Of all the ways in which the foreign-exchange industry has been described over the years, the phrase ‘ethical drift’ could well be the least desirable.
The term was coined in the UK’s Fair and Effective Markets Review (FEMR) last year to explain the multiple structural failings that led to serious misconduct in wholesale fixed income, currencies and commodities markets.In FX as in other asset classes, FEMR noted, informal codes of behaviour had been misunderstood or ignored, while within banks, internal controls and personal accountability were often found to be lacking.
Throw in compensation schemes that incentivised market participants to take big risks for short-term rewards and it becomes clear how structural opportunities for market manipulation facilitated misconduct.
Clamping down on misconduct may have been partially achieved through the multi-billion-dollar fines and remediation processes meted out by regulators, but they are only a small part of the battle to restore trust. Initiatives such as FEMR could prove to be much more significant in the long term.
For the FX market, few initiatives have received the same level of official sector and industry engagement as the move to develop a global code of conduct, first announced by the Bank for International Settlements in May 2015. The new rulebook, phase 1 of which was published in May 2016, will replace the many regional codes that are now acknowledged to have been insufficient.
The industry has been very receptive to the concept of
a single code of conduct and has made a constructive contribution to the process
- Guy Debelle
The global code articulates a consistent approach to a range of industry practices where regional standards may previously have differed, including trade execution, information sharing, governance, trade settlement, ethics and electronic trading.
Its value will be not simply to bring greater clarity and fairness to complex issues, but also to create a harmonised set of best practices that can be applied internationally.
“The industry has been very receptive to the concept of a single code of conduct and has made a constructive contribution to the process so far,” says Guy Debelle, assistant governor of the Reserve Bank of Australia and chair of the FX working group drafting the code.
While the initiative may be designed to rectify widespread failings in behaviour and controls among banks, its architects in the public sector have been conscious of the need to draft standards that will achieve that purpose without jeopardising the efficiency of the FX market.
Comprehensive industry input has been made through a market participants group, comprising 33 representatives of the buy-side, sell-side and market infrastructures and chaired by David Puth, chief executive of FX settlement utility CLS.
On top of the drafting process, a separate workstream led by the Bank of England is looking at ways in which adherence to the code will be promoted and incentivised. Such mechanisms are likely to be critical because the standards won’t have the force of law and will rely on the commitment of institutions to take them seriously.
At this stage, the level of awareness and preparedness is likely to vary significantly across the industry. The largest banks may well have many of the necessary processes and controls in place, but the code will also impact smaller institutions and buy-side firms.
“There has been a general lack of common understanding of how client orders should be handled, but it’s important to remember that the code is intended for both sides of the market,” says Debelle.
“It will set out not just how the banks should behave, but also what customers should expect from an intermediary in terms of execution and information sharing.”
For the banks, this has been a period of intense adjustment, as many have had to deal with the impact of heavy fines, intense scrutiny and a reduced level of trust in the integrity of the FX business.
After the collusion and sharing of confidential client information that was revealed to have taken place in chat rooms, it is no surprise that the general level of industry chatter has diminished, making it harder for sales teams and traders to share market colour with their colleagues and clients.
There have been knock-on effects for buy-side firms, too. With banks having to make substantial changes to their business models, with a greater focus on surveillance and control, many buy-side trading desks are looking to take greater control over execution to make sure they always get the best and fairest deal possible.
But as the scandal slowly begins to recede into the rearview mirror, some practitioners are cautiously optimistic that the industry is turning a corner.
With much of the remediation work demanded by regulators now complete or at least well advanced, many banks have more robust surveillance and controls in place that should help to identify conduct issues quickly in the future.