In April 2014, at a meeting of global foreign exchange committees in Sydney, calls snowballed to harmonize existing FX codes of conduct in the teeth of the FX scandal. On Thursday, that idea came to fruition with the publication of a code of conduct applicable to all participants in the wholesale FX market.
The document runs to 30 pages and takes a comprehensive look at best practice in areas of the currencies markets including market ethics, information sharing, execution costs, trade confirmation and settlement.
Guy Debelle, BIS |
Guy Debelle, the head of the Bank for International Settlements' (BIS) FX Working Group, which formulated the code, says the working group tried to tackle the most urgent areas first, to provide greater clarity where there was most scope for confusion and uncertainty. But there are plenty of controversial subjects yet to be addressed, including execution, prime brokerage, electronic trading and last look, which will be covered in a second publication next May.
The code of conduct has been written without jargon to ensure that small and medium-sized businesses can understand and apply its provisions easily. It is hoped this will help them quickly catch up with the large banks and other financial institutions, which are understood to be already largely compliant with its provisions.
The real value of the exercise was the creation of a single, unified and global code that applies to the wholesale FX market, harmonizing the guidance and principles that apply between jurisdictions and market segments – and, of course, boosting market intelligence for regulators and central banks alike while salvaging trust in the scandal-ridden industry.
The code seeks to ensure that institutions trading currencies are held to the same standards wherever they are in the world. Equally important, it ensures that different types of institutions, be they banks, hedge funds or exchanges, understand their own obligations, and those of their counterparties.
Some scepticism persists among those that feel a legally non-binding, principles-based document such as this cannot solve the problems that have arisen in the FX market.
David Puth, CEO of CLS, admits that for the most cynical observers only time will prove the effectiveness of the principles-based approach. But he cites the unprecedented level of industry engagement and consultation during the formulation of the code as evidence of the seriousness of the project as grounds for optimism. Where appropriate, local FX committees and regulators will also incorporate guidance into legally enforceable rules, he adds.
Others insist that it is precisely the prudential approach that will make the code effective. David Clark, chairman at the Wholesale Markets Brokers Association, says: “The fact the code was created by central banks with input from market participants and infrastructure providers is key to its success. The code does not replace regulation, it works alongside it."
Clark adds: “Rules-based regulation was not able to prevent the poor conduct in both wholesale and retail markets, and punishing banks with fines may not be an adequate response. The strength of using a principles-based approach is that principles cannot be arbitraged and emphasize responsibility and integrity.”
The future of the prudential, principles-based approach will be determined to a large extent by the success or failure of this exercise.
James Kemp, managing director of the Global Financial Markets Association’s global FX division, says: “The industry is well aware of the need to restore trust and confidence in the FX market. Time will tell if the self-regulation approach works but it is clear that regulatory intervention will surely follow if we can't as an industry demonstrate our ability to adhere to the code.”
The onus is now on wholesale FX market participants to digest the code and to begin to implement it, putting in the necessary systems and procedures where necessary, and ensuring their decisions and ethics reflect the code's contents.
Phil Weisberg, global head of FRC trading at Thomson Reuters, says: “It is down to individuals and institutions to sign up to this voluntarily, but for questions to be asked of those that do not adhere to these guidelines.”
For the code to be really effective, industry will ultimately be expected to look not only to their own behaviour, but also to police the community generally by monitoring the behaviour of others. That means that if FX market participants feel certain institutions are not adhering to the spirit or letter of the code of conduct they should refrain from doing business with them.
In some areas the guidance offered makes the code tantamount to an FX handbook, outlining what you should and should not do in given situations. The chapter relating to information sharing, for example, explicitly lays out examples of information that should not be made public, including details of a market participant’s order book; other market participants’ axes; spread matrices provided by market participants; and orders for benchmark fixes.
Similarly, it outlines how confidential information should be handled, expressly stipulating that personnel should not disclose confidential information if there is any indication it might be misused, or to people who do not have a valid reason to receive it, such as internal risk management personnel. Client information should only be used for the specific purpose for which it was given, unless there is specific instruction to the contrary.
By providing more clarity about what information should not be shared, the working group hopes to encourage the appropriate dissemination of information that can be shared, which should increase transparency and market efficiency.
Execution code
For the more technical aspects of the market, such as execution, there were a greater number of different points of view to be represented, notes Weisberg, meaning the code could not be as prescriptive. Yet it does go into considerable detail, offering a leading principle and six additional principles.
The leading principle states: “Market participants are expected to exercise care when negotiating and executing transactions in order to promote a robust, fair, open, liquid, and appropriately transparent FX market.”
Additionally, market participants should be clear about the capacities in which they act; should handle client orders fairly and with transparency; should only pre-hedge client orders when acting as a principal, and should do so fairly and with transparency; and should not request transactions with the purpose of disrupting the market. The mark op applied to client transactions by market participants acting as principal should be fair and reasonable; and clients should be aware of the risks associated with the transactions they request and undertake, and should regularly evaluate the execution they receive. Each of these principles is backed up with examples or explanatory notes to provide context.
In terms of execution, says Weisberg: “The code is a high-level document that outlines the many factors market participants should be thinking about when trading. There is more than one way to execute trades, there are different venues and different methods. But providing a guideline helps market participants understand their choices, which is not something that everyone has always understood. Having all the options laid out will allow traders to make more thoughtful decisions.”
By highlighting the differences between principal and agency trading, the code should help all market participants to better understand the implications of the decisions they make, and the obligations of their counterparties.
Kemp says: “Different people may have had different expectations of their trading relationships, but given there are two sides to every transaction the guidance provided in the code will help both sides clarify this relationship and understand each other. The code focuses on a number of these: for example, principal and agent, information sharing and market colour. That transparency has to be helpful."
Kemp adds: “The document is very clear and easy to understand. Yes, it will develop, but I don't think any market participant reading it should be left in any doubt about what is expected of them, or how these principles apply to their activities.”
The global code of conduct supersedes a number of existing regional or competing codes of conduct that relate to FX, and as adoption of it increases, and especially after the second half of the code is published next year, those existing codes will be increasingly marginalized.
But the ACI Financial Markets Association, the author of one of the better-known existing codes, pledged to “strongly urge all ACI FMA members and wholesale market participants to learn the code, attest to their compliance and demonstrate their adherence.”
“The ACI FMA’s Model Code will continue to exist for the time being, as it remains the code of choice for many market participants around the world and covers a broad range of topics. As the BIS code enters its second phase, we anticipate that many of the topics in the Model Code will also be incorporated,” adds ACI.
The publication of the second half of the code next May will not be the end of the process, with the code set to evolve over time alongside the FX industry itself. Regional FX committees will continue to monitor the market globally and report into the working group, which will be responsible for ensuring that the code remains relevant as the FX market grows.