In recent years, the foreign exchange (FX) market has undergone rapid change, with new regulation and a much greater emphasis on fair conduct, which has required a buy-in from all market participants.
At the same time, a series of abuses has created “a deficit of trust”, says Guy Debelle, deputy governor of the Reserve Bank of Australia (RBA). This was triggered in particular by the FX scandal of 2013, which exposed the practice of many currency dealers of front-running client orders and rigging the FX benchmark rates.
Fines totalling US$10bn were levied on several of the big banks, including Citi, JP Morgan, Barclays and UBS largely to settle allegations that their traders shared too much supposedly confidential information about their clients’ activities. The most recent, a fine of US$350m, was imposed last week on BNP Paribas by New York’s state regulator, which reported a pattern of “nearly unfettered misconduct” between 2007 and 2013 in the French bank’s FX trading business.
The misconduct is of great concern to the world’s central banks, said Debelle, as the FX market acts as “the basic plumbing of the financial system”. Indeed as Karim Haji, head of banking risk and regulation and capital markets sector head at accounting giant KPMG notes, the FX market’s daily trading volume is estimated at around US$5.1 trillion and its strength is integral to the global financial system.
Just over two years ago, the Bank of International Settlements (BIS) – the institution owned by the central banks – tasked its foreign exchange working group (FXWG) for cleaning up the market by developing a global code of conduct to establish common guidelines for good practice.
Work has been relatively swift. Following the issue of a first draft last year, the new code was formally launched last week at a presentation in London’s financial district, with the FXWG made up of 16 major central banks that developed 55 principles covering execution; governance; ethics; information sharing; risk and compliance; and confirmation and the settlement process across the FX market.
Debelle, who has in addition chaired the FXWG, commented: “All of us recognise the need to restore the public’s faith in the FX market. We share the view that the global code plays an important role in assisting that process and also in helping improve market functioning.” He added that the code aimed to go beyond being merely a checklist, in establishing a “robust, liquid, fair and open market.”
Chris Salmon, executive director – markets at the Bank of England (BoE) added that it had been written in a language that everyone would understand and offered examples of good conduct that would be widely recognised. “The principles apply to all market participants, not just segments of it,” he confirmed.
One particular sensitive area in the market is the practice dubbed ‘last look’, which allows dealers to reject client orders at their sole discretion, even where they are backing out of the trade after having unfairly learned a counterparty’s intentions.
The code stops short of banning last look’, but stipulate that there should be full transparency when it is employed and should primarily be used as a risk control mechanism. A directive on the issue was also published last week and a consultation period will run over the next four months to September 21.
“It’s an area where incentives can be a problem,” said Simon Potter, the BOE’s head of markets. “When an option is not priced correctly, it can potentially lead to problems and it’s important to articulate what these might be.”
However, James Kemp, managing director of the Global Financial Markets Association (GFMA) Global FX Division, who was moderator at last week’s launch, commented: “It says to me that actually 54 principles (rather than 55) were successfully discussed and that one is still in consultation.”
Other areas addressed by the code include electronic and algorithmic trading services, with the guideline that service providers should offer
“adequate disclosure” on how they operate.
It will take time for the new code to be adopted. Dealer banks, at which it is principally aimed, are likely to take between six and 12 months to reach full compliance, although they and other market intermediaries have expressed strong support for the initiative.
Harpal Sandhu, founder and chief executive officer (CEO) of Integral Development Corporation – developer and operator of a multi-sided trading facility connecting market participants with sources of FX liquidity – forecasts: “The FX global code could well be the catalyst for growth across global currency markets.
“We’ve seen this kind of effect of transparency on other industries, such as the cellular phone market, which now delivers greater pricing choice for consumers. This is because ultimately, transparency will lead to the democratisation of FX which, in the long-term, benefits everyone by creating better liquidity.”
Salmon noted that the code needed a wide range of market participants to sign up to it in order to establish credence. They then needed to embed the guidelines into their practices and processes.
“If we can move to a world where firms are following the code and demonstrate they are doing so this will create confidence.” The next stage is likely to see the setting up of a public register so that firms can post their statements of commitment.”
However, Salmon emphasised that as the aim was to develop a single code that could work in different market jurisdictions around the world, it will remain voluntary and not be regulated. “We’d rather promote its benefits,” he added.
Almost the last word at the launch went to Adrian Boehler, global head of FXLM and commodity derivatives at BNP Paribas, who wryly acknowledged that his bank was the latest to pay for past abuses. “We have to acknowledge the transgressions of the past, but today is about looking forward to the future,” he stressed.
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