Launched on 25th May 2017, the Code was the result of a partnership between central banks and market participants from 16 jurisdictions. The project leader and principal author was Reserve Bank of Australia deputy governor Guy Debelle. It is principles based and the text is at pains to make clear 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.”
No sanction in the Code then for misdemeanours. Except that a number of the market’s big brands and senior staff have already been severely hammered by regulators, especially in the USA, and others may also be if they transgress. Signing up to the Code grants no immunity in that regard but if being seen to be willing to run a clean operation might count for something, then why not sign up?
That the Code is a continuing work in progress is evidenced by an August 2018 update. There will be more to follow for sure. To date, the Global Foreign Exchange Committee (GFXC) forum’s “Global Index of Public Registers” lists 519 “entities” that have signed up to the Code. These include banks, brokers, institutions, corporates, asset managers, central banks, trading platforms, trading technology providers and non-bank liquidity providers (LP). Signing-up is effected by completing the eight-line “Statement of Commitment to the FX Global Code,” (SOC) the text of which is found in Annex 3 to the Code. Some people we spoke to expressed some cynicism that a USD5 trillion a day market could so simply be made “robust, fair, liquid, open, and appropriately transparent.” as the Code promotes.
Nonetheless, take up has been widespread and it is rapidly becoming an essential element of the fabric of the FX market. “The Code is gathering momentum and is clearly impacting how market participants interact with their customers,” explains Bloomberg’s global head of FX electronic trading, Tod Van Name. “For example,” he adds, “banks are publishing or updating disclosure documents to better clarify the nature of their foreign exchange sales and trading relationship and how they execute FX with their customers.”
“The Code has become a regular talking point with our clients and at all major FX events since its launch,” says Jeff Roberts a business manager at NEX markets. “The major banks now are also all looking to openly publish disclosures on how they handle client requests and orders. There has been a strong sign up to the public registers such as the NEX Register, where market participants can publish their Statement of Commitment, with many keen to demonstrate their sign up.”
Meanwhile Alan Marquard, CLS’ chief strategy and development officer sees the Code as a positive initiative for the market, in that it promotes the highest ethical standards but sounds a note of caution. “The industry has embraced the Code… however, for it to be considered a success, wide-spread adoption and on-going adherence by those who have signed up to its principles is required.”
And indeed there are some continuing challenges, not least with the buy-side that is relatively sparsely represented among those who have so far issued an SOC.
Anecdotally, the buy-side feels that it has been under-represented. The Code has been perceived in some quarters as a central bank / big bank initiative that didn’t have much regard for them. That may be set to change however. “There is now a Global Foreign Exchange Committee (GFXC) Buy Side Outreach Working Group which has been established to encourage buy side commitment to the Code,” explains David Clark, chairman of the European Venues and Intermediaries Association (EVIA), “and to ascertain what challenges these types of firms are experiencing when adhering to the Code’s requirements, including any sign-up and implementation difficulties.”
GFXC established its Buy-Side Outreach working group earlier this year, which is being led by the European Central Bank. It aims to “articulate the benefits and challenges related to adopting the Code.” Among the challenges, are getting to grips with the fact that LPs may have signed up to the ideals of the Code but in fact they do not all operate in the same way when it comes to their dealing practices and processes. As David Mercer, CEO of LMAX Exchange Group, which operates leading institutional FX execution venues, LMAX Exchange (FCA regulated MTF) and LMAX Global (FCA regulated Broker) puts it, “There’s a wide range of disclosures, a wide range of ways of executing orders that are legitimised and allowable under the Code. The great and the good who put it together thought this was a good first step, but there is no doubt that it puts the onus on the [buy-side] customer to understand those disclosures.” Significant issues as well as disclosure are anonymous trading and, controversially, last look, which has polarised opinions in some quarters of the market.
Disclosure and anonymous trading
“The ongoing work is ensuring that the price provider is more open and transparent towards the client and they document it in a way that shows you exactly how they’ll treat you. So, being more open and transparent is an enormous first step,” comments Roger Rutherford chief operating officer at ParFX.
“Previously, in the past, it’s been quite opaque. A liquidity provider might price you in a certain way, and you might try and trade with them. However, they might reject you without any reason if they use last look, or use types of information that are unfair towards you. This might have happened in the past, but will not be the case going forward – largely due to the Code.”
There must however be more steps to follow. Bloomberg’s Tod Van Name succinctly sums up the current state of play. “As participants cannot identify each other in anonymous trading environments, it is impossible to understand what practices a counterparty is using when they are executing with you,” he says. “This makes it difficult to demonstrate adherence to the Code or to measure best execution or perform accurate transaction cost analysis (TCA).”
And, moreover, transparency is not in itself a cure for all ills. David Mercer at LMAX Exchange is forthright. “Ultimately all of those scandals and fines can be solved by disclosure. It’s very simple. If you look at it, it was, “I tell my customer one thing, and I do another.” That’s what it came down to. Now you can say, “Look, this is how I deal with your order.” Every client is now aware of that. Certainly, all the big LPs have issued disclosures to their customers. But has behaviour changed? I’m not sure it’s changed at all, but it’s now, “I’ve now told you how I will deal with your order, whereas previously I didn’t tell you that.” I would say transparency doesn’t necessarily mean good, doesn’t mean better, it just means clarity of disclosure. That’s all. It doesn’t necessarily mean that I’m doing the best thing for you.” Yet, as Mercer points out, the Investment Association (IA), which has over 220 members, who collectively manage more than £6.9 trillion of behalf of clients in the UK and around the world, have described themselves as “strong supporters of the Code.” Yet it, and others continue to have concerns. In May this year the IA issued a position paper on the particularly thorny issue of “last look,” which is enshrined in principle 17 of the Code.
The principle says, “Market Participants employing last look should be transparent regarding its use and provide appropriate disclosures to Clients.” For David Mercer at LMAX Exchange, a no-last-look, central limit order book venue, this legitimisation of last look was a step too far in itself. “All the abuses revolve around that, because you legitimise pricing optionality. You legitimise hold times. You legitimise treating customers differently. The Global Code, the FX industry, adopted last look. Why does it not exist in any other asset class? No one has ever answered me that question. Why is it so important in foreign exchange, and irrelevant everywhere else? Why does someone need to hold a customer’s order for 100 milliseconds? What would I do differently? I’d get rid of the room for abuse. The FX market is potentially storing up a scandal of the future revolving around this.”
The IA’s five-page position paper highlighted the main areas of concern as, “Last look policy and process of transparency, unacceptable practices and data disclosures and timestamps.” In essence they call for greater clarity on all of these issues, recommending that LPs sign up to the Code but also provide much more information. “Investors are concerned,” they say, “about the lack of transparency around the use of last look. The extent to which last look practices may be used may vary depending on LPs’ internal policy and processes.
To help understand LPs use of last look and to provide a fair comparison, investors would value greater transparency on LPs’ general last look policy and procedures.”
However, Jeff Roberts at NEX Markets’ believes that the market is in the process of self-healing the last look wound. “There will inevitably always be scepticism over the actions of some within the last look trading window. But as transparency increases and firms are better able to analyse their transactions with the use of analytics tools such as EBSs Quant Analytics, the impact of dealing with those looking to negatively manage relationships will be highlighted. The symmetry between a reduction in hold times and reject rates over the past 18 months demonstrates that the Code is creating a greater openness and a sea change in behaviour for the better, which in time will dispel any remaining concerns around last look.”
It remains to be seen what changes, if any, may be made in new iterations of the Code and whether the FX markets continues to apply last look which some see as loading the dice in favour of LPs and against their counterparties. Meanwhile calls for greater transparency echo through other areas of the market not, apparently, sufficiently covered by the Code.
“Momentum is definitely also building for greater transparency around life cycle, including confirmation, settlement and data management,” according to Tod Van Name.
The Code devotes 13 of its 55 principles to confirmation and settlement, calling for high quality procedures and processes including straight through processing (STP) to aid risk management, smooth administration and fewer rejected trades, the bane of many market participants’ back offices.
Roger Rutherford at ParFX reiterates the importance of transparency in dealings between counterparties in the post trade environment, even if they are initially undisclosed in the trading process. This can be the case where, for example, a trade can be with a prime broker on behalf of their client.
“A lot of matching platforms on the street that we compete with are opaque, because a trader is only getting the name of their counterparty’s prime broker,” Rutherford explains. “We’re fully end-to-end post-trade transparent, and that means that you always get the name of the prime broker and prime client. Both are crucial – the prime brokers are the guys that you have to settle the trade with. But within the trade ticket you also get to see the name of the prime client so you know who you are trading with. So, we’re fully end-to-end post-trade transparent. Lack of post-trade transparency has become a key concern, and addressing this within the core of the Code’s objectives.”
Another firm that talks about the importance of transparency is leading international broker INTL FCStone, Fred Allatt managing director – North America FX sales, explains that they are seeing significant growth in market participants signing up to the Code. “We are seeing greater transparency both with our customers and with our liquidity partners. This has led to greater success in growing the business and an overall better experience for all parties. We provide our clients the transparency and analytical tools necessary to monitor and analyse the pricing and trading impact.” He adds that while INTL FCStone uses “a significant amount of automation” in its customers pricing, they feel that “there is still an important role for the human in the transaction process, allowing us to provide feedback and greater transparency to all parties.”
EVIA chairman David Clark endorses the transparency point. “Momentum for increasing transparency in FX post-trade processes and other operations has been building for some time,” he says, but adds, “There has also been acknowledgement that appropriate confidentiality requirements are adhered to.”
The future of the market
The FX Global Code has so far achieved considerable buy-in from the major players in the market. And it is they that have the most to gain from a market that is viewed as “robust, fair, open, liquid, and appropriately transparent.” History also shows us they that can also be the ones who lose most from prosecution for malpractice and stand to bear the brunt of cost and compliance burdens should the market have to be formally regulated. So how do those in the market view the impact of the Code and its principles for the future?
David Clark is sanguine in his views; “It will bring back a sense of integrity to financial markets and to the relationships between banks and their clients that used to always be associated with the industry. Crucially it will also emphasise the importance of principles-based supervision over a rules-based approach.”
These views are echoed by Jeff Roberts at Nex Markets. “By stating their commitment to acting in a more ethical manner we should see stronger relationships built between counterparts, while also demonstrating to regulators that the industry can self regulate and thus allow for a more cohesive and robust OTC market unburdened by over regulation.” Roger Rutherford at ParFX, notes that the Code is far from the finished article. “I think it was the right thing to do but it’s not a finished product. A lot of good things have come out of it already, although not everyone has signed up and committed to it. I think there is a general positive momentum behind it, but we’ve got a way to go yet.”
For his part, Tod Van Name is upbeat. “As more sell side and buy side firms adopt the Code and sign the Statement of Commitment, confidence will increase in the fairness of the market and its willingness to embrace transparency and to discourage unethical practice. This will hopefully encourage more interest in trading FX as an asset class and facilitate smooth and orderly markets.”
However, some, like David Mercer at LMAX Exchange have bigger reservations “There’s a lot of column inches written about the Global Code but I have seen no difference. I have seen no change. On the positive side, customers have disclosure. But in my mind FX is taking a wrong turn and moving to become increasingly quote driven. It’s a quote driven market structure and I’m not sure that’s the market that anybody would design today if you were trading a new asset class.”
So in summary, the global FX market has paved the way for its future with a strong set of principles that everyone in the market is able to understand and, with some tweaks and improvements here and there, should be able to sign up to. The proof will play out in the coming months and years. If the market doesn’t follow its own principles and there are more scandals then US and European authorities will be quick to regulate as they have done so often since the financial crisis and this would also deal a blow to principles based self-regulation itself. Some may view the current state of play as merely a stay of execution, others, who are perhaps regulation weary, will recognise this as an opportunity to be grasped and made to work in practice as well as in principle.