Fall of self-regulated spot FX

By:
Farah Khalique
Published on:

Government plans to crack down on the UK’s foreign-exchange market amid reports of mass manipulation could see the demise of the London FX fix. Suggested reforms range from a transparent auction-based pricing system to banning the practice of last look.

UK chancellor George Osborne is expected to announce new measures to better regulate the foreign-exchange market in the wake of rate-rigging rumours, in his annual Mansion House speech on Thursday.

The  UK Treasury is said to be consulting with the international Financial Stability Board to produce the regulations. The Treasury declined to comment.

Suggested proposals include: revamping the London 4pm fix, which offers customers a benchmark exchange rate they can trade; boosting the use of electronic trading platforms to improve transparency; and introducing a new code of conduct with criminal sanctions for wrongdoing.

The London 4pm fix should be scrapped altogether and replaced with a more transparent auction-based pricing system, suggest some market participants.

LMAX Exchange chief executive David Mercer says a better solution would be to educate customers and point them to online trading platforms or set up an online auction-based fix, powered by bids and offers.

"The fix is outdated and goes back to when there was a lot of phone trading," he says. "With e-trading venues, we have fair price discovery."

George Osborne 1
UK chancellor George
Osborne
The FX fix would not be the first to be consigned to the scrapheap – earlier this year, it was announced the London silver fix would be scrapped in August. A number of providers, including the London Metal Exchange and the CME, are already purporting to offer more transparent solutions as a replacement.


Global regulators were happy to let the spot  FX market remain "self-regulated", and exempt from trade reporting and clearing requirements, but legal experts expect a U-turn in the wake of market manipulation.

Ed Parker, co-head of the global derivatives and structured products practice at law firm Mayer Brown, says although spot FX should remain exempt from clearing requirements, it will likely be included in trade repository regulation.

"I don’t think it was intended to be caught, but, with the changes that have happened and the change in the mood, it is most likely spot FX will fall under reporting requirements," he says.

Naysayers argue it would be a headache to enforce reporting requirements, but the technology exists to capture the £3 trillion ($5.3 trillion) daily spot market, according to Matthew Coupe, director of regulation and market structure at software solution provider NICE Actimize.

 "The software exists – there are boxes that can handle billions of messages a day," he says.

LMAX Exchange’s Mercer believes that regulators should scrutinize the FX markets more closely and abolish the practice of last look, whereby dealers can pull a price from a platform after a customer has clicked on it.

"That should not exist in any marketplace," says Mercer. "It does not exist in equities or futures. It immediately disadvantages the customer. Regulators should look at that."

The practice of last look evolved because some customers, notably high-frequency traders, were able to arbitrage the market by being quick to click on a price, after say a market-moving central bank announcement, but before the dealer had time to update its price accordingly. To even the scales, liquidity providers introduced last look to reject trades, but now they have caught up with technology.

"Market makers can cancel and replace an order in 300 microseconds," says Mercer.

London calling

Osborne’s announcement came as somewhat of a surprise, given London’s reputation for soft-touch regulation with regards to FX. Just recently, the UK’s Financial Conduct Authority went out on a limb to rule that FX transactions with a settlement period of up to seven days, or entered into for commercial purposes, are exempt from European clearing and reporting regulations.

However, legal experts say that, even if Osborne announces hard-hitting measures, these are unlikely to hurt London’s reputation as the main centre of FX trading.

Federico Vezzani, finance partner at international law firm Bonelli Erede Pappalardo, says: "I’m not sure that Paris, Milan or anywhere in Germany can take the place of London in this kind of market."

In fact, stricter regulation could boost London’s reputation, says Mayer Brown’s Parker.

"If [people] have greater trust in a rate, it can lead to a greater advantage," he says. "Better regulation leads to greater confidence and attraction."