I may, not for the first time, be reading too much into a brief sentence, but I found it significant in my conversation with Simon Potter, outgoing chair of the Global FX Committee, that when talking about the review of the Code he mentioned “the handling of larger orders” as one area of possible review. I ought to stress that whether it is or not will be subject to the feedback process the GFXC conducts prior to setting the terms of the review, but given what is going to happen next week in the FX world I find it hugely significant.
For next week in New York we are due to have the oral arguments made in the appeal of former HSBC FX trading head Mark Johnson against his conviction for his conduct in handling a large order for Cairn Energy. I have noted on several occasions a mood in the FX industry wanting another look at the Global Code through the prism of the Johnson decision and I wonder if it will indeed now happen.
I think – always have done in fact – that such a review should take place because while it may not be able to help Johnson in the crucial days ahead, it could help avert a repeat of such a sorry, misguided and ill-informed prosecution against someone else. It is clear to me, talking to Potter and his predecessors in the chair, that not only are they keen to make sure the Code remains relevant, but they are also willing to stand behind the principles and support them as best practice. This will be important, for if, going forward, someone is charged with conduct that the Code supports, then the prosecution can not only check that the appropriate guidelines were followed, but they can also tap into a very experienced – and independent – resource when seeking to really understand the practice.
For if there is one thing that has become clear in the Johnson case – and hopefully this will be realised by the Appeal Court judges – it is that the prosecution’s grasp of how the FX market works is tenuous at best. Lest it be forgotten, this prosecution, when faced with what to most of us is a strong credible appeal backed up by independent Amicus Briefs, rather than accept that their lack of knowledge had been found out, instead doubled down on their position by not only accepting that several of the key arguments made by the defence in the original trial were actually correct, but by introducing what can only be described as new charges that the original jury never even heard. How can this stand in a fair and equitable justice system?
To remind readers and, hopefully, the people tasked with deciding the appeal’s outcome, the prosecution accepted that pre-hedging – the cornerstone of its original “front running” argument – was actually not only reasonable, but necessary in the circumstances of a large order. I may miss the legal nuance here, but isn’t that actually destroying the credibility and core argument of their case? “What we said was wrong actually wasn’t, but here’s a bunch of other things that make up for that.” Surely a legal case, that will decide someone’s freedom, needs to be on firmer ground than that?
Among the “other things” that apparently make up for the fact that pre-hedging was actually the correct way to go about the order (and the prosecution also acknowledged that Cairn’s treasurer had understood that HSBC could make money by pre-hedging) was that HSBC employees’ alleged mis-statements induced the client into settling the trade. Not only does this sound to me like a fallacious argument – do they have any understanding of the chaos that would envelop the world’s financial system if people could withhold settlement because they were unhappy with the execution quality? – but it doesn’t appear to involve Johnson at all. How can he be held responsible for other staffers’ comments, especially when they are of a similar seniority to him?
I also think it important to note that by most reasonable standards, Cairn Energy is a professional counterparty, that much should be obvious by the emails sent from the treasurer noting that HSBC would make money by buying ahead of the Fix. This demonstrates an understanding of how OTC markets work and the likely impact of such a large order and even if the firm didn’t have a deep understanding of the FX markets, this statement would appear to suggest that HSBC had kept Cairn fully informed about how the deal was to be executed. How else would Cairn know about HSBC’s likely profit avenue other than personal experience or explicit disclosure?
Finally, for this piece at least, there is the prosecution’s about face on the profit. When facing the appeal it suddenly accepted that HSBC could make some profit from the trade (by “buying in tranches” – which to you and me is pre-hedging) but that in this case it made too much. Just how we can define “too much” is left open to question and is clearly going to be a very fruitful area for the legal profession going forward if this appeal is not overturned.
The only way to judge how much is appropriate is…? No I don’t know either. Most professionals have an innate understanding of what is fair and what isn’t, but there are so many ingredients to take into account. How volatile is the market? What is the depth of liquidity? How long will the order take to execute, and how do you balance the impact of signalling risk with the benefit of taking longer to execute to minimise market impact? What about external events? Donald Trump wasn’t President then but he is now, and he can throw a spanner in the market works at any time as has been proven.
Whichever way you look at it, this conviction should not be allowed to stand, if for no other reason than the prosecution’s lack of understanding and its backflip at the appeal. If it does stand it will be a victory for the approach that basically says “let’s throw enough of the smelly stuff at the fan because some of it will stick”. That cannot be allowed to happen.
The conviction being upheld would also have serious implications for the wider world, for by throwing into doubt the practice of pre-hedging, and then adding to the mix the need to make the “appropriate” profit, the only way forward would be for banks and executing brokers to accept these trades on an agency basis only. That means market risk lies with the customer, so many of whom do not want it, but what other option will there be? As a trader in a bank would you be happy to accept a large ticket for execution at a Fix knowing that if you pre-hedge it and something happens you will be in trouble for making too much money, or that if you execute it in the window you will disrupt the market and fall foul of the Code’s principles? I am not sure I would – the personal risks would be way too high.
In these circumstances an important service disappears from the corporate world especially – for when it comes to hedging their currency exposures they would suddenly be on their own. Does anyone seriously believe this would be a good thing? I doubt they do, and for that reason above all else, Mark Johnson’s conviction should be overturned on appeal.