FSB’s fix proposals come under fire
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FSB’s fix proposals come under fire

Global regulator the Financial Stability Board (FSB) has published its proposals on how to restore the integrity of foreign-exchange rate benchmarks in the wake of alleged market malpractice, but market participants argue these simply mask deeper structural problems in the industry.

Foreign-exchange benchmarks, of which the main one is the WM/Reuters (WMR) 4pm London fix, hit the headlines last year when allegations emerged that dealers were ‘trading ahead’ of the fix and colluding to generate a fix rate which would garner them a profit from the fix trading.

The FSB formed a working group, chaired by Guy Debelle of the Reserve Bank of Australia and Paul Fisher of the Bank of England, to propose possible solutions. The FSB is now seeking feedback from the industry on its 11 proposals, which were published earlier this week.

Fix the fix

The WMR provides spot fix rates for 160 currencies using data from Thomson Reuters Matching or EBS. Sixty-one single snapshots of trade and order rates are taken over the course of a minute from 30 seconds before to 30 seconds after the 4pm fix time. This data is then calibrated and used to generate a bid and offer rate, known as the fix.

Paul Fisher, co-chair of the
FSB fix working group

The FSB proposes to widen the one-minute fixing window and is seeking feedback as to how big the window should be and whether the fixing window should continue to be centred exactly on the hour – but some market participants say it is irrelevant.

Kevin Milne, former chief executive officer of Rate Validation Services – a technology firm that was hired to help overhaul the Libor benchmark – and previously a member of the London Stock Exchange’s executive committee for post-trade business, says the proposal “misses the point”.

Theoretically, traders could still game the fix even if the fixing window is widened to include as much as the entire trading day, because there is a gap between trading a currency and the trade settlement of up to two days.

“Traders can build up a backlog of trades throughout the day that are used to calculate the fix, and then cancel them before submitting them to CLS for settlement,” says Milne.

He believes regulators need to scrutinize all trades, including cancelled, deleted or amended trades to find and stamp out nefarious trading.

Fix the bigger problems

The ultimate solution is to reduce settlement of spot FX trades from two days to real-time, which is “very easy” because spot FX simply requires an electronic transfer, says Milne. The width of the fixing window therefore wouldn’t matter because trades would have to be immediately processed and would deter traders from inputting false trades.

“I don’t know why it does not happen already,” says Milne. “There is no good reason. Foreign exchange is saddled with antiquated processes – there are many intermediaries who make a lot of money out of inefficiencies.”

Guy Debelle
Guy Debelle, co-chair of the 
FSB fix working group

The FSB is also considering whether WMR should increase the number of sources that provide price feeds and transactions data to improve its coverage of the FX market during the fixing window.

“The broader the information sources, the better,” says Hector McNeil, co-chief executive officer of Boost ETP, which offers currency exchange-traded products. “FX is still dominated by a handful of banks.

“But the whole process of fixing is flawed. Improving that doesn’t fix the problem. We need a more freely tradable market in FX. [It] seems odd that so much business gets done around a benchmark.”

The FSB is also exploring the creation of a central utility for order matching to facilitate fixing orders. The fix is widely used to benchmark FX managers’ performance, which some believe invites them to be complacent when they should be seeking out the best returns for their clients.

“There is a risk of further complacency on the part of asset managers to prove their own alpha-generation if the central fixing utility draws in more volume,” says Marshall Bailey, president of trade association ACI International.

“The unintended consequences of further concentration of FX flows may not be what the regulators and supervisors want.”

More broadly, the FSB wants banks to establish and enforce their internal systems and controls to address potential conflicts of interest arising from managing customer flow.

This is the one proposal that market participants can agree on. The onus is on banks to improve their behavioural standards, says David Clark, chairman of the Wholesale Markets Brokers’ Association.

“Something went wrong with the banks’ ability to oversee its people,” he says.

The sheer size of today’s banks means that regulators are faced with a mammoth supervisory task, and the largest banks are reacting by focusing heavily on their ‘three lines of defence’ to monitor control, compliance and group risk, says Milne.

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