I think everyone is fully aware of my views on the furore surrounding the 4PM Fix, if you aren’t please read this column on August 29 and October 14, so I thought I would look at a couple of different aspects of this issue; hubris, the effectiveness of surveillance in the e-era and one report that concerns me greatly.
First up, no one should be surprised that a group of dealers gave their chat rooms names such as “The Bandit Club” or “The Dream Team”, that comes with the territory. Dealers by nature have to be confident and sometimes this slips into arrogance. I must confess I raised an eyebrow at a room named “The Cartel” for in the bigger scheme of things, even hinting that you may be operating a cartel is not the brightest move.
Sometimes, humour does not translate well onto a screen – believe me, I know!
Secondly, this issue does at least mean we know that in this era where everything is recorded and kept, the surveillance function can do its job. You could rightly ask questions of why flags weren’t raised before about the process involved in the Fix, but to be fair to the FX teams in particular, I know of several (along with a few enlightened investment advisors) who have spent years (literally) trying to get customers off the Fix and onto a better, more efficient mechanism.
That said, with the understanding that online comments can very easily be taken out of context, at least we have the means to forensically examine what went on and act accordingly.
I have a great example of how online messages can create ambiguity – and this is the report that worries me the most. It comes from RBS, which, according to a Bloomberg report, told clients it would start “pre-hedging” orders up to 15 minutes before the benchmark is set to protect itself against market movements.
Bloomberg further reports the bank said, “You should also be aware that this could potentially result in the market moving against you. However, we will take steps to minimize the market impact within the above context notably by executing the order over a longer period of time.”
In the column on October 14 I outlined the moral dilemma faced by a dealer having advance knowledge of an order. Do they look after the customer order and execute for the client, or the bank’s shareholders and get the bank out of a position they know will lose money on in just a few minutes?
At face value the RBS email suggests the latter, which not only makes any claim to be a client-centric organisation laughable but also suggests that the authorities will find plenty of opportunity to lay front running (not manipulation) charges against people. After all, it appears to be institutional policy!
But then there as another line quoted by Bloomberg from RBS. “No traders or proprietary system will take any position on the back of your order. Our usual high standards of client confidentiality will apply.”
This is either corporate spin or, and this is how I see it, it highlights the ambiguity around online conversations and indeed the process around customer orders.
To me, those statements taken together mean that RBS is telling its clients that if they place a large order at the fix, RBS may square its position ahead of the fix, but will not take a proprietary position based upon what is confidential information. The trouble is, it will be easy for lawyers to point to even a squaring of positions and call it front running.
I always prefer to put it thus: If the client asks for a two-way price the bank is obliged to quote it and if it doesn’t suit the position then tough. Of course, the trader can skew the price to mitigate the impact and this may lead to the client dealing away, but the client is maintaining control of the execution. If the client leaves an order, the trader then becomes an agent and their sole responsibility is to execute the client order and if, for example, they are buying, then every purchase goes to the customer. If the trader is short they have to buy a few more at the end.
The trouble with the Fix is this is all known 15 minutes (or more) ahead of time. A trader merely has to skew their price to cover a position ahead of time and because they are making two-way prices they cannot be accused of front running because they don’t know what the party asking the price wants to do.
Talking about it in a chat room is a little silly, but as I have said before, sometimes dealers match interest and improve customer execution – it is all down to the motive.
Ultimately this is likely to lead to findings of process failure in the management at several banks because chat room use should have been more closely monitored, especially when the Libor news broke a few years ago. It strikes me that the oversight function at several banks may have gone missing as, and this indicates that it has gone awry, we do have best practice guidelines that reasonably address this issue.
The New York Foreign Exchange Committee’s Best Practice documents states, “Staff should not pass on confidential and nonpublic information outside of their institution. Such information includes discussions with unrelated parties concerning their trades, their trading positions, or the firm’s position.”
Equally, and more pertinently to this issue around the WMR Fix, ACI’s Model Code states, “Written procedures should clearly stipulate the institution’s control policy in relation to ‘front running’ or ‘parallel running’; where traders knowingly execute trades in front of a customer order. These trades would not have been executed without that prior information obtained(my italics); hence this is a form of insider trading and should be banned accordingly.”
That last line would suggest that even the squaring of positions is a no-no, but as I say, if a trader gets square by making two-way prices in the normal course of business what is one to do? Stop trading for 15 minutes?
In other words ambiguity reigns and that means, inevitably, that lawyers will get even richer.
Going forward there are a couple of things that could be done. Firstly, best practice documents could be updated with chapters specifically relating to handling Fix trades (WMR is by no means the only game in town).
Secondly, and I’m sorry I know I have been banging this drum for four years but I am not going to stop until something happens, we should adopt practices used by the algo execution teams. Any order given to the team to execute is behind Chinese Walls and in many cases the customer even has the right not to have the bank’s price engine or trading teams see it.
Let’s work even harder to convince clients of the value of this method because it is confidentiality, it is best execution and it is the future.
Colin_lambert@profit-loss.com Twitter @lamboPnL