It’s been two years since Bloomberg revealed the hidden chatrooms several of the world’s largest banks used to rig currency exchange rates. The FX (foreign exchange) fixing scandal soon erupted into one of the biggest headaches for those banks. Entire divisions of traders were fired and fines against the banks totaled over $5 billion,while damages against the banks’ clients were revealed to be easily in the tens of billions of dollars. Now that the dust has finally settled, it’s a perfect time to understand what exactly happened and why.

When foreign exchange trading emerged, it was seen by many to be exactly the type of trading big banks should engage in. Most of the world’s most important currencies are highly liquid and FX trading puts very little risk on banks’ books. With business and finance becoming more and more internationalized, demand for FX trading services would grow as well. The flip side, of course, is that with the level of liquidity and risk in these currency markets, the banks inevitably realized minimal returns. The profits were so little that at least seven banks, including: HSBC, Citibank, JPMorgan, RBS, UBS, Barclays, and Bank of America, looked for alternative means to boost these returns.

So, what is FX fixing and how did the banks do it? Firms and investors looking to do business in foreign markets need to trade the currency of their home market for the foreign currency. Naturally, the need for a counterparty to provide the foreign currency arises. For such a large market, however, there are no exchanges or clearing houses that match buyers and sellers like there are for stocks, for example. Instead, many looking to gain access to foreign currency need to go directly to the banks. Now, foreign exchange rates are also tracked and published by a number of organizations. The most important rate is the WM/Reuters closing rate published at 4:00PM in London based on prices calculated from data gathered 30 seconds before and after.

Banks and traders allow clients to buy currency at the fixing rate calculated later that day. The traders then buy currency throughout the day, and once the fixing rates come out, the traders make a profit if they bought the currency at a cheaper rate earlier. Traders, however, can also collect client orders throughout the day and put them in during the minute the WM/Reuters benchmark rate is calculated to move the FX rates. With enough traders colluding, banks can swing this key benchmark rate by a small amount, giving them enough edge to make significant profits. Insofar as the banks are acting in their capacity as market makers, any extra profit that they make comes directly out of their clients’ pockets.

With the FX fixing scandal investigations and proceedings now drawing to a close, the future of FX trading suddenly looks uncertain. There is tighter regulatory scrutiny into the FX trading activities of the major banks, while FX trading profits without any currency manipulation have remained quite low. Indeed, many banks are now wishing they could back out of FX all together, but client demands are forcing them to stay. Whether this equilibrium will tip in favor of pushing those banks out remains to be seen.