On November 11, 2013, I wrote in this column  that FX “needs a hero” – the industry was under pressure from all sides and the story, such as it was, was very one sided and being driven by interests that did not necessarily have the market’s best interests at heart.

My call was for leadership and as an industry we were lucky that the BIS FX Working Group, under the leadership of the Reserve Bank of Australia’s Guy Debelle, provided it in the form of the Global Code of Conduct (the same man led the FX benchmark reform process, which was an equally important piece of work).

The time has come for another leader to emerge, it doesn’t have to be an individual, in fact I would argue it should be an industry group, be it the Global FX Committee (and I accept the interim nature of that group’s leadership is unhelpful at the moment), AFME, ACI or FXPA. 

The task this time is a little trickier and it is much more sensitive than responding to an obvious flaw in the industry structure as happened in 2013/14 because the new leaders have to get involved in Mark Johnson’s appeal.

I would stress that this is not about Mark Johnson personally, even though as I have stated previously I don’t believe even if his appeal fails he deserves to be jailed, rather it is about a factual representation of how the FX market works, using data. Perhaps by taking this approach the obvious and understandable ignorance of how the FX market works exhibited by the jury and indeed the US government, can be rectified.

This approach is not advocacy, or even taking sides, it is educational. We all hear the trite comments about “educating the clients” and “educating the regulators” well we now have the opportunity to educate the US legal system, for if this appeal goes wrong and pre-hedging is effectively outlawed in the US the ramifications will be serious for FX industry as a whole. 

The associations purport to speak for their members, well I would suggest the members – dealers of the present as well as of the recent past – need their voice represented loud and clear over this issue. We need voices and data to show why pre-hedging is important to a stable market environment, and also to explain why the Global Code, a document created with no little US input, supports the concept of pre-hedging. The appeals judge needs to hear why, after considered discussion and much analysis, the Code supports the practice? What is the background to the decision? What data was used to come to this decision?

Personally I keep coming back to the same point, the Fix has evolved into an awful mechanism that has delivered nothing but trouble to the industry – trouble that is by no means over, especially if US investors really start to pay attention to the slippage involved on so many occasions during the 4pm rate setting.

I spoke to someone familiar with the trial last week who pointed out the weakness of my argument in Thursday’s column that the defence should have explained what would have happened if HSBC bought 2.2 yards in one minute (I was also informed that the evidence shows that my concern over allegations HSBC staff bought ahead of the Fix and then sold, were misplaced, all buys went to the order). The weakness was, apparently, the chance that there could be a large counter order just a few pips away and therefore there was no way to prove that buying the sterling would have caused a flash move.

I may be naïve in this, but I think that misses the point. The US government clearly didn’t deal wholly in facts when presenting the prosecution’s case – why would it? So much involved in a legal trial is appealing to the instincts of the person or people making the judgement, and that should go for both sides.

I would be truly amazed if, for example, Thomson Reuters Matching – the platform of record in sterling still – had a huge number of occasions when an order for more than a yard of sterling existed at a single price point, let alone two yards. I would also be surprised to hear that an amount similar to the Cairn Energy ticket went through within one minute on the platform. In fact, let’s broaden that out: how often does two yards go through in a small price band in five minutes?

I fully accept that we have all had occasions when we had a large order in the market and not only managed to execute it reasonably quickly, but have then seen the market go against the order. But firstly, we didn’t try to buy/sell in one minute and secondly, it didn’t happen that often.

So my point is that yes, while there is a chance that a counter order could have existed at the time of the Cairn trade, the statistical chances of it being close enough to market at the exact minute that the deal was going through were very low. I can’t speak for a US jury or judge, but I would find that pretty compelling evidence and what is needed now is  for the industry to do the analysis and come up with a statistical number for my scenario using hard data from the markets that shows the extremely high chance of there being a flash move. I don’t know of many customers – and of no traders – that would take the chance of there being a counter bid or offer just a few pips away when they have to execute a large order.

I also think this new leadership could stress what is the often-overlooked Principle 12 of the Code, which states: 

Market Participants should not request transactions, create orders, or provide prices with the intent of disrupting market functioning or hindering the price discovery process. 

I would argue if, as the prosecution in the Johnson trial appears to have suggested, the order should have been filled in one minute, that this would have been a very disruptive event and in the current day, the market would transgress Principle 12. Ask any asset manager whether they would, as I asked in this column back in 2013, buy billions of dollars worth of equities or bonds in one minute? The answer would be they wouldn’t, because it would badly disrupt the market and probably lead to a trading halt and an investigation. Why then, do we think it’s OK to try to do the same thing in FX? 

So for me it’s time for actions not words, let’s stop spouting the trite clichés and actually do something that might help the industry. Leadership is about more than talking, it is about taking action and, occasionally, taking risks. Having said that, I don’t see the risk in delivering data-based analysis of the FX market to explain why pre-hedging was necessary then, and as long as we continue to use the Fix, why it is necessary now.

There are those that disagree with me on my next argument and that is fine, I welcome debate and contrary opinions, but I strongly believe if this conviction stands, then surely the banks have to stand up and say, “no more fix orders”. If they decline to do so, surely they are placing their staff at risk or either a prospective legal action, or significant losses associated with holding the risk until the five minute window, failing to clear the entire risk in that time, and then having to buy it back (often in a very thin end of European day market)? The third option is, of course, the market gets wrecked on a regular basis by flash moves around the window, to the detriment of the client.

Of course, customers are now fully informed of the need for pre-hedging and significantly a large number of them accept it, but what happens if the US legal system finds the process illegal? I cannot believe banks would be willing to continue to support it, therefore I see no alternative to ending the Fix in its current form and returning it to what it was originally intended to be – a reference rate.

So these are serious issues for an industry that all too often over the past decade has, for various reasons, been much too quiet when it comes to explaining what it is we do, how we do it and the benefits to the client base, especially in the “real economy” from this approach. 

Now is the time to end that period of relative silence and speak out. I have to say that if we remain mute on this issue then the entire industry should hang its head in shame, for if, the one time when it was vital – and indeed possible – to make a significant difference, we didn’t act, it would be a systemic failure. Obviously, Mark Johnson wouldn’t want the industry to fall short and neither would I. Hopefully, many others feel the same way.


Twitter @lamboPnL

Twitter @Profit_and_Loss

Colin Lambert

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