Redefining Conduct

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Investigations into benchmark manipulation have cast a long shadow over the FX industry, but efforts to address what went wrong through stronger behavioural standards are now well advance

In the two years that have passed since damaging allegations were first made about improper behaviour among foreign exchange traders, the microstructure of the industry has been more closely and widely scrutinised than ever before. But while the market manipulation that has been unearthed has clearly damaged the industry’s reputation, significant progress has already been made to address key issues.

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"Most market participants still care very deeply about the integrity of the industry and have been working collectively to come up with constructive suggestions to address past failings. In the long term, dealing appropriately with these conduct issues will be to the industry’s benefit," says Guy Debelle, assistant governor at the Reserve Bank of Australia and chair of the Australian Foreign Exchange Committee.

Standard-setting bodies and industry leaders began addressing key policy objectives even before regulators had completed their investigations into manipulation of FX benchmarks. A working group of the Financial Stability Board (FSB), co-chaired by Debelle and the Bank of England’s Paul Fisher, was convened early last year and published its final report on FX benchmarks in September, containing a number of important recommendations, some of which have already been put into action.

Meanwhile the Bank of England initiated its Fair and Effective Markets Review (FEMR) in June 2014, which consulted widely on how to restore trust and confidence in fixed income, currencies and commodities markets, issuing a consultation document in October, with the final framework expected soon.

Both the FSB benchmark review and FEMR were well-advanced by the time the first batch of fines were meted out to banks in November 2014, with the UK Financial Conduct Authority (FCA) fining five banks £1.1 billion for "failing to control business practices in their G-10 spot FX trading operations". Serious and damning as those fines may have been – they constituted the largest ever imposed by the FCA or its predecessor organisation – the remediation efforts highlight the widespread commitment to restoring the reputation of the industry.

"The work is clearly not yet finished," says Debelle. "Efforts are still ongoing, and everyone is taking it extremely seriously. The banks have spent a lot of time on this; they have tightened up their internal controls and have compliance officers on the trading floor monitoring trader behaviour and interaction with clients."

One of the most fundamental challenges for the industry, which underpins efforts by the FSB, the Bank of England and the banks themselves, has been to find a way to enforce better behaviour among traders without making major changes to the market structure that could have an adverse effect on liquidity and access.

In the past, FX market committees and industry associations drafted codes of conduct to engender consistent and fair behaviour across institutions, but the investigations showed that those behavioural codes had in many cases not been properly enforced, allowing some traders to seize on opportunities to manipulate exchange rates. Beefing up those codes and aligning them to ensure international consistency is now a priority for the whole industry.

On March 30, eight foreign exchange committees jointly published a high-level set of conduct principles that should be expected of all participants. The eight-page document, Global Preamble: Codes of Best Market Practice and Shared Global Principles, is not intended to replace codes of conduct or regulations already in place in different regions, but rather aims to harmonise behavioural standards internationally.

"The challenge we have encountered is that one can write high-level guidelines that everyone agrees on, but the more specific it gets, the harder it becomes.

It is impossible to define every scenario that is or is not permissible, so we want participants to use the globally agreed principles to help them reach their own conclusions about what kind of behaviour is appropriate," says Debelle.

Key principles covered in the preamble include personal conduct, confidentiality and execution practices. At an annual meeting of the eight FX committees held in Tokyo on March 23, officials unanimously endorsed the preamble and committed to further work to harmonise regional codes of conduct and to find ways to promote more consistent adherence. The commitment of the FX committees to global consistency has been welcomed by the industry.

One code to rule them all
While work continues on enhancing regional codes of conduct to improve and standardise behaviour across the global FX industry, central bank governors now have their eye on a single global code.

Following a meeting of the Bank for International Settlements’ (BIS) Economic Consultative Committee (ECC) on May 10-11, BIS governors set out the terms of a new working group, chaired by Guy Debelle.

"The BIS Governors have agreed to set up a working group under the auspices of the Markets Committee to take these issues forward with a view to facilitating the establishment of a single global code of conduct, standards and principles," said ECC chairman Agustín Carstens

"There is clearly a very strong desire for coordinated alignment of the regional codes of conduct so that we reduce duplication and create a common reference point for the industry on a global basis. This is an opportunity for market participants to demonstrate that they can put the right controls and rules in place going forward," says James Kemp, managing director of the Global Financial Markets Association’s global FX division, which represents 24 banks in the FX market.

Among the most important issues requiring attention in the wake of the investigation, Kemp believes, are the need for clearer disclosure about the capacity in which a bank acts when it trades with a client, as well as clearer in-house guidelines on execution of client orders and internal and external information flow.

The global preamble addresses the disclosure issue from a high level by requiring that all firms must identify "potential or actual conflicts of interest that might arise when undertaking FX transactions, and take measures either to eliminate those conflicts or control them so as to ensure the fair treatment of counterparties".

Market participants acting in an agency capacity must not undertake trades that could result in a conflict of interest without disclosing it to the customer first and making sure any conflict is resolved, the preamble adds.

"There is certainly a need for greater disclosure on the capacity in which participants act. As the same salesperson often represents different services within an institution, including both agency and principal, both the provider and the client need to be absolutely clear on the type of engagement and the conduct rules that apply," says Phil Weisberg, global head of FX at Thomson Reuters.

In addition to greater disclosure and control of information flow, a further priority is to ensure that market participants are compensated for the risks they take by participating in certain business practices such as benchmark fixings, Weisberg adds. The FSB report recommended that fixing transactions should be priced "in a manner that is transparent and consistent with the risk borne in accepting such transactions". Accordingly, some banks are now charging clients for executing their orders at the 4pm London fix.

"Creating a business that imposes trading risk but doesn’t have an explicit revenue model associated with it could create the potential for harmful behaviour, so it is important to make sure market participants are compensated for the risks associated with particular business models," Weisberg explains.

As industry officials work with central banks and regulators over the coming year to review the regional FX committee codes of conduct and ensure they are properly and consistently enforced, it will be critical

to make sure such issues are properly addressed. The alternative to dealing properly with conduct issues now, Kemp believes, could be more fundamental and possibly detrimental changes to the market structure.

"One key question has been whether the findings of the investigation and market reviews point to the need for changes to the structure of the market or to the need for enhanced conduct in the market," says Kemp.

"The general consensus is that the current FX market structure works well and provides a good service for end users. Given that sentiment, what is clear is that bad conduct absolutely needs to be dealt with through enhanced conduct guidance and enforcement, while any structural change should be kept to a minimum to ensure we retain an effective market for end users."