A YEAR OF LIVING DANGEROUSLY
A personal view by Patrick Fleur.
Last year was volatile not only in terms of market movements but also around claims of market manipulation and collusion, with the focus on FX benchmarks. An initial article on the topic appeared on Bloomberg in June 2013 but the reaction was relatively subdued. But when it was published again some time later it sparked off all manner of questions and initiatives.
Never, in my almost 20 years in FX, have I received so many phone calls and emails on a topic, and it hasn’t gone away yet. On the contrary, it looks like 2015 will continue to be dominated by issues around FX benchmarks.
The 4pm London fix
After recommendations by the Financial Stability Board (FSB) the first movers were the UK, who developed the Fair Effective Market Review (FEMR) committee, a joint initiative by the Bank of England, the Financial Conduct Authority (FCA) and HM Treasury. This has been followed with great attention by other regulators and industry bodies around the globe. In the meantime, though, a great deal had already changed in the FX market.
Many of the allegations centred on the pivotal London, 4pm foreign exchange fix, a daily rate determined by trades in a 60-second window. In an attempt to address this, there are a number of new initiatives around netting facilities, with the first two going live in Q4 2014. It is attracting some liquidity but the matching figures are still not high enough to prevent some substantial swings around this still increasingly popular fixing time. It is frightening to see that some participants wait all day and execute the majority of their trades just before 4pm instead of spreading their risk over a longer timeframe. The good news is that WM Company (a provider of the WM/Reuters benchmark fix at this time) plans to widen the existing 60 second window to 5 minutes, based on the average suggested time from feedback to the FSB paper. Unfortunately some of the other suggestions haven’t been followed. For example, greater transparency on how it’s being calculated and also optimising the venues used to make the calculations haven’t been implemented in the most ideal way. The request for consultation as conducted by WMR certainly wasn’t optimal. In the first place, hardly anybody had seen the request, and secondly the time offered to reply was so short that many people were unable to respond due to internal compliance policies. There’s room for improvement in this New Year.
Another big theme, correlated to benchmark issues, concerned behaviour. Most sellside organisations updated and implemented numerous internal procedures on client interaction, sharing of client information and fixing procedures. Unfortunately, communication of these procedures to clients is not formalised and hence only happens rarely. This is one of the main reasons why I am a firm advocate of the ACI Model Code (a formal attempt to encapsulate the best possible practice and code of conduct in the financial markets industry). It is the only document that gives a good description of proper behaviour for all market participants (not just those poor bankers!). While not new, there is an updated version on its way, which will also address recent issues such as: last look, barrier protection and behaviour around fixings. Needless to say it contains a section on information usage and sharing, more reasons why we will be talking about benchmarks through 2015.
Alongside the ACI Model Code the major central banks are working on their own code of conduct. Hopefully the awaited abstract will capture most of the issues and reduce the differences between individual codes. A few central banks have already adopted the ACI Model Code, and who knows, perhaps the new version can ‘seduce’ the other banks into adopting it as well. I do believe these codes should be the standard for all participants in foreign exchange and should form the base upon which to construct internal policies. Only when you know what the policies and minimum standards of behaviour are can you create a level playing field – not only around fixings but throughout the 24×6 FX market.
One of the missing pieces of the puzzle is transparency around market data. The European Market Infrastructure Regulation (EMIR) partially addresses this by relinquishing all swap transactions to a trade repository. However, this is not applicable to spot FX, which is where the crux of the problems have been. There are some commercial activities emerging to create something which starts to look like a consolidated tape in FX, but the willingness of the bigger players will be crucial if these initiatives are to survive. I am actively lobbying for this wherever my voice is heard, but costs are still the main argument against this, as well as the lack of clarity about which problem it will solve. At least it would create more transparency around mid-market and give TCA more meaning. Plus, it would allow users to have more independent TCA rather than from the vendor used for execution. It would also give more insight into what the added value of dark pools and internalisers is.
Agency or principal?
The final topic which gained momentum last year is the way price makers are dealing with the order flow of the other market participants. Currently it is not always clear whether they act as agency or principal, what happens with the transactional data, and who has access to the information on this flow? Not only should this become more transparent for end-users, but the regulator should be looking more closely at how banks have set up their internal Chinese walls. They should be asking whether the internalisers of these institutions are treating the client flow in a fair way when their internaliser acts as a dark pool?
2015 will be an interesting year in which many of these topics will again dominate the FX world. After the new WMR fixing window goes live in February, it will be interesting to see how successful some new initiatives on matching engines, exchange-traded FX and the new versions of the different codes of conduct will be. The microstructure of FX is changing rapidly and it is finally moving in the right direction. Despite all its issues the FX market is still a wonderful world in which to work.©BestExecution 2015