meant that instead of collecting the money they should have because the ruble did indeed depreciate, the western banks were left with contracts worth no more than when the ruble traded at six to the dollar.

It was all only an exercise in paperwork because as part of the Russian government's 90-day moratorium on debt repayment, such forward and futures contracts have been frozen. The western investors must wait to get even the original amount owed.

The ruble exchange rate for these special financial instruments was determined by the Moscow Interbank Currency Exchange. It collapsed a few days later at the end of August, but it's legacy greatly worried the banks and investors who still hold those Russian bank contracts.

The rate as determined by the old Moscow exchange was simple to manipulate. At a predetermined time each day, the exchange telephoned each major commercial bank in Moscow and asked its exchange rate. It then averaged those and issued the daily rate.

Realizing that the best solution to this problem should be market based, two U.S.-based organizations -- the Chicago Mercantile Exchange (CME) and the Emerging Markets Traders Association (CMTA) -- decided to jointly create a new index.

This one is being done by conducting random surveys of commercial banks in Moscow -- including foreign banks and commercial financial operations -- twice daily and combining those results to determine the rate. Using normal western banking practices, the new survey is designed to expose any attempt at manipulation.

The two organizations actually began testing the new survey within days of the Moscow exchange's collapse. With announcement of its creation Wednesday, CME spokesman John Holden says the two groups will carefully weigh reaction of market traders around the world. They must also receive formal approval of the U.S. Commodity Futures Trading Commission (CFTC), which regulates futures trading instruments in the United States.

For the first day, the survey produced a reference rate of 14.43 rubles to the dollar. That was slightly below a rate of 13 to the dollar that was created Wednesday morning by the Russian Central Bank when it held two trading sessions. The 13 rate represented a nearly 16 percent jump in the rubles value from the day before, reflecting what traders said was the effect of the bank's adding 800 million dollars to its reserves.

CME spokesman Holden said there was no connection between the Central Bank's rate and the new survey. The new survey, he said, is designed to provide a more balanced figure to give the investors who have been frozen out a reasonably accurate rate for future settlement.