To recap, the Code was launched in May 2017. It was the product of collaboration between central banks and market participants from 16 jurisdictions led by the Reserve Bank of Australia deputy governor Guy Debelle. It is principles based and as it explains at the outset, “the Code does not impose legal or regulatory obligations on market participants nor does it substitute for regulation, but rather it is intended to serve as a supplement to any and all local laws, rules, and regulation by identifying global good practices and processes.”
At time of writing, 1,057 organisations from around the world had signed the Code’s Statement of Commitment, most of these, but by no means all, are banks, liquidity providers and electronic platforms. It is fair to say therefore, that the Code is truly global and adoption has been widespread across the FX market whose daily turnover was put at USD6.6 trillion in April 2019 in the Bank for International Settlement’s December 2019 Triennial Central Bank Survey of foreign exchange and over-the-counter (OTC) derivatives markets. That’s some success from the low ebb reached post the 2008 financial crisis and the subsequent market abuse cases.
However, like every other FX market practice, procedure, regulation and convention, the Code was established prior to Covid 19, which exiled market participants from their trading floors, dealing rooms and office workstations to their home offices, back bedrooms and dining tables.
What that meant for market activity and behaviour was addressed in a 26th March Statement on FX Market Conditions by the Global Foreign Exchange Committee (GFXC), a forum comprising of central banks and private sector participants whose aim is “to promote a robust, liquid, open, and appropriately transparent FX market.”
It said, “Given the intense volatility seen in global financial markets this month, it is possible that FX market participants may execute larger than usual FX volumes during end-of-month benchmark fixings. In addition, FX market participants may face more operational constraints reflecting lockdown in some financial centres. In light of these possible developments, significant volatility and price movements may be observed during FX fixings in the coming days.”
The GFXC encouraged market participants to follow the Code’s precepts and this was valuable, according to Chip Lowry, Chair of The Foreign Exchange Professionals Association (FXPA) that represents FX industry participants. “Existing business processes changed, some of them changed dramatically as a result of the Covid-19 situation, and people used the Code to go back to first principles saying, “Now what does this mean for us where we have traders and salespeople working from home, where historically that would never have been in the solution set. We never would have considered salespeople and traders working from home.” The code has given us a structure by which to rethink some of those, and certainly the GFXC with their statement gave us the particulars of where we should be looking.”
Coping with high volatility
For Neill Penney Managing Director, Global Head of Trading at Refinitiv, the proof of the pudding is how the market worked and coped with the period of high volatility in late February and March. “Spreads doubled, they tripled, they quadrupled in some markets. Last look rates, again, rose, and obviously everybody would like to have had really tight prices all the time and very low last look reject rates, but in a period of extreme volatility that can’t be the case. I think the market as a whole understood that... The Code, along with other measures, has driven concrete improvements in the way counterparties work together. This includes the way algorithms are implemented, the way last look is implemented, the transaction cost analysis (TCA) tools that people use to track their execution for example. It’s created a culture where somebody says, “I don’t understand why my spread’s got wider,” and they can feel empowered to talk to their market maker about that and get an answer that satisfies them as to the difficulties of the market and how that’s reflected in their pricing.”
It may be early days. No one knows if Covid is now over, whether there might be further outbreaks or whether it’s here to stay. Trading floors have not returned to normal conditions and many market participants are still working remotely. Moreover, if there have been any misdemeanours in the market during lockdowns they may not yet have come to light. If the Code has been universally observed and adopted, there shouldn’t be any but the market is made up of individuals and there could be temptations for them to err while out of sight of their organisations and colleagues.
So should the Code be adapted in any respect to cover a new normal, Covid-present working environment? Code author and GFXC Chair Guy Debelle, thinks not. “No one I’ve spoken to expressed the view that the Code should be updated for this reason exactly because it’s principles-based. There’s nothing there about location in it. Nothing that I’ve heard that’s come up in any of our discussions around how things have gone in the working from home environment has highlighted anything in particular.”
Meanwhile, the Code is now three years old and is due to be reviewed, in line with the original plan, to check how it has fared and whether any adjustments are required. The Code was never meant to be a static rulebook. Rather it was designed as an evolving piece of guidance that would keep pace with a market that is constantly changing, for example through adoption of new FX products, new technology and other developments.
The GFXC agreed its priorities for updating the Code in December last year, based on feedback it had received from market participants. The priorities are:
Sell-side firms have, for the most part, swiftly adopted the Code. No bank for example, wants to be seen not to have adopted it and so most have registered their Statements of Commitment to the Code with a local public register. The buy-side has been slower to follow. This has been largely because for buy-side participants, FX is typically not their main business activity. Many of these, especially those engaged in regulated activities such as fund management, have had their hands full complying with a raft of mandatory regulation and focussing on voluntary guidance has slipped down their to do list. Others feel that the Code is more of an issue for banks and larger financial institutions to address, rather than them.
“Buy-side adoption is by far the priority in everybody’s minds,” says Refinitiv’s Neill Penney. “We have some real work to do there. The Code does, I think, capture the definition of good conduct but we have to make it more digestible to the buy-side. So, speaking personally, we need to look at the concept of proportionality. That means you start with everything in the Code and you cut away what’s not relevant to a buy-side market participant. I’d almost prefer a bootstrapping approach where we say, “If you’re such-and-such a type of customer, why don’t you look at these four principles first, or these six principles first? These are the most relevant to your business.”
An additional point which has a buy-side impact is the place where a firm’s Statement of Commitment is registered. Guy Debelle has always stressed the global reach of the Code which should be relevant, applicable and adopted in its entirety across all regions for what is after all a global FX market. However, FXPA Chair Chip Lowry is concerned that registration with a public register in one jurisdiction may differ slightly to registering with one in another. It may also imply adoption of local market rules or standards. While this is not necessarily problematic, organisations with international reach need to be mindful of the implications for their operations in case they unwittingly fall foul of local rule or regulation that they have in fact signed up to by registering the code in a particular jurisdiction.
A further potential concern is the role of private registers. If a market participant is not registered with a particular private register that a counterparty approves of, this may be an obstacle to doing business with them. In addition, this may hand an inappropriate degree of market power to particular private registers which may not suit everyone.
The GFXC’s review agenda includes considering additional guidance on anonymous trading on e-trading platforms. This was the subject of a report published by the GFXC in January where the concern is that when trading with an anonymous counterparty, market participants should be aware of the risks that may be inherent if doing so and that there should be a sufficient level of disclosure.
“The clarity and adequacy of some elements of disclosures made by market participants remained an issue,” the GFXC says, as a result of its market survey feedback. Guy Debelle makes the point that disclosures can come in all shapes and sizes – “…either they’re 200 pages long, and have been written by lawyers for lawyers, and require a lawyer to actually understand them, or they’re just saying, “Well, here’s a disclosure, and that actually means I can do whatever I want.” That’s one of the key areas of focus, to try and say, “Okay, here is some sort of stuff you need, the minimum stuff you need to cover in a disclosure to make it effective.” Some disclosures are basically a long-winded version of caveat emptor, which is not really what we’re after here. So we’d like to offer a bit more guidance as to what we do expect within this space,”
Neill Penney agrees, “There’s more work to do on disclosure and I think the essence of the Code is absolutely right. Principle-based, not prescriptive. Efficiency comes from freedom to determine the right trading model for the different types of counterparties in the FX market, and that’s balanced off by the transparency, that people understand what they’re purchasing when they purchase foreign exchange.”
Algorithmic trading and TCA
The use of algos and the availability of TCA tools have increased significantly since the Code was launched. The GFXC therefore feels that it may be time to include in the Code additional guidance of these aspects of market practice.
“The GFXC discussed the extensive feedback on various execution principles in the Code, particularly those dealing with pre-hedging and last look,” the GFXC says. “It was agreed that there was a clear need to respond to this feedback.”
It may be significant that last look has slipped to fifth and last place on the review agenda. Significant, either perhaps because it is not going away or that there may be less heat around it than there was three years ago. Some may still contend that last look protects banks in a quote driven system and be counter to the interests of liquidity takers. That it enables banks to deal at rates that always suit them rather than the customer. Guy Debelle’s view is that education as to what last look means could be useful, so that liquidity takers understand its implications. The recent period of high market volatility has perhaps reduced the level of concern around last look. Counterparties may have been forced to adopt a win-some, lose-some philosophical view because no one could read how the market would move. In addition, a definition of last look could include further clarity in its use. If a last look is used to ensure the liquidity provider (still) has credit to trade with the counterparty, that may validate its use. That last look might be used to either front run a client or merely to gather market information without an intent to trade, points to market abuse. The triennial review could and some have argued should put the concerns around last look to rest once and for all.
An area not specifically slated for discussion during the Code’s review is settlement, a topic leading settlement firm CLS is understandably interested in examining more closely.
“Mitigation of settlement risk is a high priority for the FX community, and its importance was reaffirmed during the emergence of the Covid-19 pandemic,” says CLS CEO Marc Bayle de Jessé. “Firms already using payment-versus-payment (PvP) settlement services and netting services were better positioned to continue seamless operations during a turbulent March and April.”
He believes that Covid-19 is further evidence of the value of PvP, reinforcing “the need to further promote PvP as best practice for market participants. For example, there may be scope to strengthen Principles 35 and 50 of the Code (relating to FX settlement risk mitigation) to better emphasise the use of PvP settlement solutions.”
To conclude, the Code seems to have provided a valuable set of principles to assist the market in responding to the impact of Covid-19. It has proved to be just as relevant, and possibly more so, as the market went home to work and used technology to replicate the trading environment as closely as possible. That the massive, global FX market continued to function successfully in the way that it appears to have done is proof of concept for the principles of the Code, though from a practical point of view, the market’s view may well be, “It was the technology that got us through.”
When the Code was launched three years ago, Zoom didn’t exist. Since then, the power, speed and sophistication of technology tools such as algos have developed considerably. E-trading has become the norm. If the Code requires an update, it may be mainly because technology has led the market forward, but the need for market integrity and best practice remains constant, especially in times of global crisis, such as a pandemic.
The FX Global Code is structured around 6 leading principles, encapsulating 55 sub-principles. The main areas covered are: