The advent of a global code of conduct for the FX market should bring greater consistency, fairness and transparency to key industry practices.
Of all the ways in which the foreign exchange industry has been described over the years, the phrase “ethical drift” could well be the least desirable. The term was coined in the UK’s Fair and Effective Markets Review (FEMR) last year to explain the multiple structural failings that led to serious misconduct in wholesale fixed income, currencies and commodities (FICC) markets.
In FX as in other asset classes, FEMR noted, informal codes of behaviour had been misunderstood or ignored, while within banks, internal controls and personal accountability were often found to be lacking. Throw in compensation schemes that incentivised market participants to take big risks for short-term rewards and it becomes clear how structural opportunities for market manipulation facilitated misconduct.
“Unethical behaviour went unchecked, proliferated and eventually became the norm. Too many participants neither felt responsible for the system nor recognised the full impact of their actions. For too many, the City stopped at its gates, though its inﬂuence extended far beyond,” said Bank of England Governor Mark Carney on on publication of the final FEMR report in June 2015.
Clamping down on misconduct may have been partially achieved through the multi-billion-dollar fines and remediation processes meted out by regulators, but they are only a small part of the battle to restore trust and confidence in FICC markets. Initiatives such as FEMR, which made a number of important policy recommendations to raise the bar on conduct, could prove to be much more significant in the long term.
For the FX market itself, few initiatives have received the same level of official sector and industry engagement as the move to develop a global code of conduct, first announced by the Bank for International Settlements in May 2015. When it is implemented in May 2017, the new rulebook will replace the many regional codes of conduct that are now acknowledged to have been insufficient.
The global code will articulate a consistent approach to a range of industry practices where regional standards may previously have differed, including trade execution, information sharing, governance, trade settlement, ethics and electronic trading. Its value will be not simply to bring greater clarity and fairness to complex issues, but also to create a harmonised set of best practices that can be applied internationally.
“We are developing something that is intended to work very much at the global level and the general feedback we have received is that this is a constructive way forward. The industry has been very receptive to the concept of a single code of conduct and has made a constructive contribution to the process so far,” says Guy Debelle, assistant governor of the Reserve Bank of Australia and chair of the FX working group (FXWG) drafting the code.
While the initiative may be designed to rectify widespread failings in behaviour and controls among banks, its architects in the public sector have been conscious of the need to draft standards that will achieve that purpose without jeopardising the efficiency of the FX market. Comprehensive industry input has been made through a market participants group (MPG), comprising 33 representatives of the buy-side, sell-side and market infrastructures and chaired by David Puth, chief executive of FX settlement utility CLS.
For both the MPG and the FXWG, which bring together a wide range of stakeholders, the most obvious challenge is to agree on detailed standards that will work on a global basis without them remaining so high level that they have little practical value. It was a challenge that faced the eight regional foreign exchange committees in early 2015 when they jointly drafted an initial set of conduct principles known as the Global Preamble, but both Debelle and Puth say that building consensus has been easier than expected this time round.
“We encouraged participants to come with a very open mind on how issues might be approached and to set aside all commercial considerations so that we could focus on ensuring the market operates in the most fair and effective way possible,” says Puth. “It is not expected that there will be exemptions from this code for any regions or participants, which has certainly helped to engage everyone in the process.”
The true value of the code of conduct cannot be properly tested until it has been implemented, and with only a subset of the final standards so far agreed, there is still a great deal of work to be done. On top of the drafting process itself, a separate workstream led by the Bank of England is looking at ways in which adherence to the code will be promoted and incentivised.
Such mechanisms are likely to be critical because the standards won’t have the force of law and will rely on the commitment of institutions of all types and sizes to take them seriously. At this stage, the level of awareness and preparedness is likely to vary significantly across the industry. The largest banks, particularly those that have already been involved in remediation processes, may well have many of the necessary processes and controls in place, but the code will also impact smaller institutions and buy-side firms.
“There has been a general lack of common understanding of how client orders should be handled, but it’s important to remember that the code is intended for both sides of the market,” says Debelle. “It will set out not just how the banks should behave, but also what customers should expect from an intermediary in terms of execution and information sharing.”
For the banks themselves, this has been a period of intense adjustment, as many have had to deal with the impact of heavy fines, intense scrutiny and a reduced level of trust in the integrity of the FX business.
After the collusion and sharing of confidential client information that was revealed to have taken place in chat rooms, it is no surprise that the general level of industry chatter has diminished, making it harder for sales teams and traders to share market colour with their colleagues and clients.
There have been knock-on effects for buy-side firms, too. With banks having to make substantial changes to their business models, with a greater focus on surveillance and control, many buy-side trading desks are looking to take greater control over execution to make sure they always get the best and fairest deal possible.
But as the scandal slowly begins to recede into the rearview mirror, some practitioners are cautiously optimistic that the industry is turning a corner. With much of the remediation work demanded by regulators now complete or at least well advanced, many banks have more robust surveillance and controls in place that should help to identify conduct issues quickly in the future.
“Like most top-tier banks, we have our own code of conduct and there has obviously been considerable focus in making sure our compliance and surveillance systems are robust,” says James Bindler, head of G-10 FX at Citi. “We are confident our staff is being properly managed.”
But with such rigorous surveillance of conduct now in place or set to be installed on trading ﬂoors across the market, does it become more difficult to attract young professionals to work in foreign exchange? Could the brightest graduates be deterred from an environment characterized by higher levels of uncertainty than in the past?
Bindler is confident that in spite of recent events, the FX market still offers unparalleled opportunities to gain exposure to the forces driving the world economy. And for the next generation that has grown up with social media, heightened surveillance is fast becoming the new normal.
“FX is a truly fascinating market, because it’s everywhere at the same time – at the ATM, at the airport, on the trading desk or in a business contract,” says Bindler. “The market is at the cutting edge of what is happening in politics and the world economy, which can be very exciting for younger staff and means we continue to attract fantastic talent.