The FX industry has made good progress in implementing many of the recommendations set out by the FSB on FX benchmarks, says the regulatory board, a move that, in theory, reduces the incentive and opportunity for improper trading behaviour by market participants around the benchmark fixes.
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It is a very innovative business. It is important we don’t stifle that innovation through dictating the solution James Kemp, |
Guy Debelle, head of the FSB’s FX group, and assistant governor of the Reserve Bank of Australia, tells Euromoney: “We cannot take all the credit for encouraging these changes. The fines that have been handed out and the increased scrutiny around benchmarks have clearly focused the minds of the banks, but the recommendations have shown why change is so important and have provided a framework for change.”
However, the FSB notes that in some cases progress has been mixed.
Specifically, it warns that reforms of smaller FX benchmarks, other than the WM/Reuters 4pm London fix, are lagging the recommendations it made in its September 2014 report for cleaning up the FX benchmarks business.
The FSB report published in October 2015 concludes: “A more complete implementation of the recommendations would increase the likelihood of maintaining and extending this improvement. Regulators and FX market participants must remain focused on achieving such an outcome.”
The FSB made 15 recommendations in its September report, including widening the fixing window – which was previously set at one minute – and increasing the number sources providing data feeds. It also suggested a group be formed to monitor the calculation methodology on an ongoing basis.
On February 15, the window used to calculate WM benchmark rates was widened from one minute for traded currencies and two minutes for non-traded currencies, to five minutes for all currency pairs.
The FSB says feedback from both the buy side and sell side suggests this change is helping, although having only been live for eight months it is too early to fully assess its impact.
The WM has also begun to incorporate more data feeds, the FSB adds, though there is scope for more improvements in this area. The industry, however, has yet to form the recommended user group to advise on changes to the calculation methodology.
The FSB’s Debelle notes most of the attention has been on changes to the WM London 4pm fix. There has been less follow-through on the recommendations of the report for other benchmarks, and while they are less significant at a global level, some are important in specific regions.
Market participants must recognise that the recommendations apply to these benchmarks too, he says.
Having to pay for this service has made the buy side Guy Debelle, FSB |
Debelle declines to single out any smaller FX benchmarks, but notes some are significant in specific regions, such as Brazil’s Programa de Taxas (PTax) and the Treasury Markets Association (TMA) FX rates in Hong Kong. There is also the Sterling Overnight Interbank Average Rate (Sonia) in London. The ECB benchmark – the second most-prominent in the market – is said to have made better progress than some of its smaller peers.
The FSB had also called for industry-led initiatives to create independent netting and execution facilities for transacting fix orders, for increased transparency in pricing, and for banks to adopt better internal guidelines and procedures for collecting and executing fix orders.
It says progress has been made in these areas. In particular, the largest financial institutions have made the most advances in providing increased transparency in customer pricing for fixing transactions and the most-used benchmarks, the FSB says. The same institutions have also taken steps to separate dealers’ fixings business from other activities.
James Kemp, managing director for global FX at the Global Financial Markets Association (GFMA), stresses the importance of banks developing their own approaches to the implementation of the recommendations.
“There are different business models in FX,” he says. “It is a very innovative business. It is important we don’t stifle that innovation through dictating the solution. I think we will end up with a number of different models, in terms of how benchmarks are offered and pricing, and clients will dictate what services they want. It will evolve over time.”
This is forcing banks’ buy-side clients to think more about their own trading strategies.
Debelle says: “Having to pay for this service has made the buy side think about their FX business more. It remains to be seen what impact this will have.”
However, the FSB warns more progress is needed, especially among the smaller banks. Clearly, such banks have less opportunity to manipulate rates than their larger peers, and therefore represent a smaller systemic risk. However, the FSB is adamant the rules apply to everyone.
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Guy Debelle, FSB |
Some participants have found the costs of implementing recommendations for separating trading from customer price fixing prohibitively expensive. In some cases this has prevented any action from being taken, while in others it has encouraged banks to cease offering fixing-related services themselves, and to instead offer a portal to other providers. As a result of both the widening of the fixing window and the separation of the fixing business from the trading desk within many banks, there has been a marked increase in algorithmic trading in fixing orders.
“A noticeable jump in the share of algorithmic trading also occurred when the window was expanded to five minutes,” says the FSB. “Outside the window, prime-brokered customers trading algorithmically are the most active participants during the rest of the day.”
The development of a single code of conduct for the FX market through the Bank for International Settlements markets committee working group on FX markets is also progressing.
Debelle says: “There has been a real willingness to engage with the initiative for a global code of conduct in the major FX centres, from central banks and market participants. We expect to have a draft code within around 18 months.”
GFMA’s Kemp says: “The plan is to deliver some aspects of the code in 2016, and then finalise it by May 2017. If certain aspects of the business represent a higher conduct risk, it makes sense to focus on those first.”
Kemp believes the six existing codes of conduct relating to FX have different areas of emphasis and are therefore potentially complementary.
“It is a question of setting it all out in one place and assessing what you end up with, if there is too much information in one area or not enough in another,” he says. “It may need to be streamlined and there may be gaps.”