FX benchmark probe highlights flaws in voluntary best practices

By:
Joel Clark
Published on:

As the Bank of England conducts a review into what its officials knew of FX benchmark manipulation, observers call for more robust adherence to trading best practices.

The investigation into manipulation of foreign-exchange benchmark rates has highlighted the need for traders to pay greater attention to best-practice guidelines – and for some of those guidelines to be tightened up – if the industry is to remain self-regulated, according to market participants.

In the latest twist to the investigation that began last year, the Bank of England (BoE) published the minutes of an April 2012 meeting of the chief dealers’ subgroup of the BoE’s FX joint standing committee, after allegations in media reports that bank officials had condoned the sharing of confidential client information ahead of the WM/Reuters 4pm fix.

However, some believe there is a lack of understanding, within and outside the industry, on the distinction between front-running – which would involve traders using confidential client information to make a profit – and prudent risk management when trading orders at a fix.

Such a distinction could be more widely understood through the adoption of best-practice guidelines, say industry associations.

“There is an issue around terminology,” says David Woolcock, global head of sales and business development at Eurobase – a technology vendor – and vice-chair of the ACI FX committee.

“Some traders seem to have admitted to supposedly front-running orders when in fact what they mean is that they have accepted a big order to execute at the fix and then managed the risk through executing some of the order ahead of the fix to mitigate the exposure on their books – that is very normal and is not front-running.

“It’s even possible that is what the Bank of England may have condoned.”

The minutes of the meeting between dealers, held on April 23, 2012, allude only to “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 fixings”.

However, media reports allege the discussion was more detailed and that bank officials knew of manipulation of benchmark rates. The meeting was chaired by the BoE’s chief dealer Martin Mallett, and was attended by Rohan Ramchandani, then Citi’s European head of spot trading, who was dismissed from the bank last month in connection with the investigation.

Speaking before the UK’s Treasury Select Committee this week, Andrew Bailey, deputy governor for prudential regulation at the BoE and chief executive of the Prudential Regulation Authority, said the bank had launched an internal review into the matter when it first became aware of the allegations in October 2013, but has not yet found any evidence that the central bank condoned FX market manipulation.

“The Bank of England does not condone any form of market manipulation in any context whatsoever,” said Bailey. “We, the governors of the bank, have taken the claims about the meeting with bank officials extremely seriously.

“We have no evidence to substantiate the claim that bank officials in any sense condoned or were informed of price manipulation or the sharing of confidential client information.”

Several central banks publish voluntary best-practice guidelines for the FX market, including the BoE’s non-investment products (NIPs) code, while the ACI has a “model code”, which states clearly that traders should be banned from executing trades in front of customer orders on the basis of confidential client information. Some believe those codes will now have to be beefed up.

“It is frustrating that the ACI model code is very clear on the definition of front-running and yet some of the banks clearly aren’t using it, and the Bank of England’s NIPs code is strangely silent on this,” says ACI FX’s Woolcock.

“Traders, it appears, aren’t being taught the difference between front-running and risk mitigation, and this urgently needs to be rectified.”

However, while some would favour more rigorous adoption of industry standards, others believe the regulators will look to clamp down even harder, and FX is unlikely to remain a self-regulated industry after this scandal.

“There was widespread knowledge that this may have been going on and it wouldn’t surprise me if central banks knew,” says a senior official at an FX trading technology company.

“When you had a disproportionate amount of volume going through at a particular point in time, the banks made every effort to deliver a good service to their customers, but they also sought to make money on it.”

The official concludes: “I honestly can’t imagine how this will play out, but I don’t think the industry will get away with not being regulated anymore. I hope the banks are proactive and can assist the regulators by using the universally accepted ACI rules of conduct as a guideline.”