FX: Market struggles to interpret global code

Adherence to policy in the FX market is always a hot topic, but even more so with the approaching end-of-May deadline for the code.

Market participants need to understand that stating their commitment to the code is only the beginning of the process – and that keeping it up might be trickier than they imagined.

For example, the first principle of the code states that “market participants are expected to behave in an ethical and professional manner to promote the fairness and integrity of the FX market”.

Yet different societies have different ethical practices, and ethics also evolve over time, so what might be deemed fully ethical now might not be deemed so 10 years down the line, says Richard Longmore, co-founder of Finoesis, a capital markets consultancy.

In effect, market participants are subject to a permanent look-back by regulators through the prism of an evolving set of ethics, he adds.

“This places a heavy burden on senior management in trading, sales and compliance to ensure that there is a constant adherence to a changing landscape at a time when there has been significant delayering – typically at the higher end of the management experience scale – and the consequences of failure are exponentially higher,” says Longmore.

Julian Gladwin, co-founder of Axiom Global Advisors, says adherence demands a comprehensive review of people, policies, procedures and practices across the firm’s FX activity; an appropriate framework to monitor ongoing adherence; and the ability to proving to counterparties, investors, shareholders and regulators that all FX activity is in line with the code.

Yet many buy-side firms – particularly asset managers – have limited internal compliance resources for conducting in-house training, says Paul Chappell, director of education at the ACI Financial Markets Association.

“Even those organizations with large internal training capabilities need to know what they are benchmarking themselves against,” he adds.

Last look

According to Institutional FX Advisory Partners founding partner Henry Wilkes, there is a widespread belief that on some specific issues, such as last look, the GFXC – which maintains and updates the code – has not provided clear and strong guidance, making it difficult for market players to interpret what is good practice.

With last look, that could undermine the confidence of market participants, which could have a knock-on effect on the quality of liquidity provided by certain banks and platforms, he says.

“My concern is that there doesn’t appear to be a clear method of measuring and enforcing how market participants who make a statement of commitment actually adhere to the principles of the code on a daily basis,” adds Wilkes.

He suggests that participants consider attestation compliance benchmarking, in which qualified third-party firms certify that institutions are conducting their businesses in line with an independent standard benchmarked to the code.

Axiom Global Advisors co-founder Nick Downes notes that the larger the organization, the more interdependencies it has with other market participants, which makes adoption, governance and the evidencing of ongoing adherence more complex.

ACI’s Chappell agrees that it is not always easier for larger organizations with greater resources to achieve and maintain compliance.

“There are elements of the code – particularly around pre-hedging as well as last look – that demand a significant cultural shift and some large market participants have a long way to go in this respect,” he says.

Longmore at Finoesis reckons there will always be a desire for greater clarity, since applying the code will inherently require making subjective judgements.

“In general, it is felt that the code is a work in progress,” he says. “My own thoughts are that the committee will probably be forced to offer an opinion in the case of significant events of conflicting interests.”

One of the most interesting developments in relation to the code is the extent to which corporates commit themselves to adherence. When the code was issued, some firms assumed it was targeted at a few dozen misbehaving banks and were surprised to learn it was intended to cover all market participants, according to Chappell.

“Corporates signing up will definitely become more commonplace,” he concludes. “Rather than the major market makers signing up to the code and then persuading their clients to do so, corporates will take the lead and push their banks to follow suit.”

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