Is Lasting Change Coming for FX Market Practices?

Recent Events Lead to Increased Scrutiny

In the aftermath of global market manipulation events, the foreign exchange (FX) market has been subject to increased regulatory scrutiny. Mark Follows examines the compliance trends FX traders should be aware of moving forward, from enhanced surveillance to the management of conduct issues. Here are some strategies the industry can take to improve ethics and compliance.

The foreign exchange (FX) market, one of the world’s largest financial markets, continues to face increasing regulatory scrutiny. Clearly, regulators are in agreement that deep and lasting change is still needed, especially as they review the findings of the aftermath of the various 2013-2014 global market manipulation events. FX market manipulation issues at the time were so prevalent that global fines hit upwards of US$10 billion.

Among the penalties levied were those issued by the U.K. Financial Conduct Authority (FCA), which fined five banks for failings in their G10 spot FX trading operations, as well as those issued by the Swiss Financial Market Supervisory Authority (FINMA), which fined a large bank CHF134 million. Things were also grim in South Africa, where recently 17 banks faced prosecution for manipulating the rand.

The main themes of regulatory concern covered all the expected bases, including risk management, lack of controls, compliance, conduct risk, culture, market abuse and governance. Certainly, it is no surprise then that there continues to be increased regulatory scrutiny and a concerted effort to enhance standards in what is a systemically important financial market.

Globally, regulators have been vocal on FX failings. In the follow-up work to the fines delivered to financial institutions, regulators looked toward establishing measures that would result in real and lasting change in the financial markets. This is perhaps easier said than done, however, considering the complexity of FX, but it is necessary in such a critical global market.

Let’s examine several of the main drivers for the desired, primary changes in FX markets. First, raising standards and strengthening regulation in FX were the subject of the U.K. Fair and Effective Markets Review (FEMR). FEMR proposed various changes, including creating a new civil and criminal market abuse regime for spot FX (filling the void left by MAR). Significant progress against FEMR recommendations have been made, including creating the U.K.’s Senior Managers & Certification Regimes (SM & CR) and establishing the FICC Markets Standards Board (FMSB). The FMSB has produced guidelines for FX surveillance that were a key contributor to the FX Global Code, and they also keep an eye on the wholesale FICC markets for emerging risks. I think it is safe to say that we should expect more to come from them in the future.

Another driver for change came from the FCA, which followed up on its 2014 FX enforcement with an industrywide remediation program aimed at addressing the root causes of past failings while driving up standards across the market.

Clearly, as the FCA itself has stated, the days of traders being able to easily game the system to boost profits are gone. Senior management responsibility has become part of the remediation program, and they must now attest that remedial work had been completed. Senior management responsibility is also a key part of the SM & CR that is extending to all regulated firms, and those on the front lines are expected to concern themselves with the ethics of their firm’s conduct.

The U.K. FX remediation program initially targeted the majority of FX market actors; however, the FCA “expect[s] firms who were not involved in the remediation program to carefully consider the details of the program set out below and to implement remediation plans that are appropriate for their FX business.”

Examples of controls areas highlighted by the FCA as mission critical include:

• A renewed focus on personal account dealing (PAD), particularly use of spread-betting accounts.
• Enhanced surveillance in areas such as: front-running, layering, wash-trading, collusion/coordinated trading (including sharing confidential information externally) and manipulating fixes. Some of these clearly relate to communication surveillance.
• Conduct issues, such as abusing partial fills, deliberately triggering client stop-loss orders or applying indefensible mark-ups.
• Managing conflicts of interest.

As the FCA says, this work is “not about having armies of compliance staff ticking boxes.” In the U.K. and beyond, work is being carried out to ensure there is lasting change in the FX market. Firms who haven’t got the message already should be assured that they face ongoing risks of “significant regulatory and reputational costs.”

Next month, we will see publication of the Global FX Code, produced by the Bank for International Settlements (BIS) with support from Foreign Exchange Working Group (FXWG) that includes regulators such as Reserve Bank of Australia, Bank of Canada, European Central Bank, Hong Kong Monetary Authority, Bank of Japan, Monetary Authority of Singapore, Bank of England, Federal Reserve Bank of New York and more.

The Global FX Code establishes a single set of global principles of good practice for FX markets that addresses ethics, governance, information sharing, negotiating and executing transactions and risk management and compliance among its core standards areas. To avoid heavy fines and regulatory scrutiny, market participants must aim for the highest ethical and professional standards and compliance. And senior management must aim to ensure they have the necessary tools for surveillance in such areas as market abuse whilst monitoring and establishing sound policies in such key risk areas as trading conduct, gifts and corporate entertainment, PAD and conflicts of interest (including personal relationships).

Clearly the FX market will continue to face regulatory scrutiny and change – and it is up to the rest of us to ensure that the change continues to move forward in a sound, ethical and lasting fashion.