FEMR consultation highlights scale of regulatory challenge in FX
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FEMR consultation highlights scale of regulatory challenge in FX

In its fair and effective markets review, the Bank of England has acknowledged end-users are largely ill-suited to the task of combating market misconduct in FICC markets. But opinion remains deeply divided over how best to strengthen oversight in wholesale markets, and which regulatory body should lead the charge.

Buy-side and end-user institutions feel unable to police market conduct by moving business away from counterparties perceived to have engaged in abuse, according to Andrew Hauser, director of markets strategy at the Bank of England (BoE).


Andrew Hauser, at the
Bank of England

Speaking in his role as head of the fair and effective markets review (FEMR) secretariat to an audience in London on February 25th at an Association for Financial Markets in Europe conference, he said respondents to the FEMR consultation felt unable to act as a central bulwark against misconduct.

Although technically able to shop around and avoid institutions perceived to be abusing the system, end-users feel their primary concern is to secure the best possible terms for each transaction, he said.

The finding calls into question the viability of the BoE’s regulatory ethos, which contends that wholesale markets needn’t be heavily regulated because end-users will hold financial institutions to account.

And Hauser explicitly acknowledged this, warning firms it could mean tougher oversight from the regulator. “If neither market discipline nor firms’ self-discipline can be relied upon to operate more effectively, more intrusive regulation may be the inevitable consequence,” he said.

The system’s failure to police itself has been laid bare on numerous occasions in recent months, with the FX market – long seen as the poster-child for well functioning, unregulated markets – taking centre stage in the rate-fixing scandal.

The FEMR consultation intends to identify how best to restore confidence and trust in the fixed income, currencies and commodities (FICC) markets. It identifies common themes in FICC misconduct in the hope of finding solutions applicable to all.

Most importantly, it seeks input from market players regarding how best to strengthen oversight, asking 49 questions in areas such as how best to manage conflicts of interest and maintain market discipline, benchmarks and surveillance.

The FEMR board promises to use the responses to these questions as the basis for its recommendations, which are expected in June. Hauser insisted no conclusions have yet been reached and the market can only guess what the final recommendations will be.

'Easily manipulated'

However, it is hoped some of the more glaring examples of unfairness and ineffectiveness in the FX market will be tackled.

“Fixing is a legacy from the past and even if it wasn’t so easily manipulated it would still be a crap system,” says Fred Ponzo, managing partner at consultancy GreySpark Partners. “I would like to see FEMR propose a new mechanism for setting the benchmark price, probably via a series of auctions.”

Among the key questions up for debate is whether there should be an explicitly regulatory response or whether the market can do a better job of policing itself with more universally accepted codes of conduct.

The latter has naturally proved the overwhelmingly more popular choice in the market. Marshall Bailey, president of the Financial Markets Association (ACI), believes it will prove easier to agree to the adoption of codes of conduct that apply across borders than globally agreed regulations.

And he believes a code of conduct is better placed to tackle the problems recently exposed in the financial system.

“With the more recent misbehaviours that have occurred, the central issue is not so much about the structure and operation of the market, but rather the behaviour of a few individuals and a lack of ethics and conduct,” says Bailey.

Trader education, not regulation, is key to
solving the current market issues

Marshall Bailey, ACI

Although there is broader support for a code of practice-style solution than for tougher rules, some have expressed reservations about this approach. While it might be easier to agree a code of conduct globally than a binding set of rules, it might still prove out of the reach of so diverse a collection of participants and geographies.

That would be true even if the market had a clean slate, but given the existence of at least seven existing codes of practice which apply to the FX space, it is even more challenging. The question then becomes, which ones should people be looking at? And can these codes be consolidated?

Some of these existing codes, such as the ACI’s model code, are global in coverage, even if not universally adopted. Others are more nationally focused, such as the UK’s non-investment products code. Yet institutions that trade across borders have to be aware of all of them and, taken together, the message can become quite muddled.

“The existing range of market and industry-led guidance can be contradictory, diverse and often lacking in practical examples to be truly useful to front-office participants,” says the British Bankers’ Association (BBA), though when pressed for an example of guidance being contradictory it was unable to provide one. 

The FEMR’s market practitioner panel (MPP), chaired by Elizabeth Corley – CEO of Allianz Global Investors – echoes the BBA’s concerns, saying: “Codes, regulations and other sources of information across activities, geographies and types of firm were overlapping, contradictory, difficult to navigate and/or not fully consistent.”

The ACI insists its code is widely accepted as the most complete and believes it can form the basis of a universal code, transcending the others. Having a single code – whether it was the ACI’s model code or another – would certainly be the neatest solution.

However, most see this as wishful thinking. If the US and EU cannot even agree on a unified approach to a single, specific problem such as benchmarks, what hope is there on all global regulators agreeing to a far more detailed and comprehensive code of practice?

Dominant position

Rather, there is a worry that instead of resolving the issue by helping the industry settle on a single code of practice, FEMR might instead add to the problem by coming up with yet another set of recommendations for best practice that will only apply in the UK.

Whether FEMR succeeds or not will ultimately hinge on whether the UK can leverage its dominant position in FX to influence the whole market, or whether it just creates another layer of global regulatory inconsistency.

If any single jurisdiction is in a position to influence this global market it is the UK. Around two thirds of global FX is traded in London. To put this into context, one day of FX trading in London is greater than the market capitalization of every stock exchange in the world put together, says Ponzo.

As such, the UK is arguably best placed to lead the regulatory debate in FX.

David Strachan, partner in the European Centre for Regulatory Strategy at Deloitte, says: “It would be short-sighted to regard the outcome of the FEMR as only affecting the UK. Given the UK’s role in global markets, what starts there is bound to have ramifications for other major financial centres.”

You could argue the market itself has endorsed this view, given that 50% of the responses to the FEMR consultation came from overseas.

Further reading


FX scandal: in the spotlight

However, some remain convinced a global initiative will be needed to tackle the market conduct issues in the FX. The BBA argues the debate should be taken up by an international regulatory body, such as the International Organization of Securities Commissions or the Financial Stability Board, which should agree to a set of regulatory principles that the various existing codes can align with.

Crucially, regulators must then explicitly endorse the codes they believe best reflect the internationally agreed principles, so the industry can be confident adherence to the codes provides them with a regulatory safe harbour.

Even without the guarantee of a safe harbour, the codes have been criticized for being difficult to translate into practical guidance. The MPP says there is inadequate communication and training on codes, policies and procedures, and a disconnect between these codes and firms’ incentive and promotion policies or decisions.

This is another area in which ACI insists it is making great strides.

“Trader education, not regulation, is key to solving the current market issues, and once individuals are made aware, their managers and compliance departments need to make sure it is enforced appropriately,” says Bailey.

The ACI has developed an e-learning and certification portal to maintain its standards as markets evolve, says Bailey, adding: “There is no other code or institution with such a strong ability to lead the world’s conduct training.”

He believes the ACI’s model code offers the best hope of a globally accepted set of principles.

“If applied universally and backed by regulators, it has the potential to provide a moral compass and guidance to which all professionals can adhere,” concludes Bailey. 

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