It will not have the force of law, but a global code of conduct being drafted for the foreign-exchange market will be central to addressing conduct issues that have emerged in the wake of the benchmark rigging scandal, according to regulators and industry bodies.
“There is a requirement for staff to comply with relevant standards of market practice, so in our senior managers and certification regime, we will expect firms to show that their staff are complying with those standards.”
Speaking at the Association for Financial Markets in Europe’s (AFME) European fixed income and FX market liquidity conference in London on February 25, Schooling Latter raised the possibility the FCA might revoke certification of individuals and managers if the code of conduct is not properly enforced.
The comments get to the heart of one of the major unknowns regarding the high-profile code of conduct – how it will be enforced without the power of law. The Bank for International Settlements announced the code last year and drafting is now well under way, with the aim of it being finalized by May 2017.
“Previously we had seven or so different codes in different regions and that actually does create some challenges, because when you’re looking at a global asset class, you want to have a single standard to which you’re looking to conform,” says James Kemp, managing director of the global FX division of the Global Financial Markets Association (GFMA).
“Where the challenges are going to come is in the enforcement and adherence mechanisms, and making sure they don’t create an unlevel playing field.”
The code of conduct will cover a range of market practices, including order handling, information sharing, settlement and electronic trading. In recent months, the working group has addressed the distinction between principal and agency models of execution, with the aim of creating standard definitions of the two practices.
In a principal model, the dealer typically takes the other side of an order, whereas an agency model sees the dealer working the order in the market as a third party.
However, speakers acknowledged there is a grey area between the two models, such as executing orders at a reference rate.
“Difficulties can arise when you have types of transactions that are not purely agency or are not purely principal, and FX trading at the fix is a great example,” says Andrew Morton, global head of G10 rates, markets treasury and finance at Citi.
“It’s not obviously an agency trade and it has the feel of a principal trade, but the price is determined by the fix.”
Schooling Latter welcomed the discussion of conflicts relating to agency and principal trading, adding that a key element to consider is discretion. In cases where the dealer is contractually acting as a principal, but retains some degree of discretion, the transaction crosses over into agency territory.
“For us that’s an underlying principle – where you are acting with discretion and holding yourself out as doing that in the client’s interest, then you have to demonstrate you can do that in practice as well,” warns Schooling Latter.
Trading at the widely used WM/R reference rate has changed significantly over the past year, after the widening of the calculation window in February 2015 from one to five minutes. The rate is now calculated on the basis of live trades in the 2.5 minutes before and after 4pm London time each day.
|James Kemp, GFMA|
“Changing the window has changed behaviour in terms of when people are trading and how they’re trading,” says GFMA’s Kemp.
“The idea was to reduce concentration – whether it has done that completely is a moot point, but what it has meant is the risk profile has changed and you have new entrants coming into the window while others are starting to question whether they want to continue taking orders at the fix.”
Beyond the changes to the fix and the emergence of the new code of conduct, the FCA’s supervisory remediation programme – announced as part of its FX enforcement action in November 2014 – has also seen greater scrutiny of industry practices as banks have been required to review and improve the systems and controls in their FX businesses.
“The remediation process has succeeded in identifying the main risks and building some controls around those specific risks, but we haven’t finished answering all the questions around the specific duties owed in relation to an order which is not immediately executed – there is still some work in progress on this,” says Michael Kent, partner and global head of the finance and projects division at Linklaters.