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Forex manipulation: How it worked

The investigation into alleged manipulation of the foreign exchange market now takes in most of the world's biggest banks, regulators in three continents, potentially hundreds of traders – and now the U.K's central bank.

Here's a look at the key issues involved:


Anthia Cumming | E+ | Getty Images

The 'fix'

Every day, a currency "fix" known as the WMR/Reuters fix, is agreed, based on the price that currency trades at over a 60 second period. At the center of the probe seems to be traders eager to make a quick profit by buying up currencies just before they knew clients were going to buy large amounts of the same currency at the daily "fix". This way the traders could sell on at a profit when the price rose at the "fix."

Some also appear to have passed on information to traders at other companies about big upcoming trades. All of this could have artificially raised the value of one currency against another.

(Read more: Forex scandal: The last nail in chat rooms' coffins?)

Trader tactics

Traders are supposed to have colluded to set a currency's rate through conversations in chat rooms, usually via their Bloomberg or Reuters terminals. Several of the investment banks involved have since banned the use of such chat rooms, which also made an appearance during the scandal surrounding the fixing of the key overnight bank rate Libor.

The issue around which most debate has focused is whether what happened amounted to illegal "front-running" (profiting by your knowledge of client orders) or just risk management for the bank's clients.

Banks often manage the risk of a jump in the price of a currency made by a large order, by spreading out the order ahead of the "fix."


(Read more: Forex troubles ahead for Carney)

Why it matters

If the rates were rigged, it could have affected the hedges which companies with operations in more than one country usually put in place to minimize their exposure to currency swings. It could also have affected the value of options and funds tied to currency values. These can all affect investments made by ordinary shareholders and even the prices paid by consumers.

How is the Bank of England involved?

On Tuesday, Mark Carney, governor of the Bank of England, will face questions on whether Bank of England officials effectively told leading foreign exchange traders that such actions were not illegal.

All the minutes of the key meeting, in April 2012, say is that there was "a brief discussion on extra levels of compliance that many bank trading desks were subject to when managing client risks around the main set piece benchmark fixing." This meeting happened before Carney joined the Bank – but how he deals with what emerges about its contents may set the tone for his entire governorship.

- By CNBC's Catherine Boyle. Twitter: @cboylecnbc.

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