Global Code of Conduct for FX Explained

The Bank for International Settlements (BIS) Foreign Exchange Working Group (FXWG) published the first phase of the Global Code of Conduct for the Foreign Exchange Market (Global Code) today.  It also published principles for adherence to the new standards, entitled FX Global Code: Public Update on Adherence. Final publication of the complete FX Global Code is targeted for May 2017.

The Global Code is not a legally binding document. It identifies global best practices and processes that are meant to inform corporate practice, and assist in developing and reviewing internal procedures. The Global Code is also meant to help inform the development of regulation, and could be used by regulators and courts in analysing wholesale FX behaviour going forward.

Guy Debelle, Assistant Governor of the Reserve Bank of Australia, and FXWG Chairman issued a statement today underscoring that the guiding theme of the new Global Code is promotion of a “robust, fair, liquid, open, and transparent market," with the ultimate goal “to restore confidence and promote the effective functioning of the wholesale FX market.”

Written by representatives from 16 jurisdictions, the Global Code is meant to have wide applicability, not just to financial institutions such as banks and brokers, but also asset managers, including sovereign wealth funds, hedge funds, pension funds, and insurance companies, as well as corporate treasury departments, family offices, and electronic trading platforms. 

The first principle of the Global Code is that market participants should strive for the highest ethical standards.  This includes

• acting honestly in dealings with clients and other market participants

• acting fairly, dealing with clients and other market participants in a consistent and appropriately transparent manner

• acting with integrity, particularly in avoiding and confronting questionable practices and behaviours

Offering best execution to clients will be fundamental to this principle, and establishing technologies to evidence best execution will be key to delivering fairness in a transparent manner.

A further principle is that market participants should identify and address conflicts of interest. Many firms have already undertaken great steps to alleviate conflicts of interest, including mandating independent FX transaction cost analysis providers that are independent of execution venues.

The Global Code further clearly states that market participants should handle Client orders fairly and with transparency. Noting that the FX market has traditionally operated as a principal-based market, the Global Code makes clear that “[w]here the acceptance of an order grants the Principal executing the order some discretion, it should exercise this discretion reasonably, fairly and in such a way that is not designed or intended to disadvantage the Client.”  This aligns with the new requirements under MiFID II, including those requiring best execution, greater fairness in pricing, and more transparency.

A key aspect of the final Global Code will be the expectation that market participants promote and maintain a robust control and compliance environment to effectively identify, measure, monitor, manage, and report on the risks associated with their engagement in the FX market.  This section is in development as content to be published May 2017 as part of phase 2 of this work.  Principles related to electronic trading, including algorithmic operators and users, and unique features of FX swap, forward, and options transactions FX are also to come in May 2017.  We anticipate that these principles will underscore the need for compliance systems that are able to test for forms of market manipulation like front running, abuse of barrier options or inappropriate use of last look. Work on a robust control environment is also likely to point towards implementing automated systems that can verify best execution across FX products, including both voice and electronic trading, as well as algorithmic trading.  

Although the new Global Code is light on specific guidance, the annexes provide useful examples that are certain to make their way into compliance handbooks worldwide.  These include examples of inappropriate use of information sharing in the context of offering market colour, inappropriate handling of client’s stop loss orders and inappropriate hedging. 

There are also very helpful examples on mark up practices, including the following inappropriate example:

A Client asks a Market Participant to fill an order to sell 50M USD/JPY and to confirm the details at a later time period. The Market Participant adds a higher Mark Up than normal, by filling the order further away from the actual executed rate, but within the day’s trading range.

The Global Code emphatically states that market participants must be clear and transparent about the application of mark up and that mark up may not be decided by the daily range of the day. 

And yet, critics will argue that the Global Code does not go far enough in banning mark up vagueness. As written, Principle 5 of the new Global Code merely requires participants to publish disclosures that help “Clients understand the determination of Mark Up, such as by indicating the factors that may contribute to the Mark Up, including those related to the nature of the specific transaction and those associated with the broader Client relationship, as well any relevant operating costs.” In other words, mere broad statements will continue to suffice and executing parties will have no obligation to be transparent about the degree or range of mark-up applied unless asked. The Code merely states that “If the Mark Up details are requested by the Client, the Market Participant should make the best effort to explain the factors that help determine the Mark Up.”

The new Global Code in a sense blesses the right of those acting in a principal capacity to keep their secret formula for mark-up under lock and key. While abuse or manipulation will not be tolerated, and while individual jurisdictions may have higher legal obligations, at least per the Global Code, market participants will have no obligation to fully disclose their precise mark-up. In this regard, the new Global Code makes the strongest case ever for the value of independent and sophisticated transaction cost analysis. In a wholesale market of sophisticated market participants, clients are expected to have their own tools to evaluate fair execution.

While the release of this first part of the new Global Code is a welcome development, there is still much to be done by regulators and companies to change the structure and culture of the FX market and restore confidence in the $5 trillion a day market. One step in the right direction is for businesses to equip themselves with new technologies sophisticated enough to analyze transaction costs both pre and post-trade, as well as in a live trading environment. 

BestX is working hard to fill this space and to provide a more transparent and fair FX market place, agnostic of counterparty, medium or venue. 

Please contact us with any questions or comments about this article or to learn more about how BestX can be part of your solution for better execution.