Following a recent podcast someone asked me why I thought the FCA’s recognition of the FX Global Code in the UK was so important, as I had stated. I won’t bore you with the full answer – it seems pretty clear to me that if a regulator is going to be guided by the Code’s principles then that provides the Code with “teeth” and also means no one should be under any illusion of the consequences of stepping outside the guidelines.

The number of regulators using the Code as their guide is pretty small still, hopefully that will change, and one of those jurisdictions that does not is the impenetrable tangle that is the US regulatory system. Perhaps it should though, for going through the National Futures Association’s Complaint against Wells Fargo again today it struck me how easy the whole process could have been if the Code had been the basis for judgement.

In the normal convoluted style of US settlements, the bank neither admitted nor denied the charges, but it has to accept, in settling the Complaint, that it will be assumed that it did in fact commit the transgressions. So, neither guilty nor innocent…but they did it – and people wonder why lawyers get a bad press.

On the basis then, that the violations were committed, I ran through them seeing how many were in breach of the Code and I reckon it is seven Principles for sure, with another three being in play.

Principle One says participants should strive for the highest ethical standards – I don’t think lying to the customer reflects that – and nor does it the values in Principle Five which says the firm should embed an ethical culture of fairness and transparency.

I was very interested in Principle Six, which states, “Market Participants should have remuneration and promotion structures that promote market practices and behaviours that are consistent with the Market Participant’s ethical and professional conduct expectations.”As I wrote in this column, the remuneration regime in place at Wells Fargo at the time was asking for trouble, to the extent that the head of FX trading specifically asked that his business be moved to a different framework.

Principles Eight and Nine deal with handling orders, and while I don’t think the order was handled badly by the trading desk, the way it was transmitted to the customer certainly wasn’t up to scratch, was the bank an agent and taking an extra couple of pips on top of the established agreement, or was it a principal? Perhaps it was both?

Of course there has to be an element of pre-hedging involved, something Principle 11 deals with, but did the bank act transparently and fairly? I would argue that by buying options ahead of time and by not informing the client of the actual start time for the execution (not to mention the starting rate, the final rate and the “under-fill” on the order) then it did not.

Finally, you can go down to Principle 39 which says participants should generate a timely and accurate record of transactions – well the bank did for itself I suppose, but for the client? Hardly.

Throw in elements of Principles Three, 10 and 14 and you have a pretty good idea of whether what went on was appropriate and I don’t think many would feel that it was. The use of options to pre-hedge is an interesting diversion from the norm, generally speaking one would think that these would only be of use if they were exercised and the customer given the fill, but then would this justify the premium paid? In reality what a pre-hedge of options does is protects the bank against the execution going horribly wrong and leaving it with a large loss because it agreed a rate limit with the client.

In theory such an approach would appear sound risk management, but the fact is by entering into such transactions, information gets into the market and the price is affected and therefore we step into a grey area – namely is this front running or prudent risk management? That’s a tough one but the fact that the trade would influence the market price suggests it has to be the former unless – and this brings us back to the Code, the client is informed of what the executing party is doing and agrees to it. In reality a $350 million USD/CAD option probably didn’t have a huge influence on the spot price – if any at all – but it’s the fact that it was not disclosed to the client that should be the problem.

The Code then, using this instance as an example, proves its worth for yet another reason – streamlining investigations. If it had been in existence in 2014 then Wells Fargo would have been able, assuming it signed up (which it did in May 2018, at the end of the 12 month grace period following publication of the full Code), to have easily identified violations, dealt with any miscreants and recompensed the customer – all without having to go through two years of regulatory investigation. If the latter had been involved, one presumes it would have been a quicker process as well having the Code as the basis for acceptable conduct.

That alone should be a strong case for more regulators to accept the FX Global Code as their benchmark for behaviour, for by doing so they will be making clear to everyone in the market – whether they have signed up or not – that these are the standards to which they will be held. The fact that this could also mean less lawyers get involved in just the icing on the cake…

Twitter @lamboPnL

Colin Lambert

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