2018 is a big year for the FX Global Code as it will celebrate its first anniversary – a date by which all participants are expected to have adhered to the code’s principles. Will the code be a success? Colin Lambert thinks he has the answer.

It was, and still is, depressing having to read through legal papers and regulatroy notices on a regular basis, all of which deal with misconduct in FX markets, and nobody whould be misguided enough to think that such actions will not continue in the year ahead. They will, and probably the year after that.

There is an upside in having to rake over the ashes of past misdemeanours, however, because it offers a timely and regular reminder of the importance of the FX Global Code.

A regular ingredient of misconduct in financial circles is complacency, normally on the part of the person committing the misdeed, their oversight, and in turn the oversight’s oversight. If there is one thing that the Global FX Committee (GFXC) – the body formed to manage the code going forward – has to avoid, it is complacency.

Luckily enough, there was plenty of criticism of Principle 17 in the original code for it to trigger a consultation process and a rewrite. This, if nothing else, showed the passion there is for the FX industry among those who work in it, and the GFXC responded admirably.

The work is not complete, however, because there are still nuances that need looking into. One being, as highlighted by the GFXC, the use of last look by the ‘quote and cover’ or ‘riskless principal’ (whatever that means) players.

Another issue is forming a framework that allows certain players to enforce adherence to the Code, and that is where both customer and peer pressure come in. Generally speaking, most of the code’s guidelines are easily executed and monitored…in the OTC space. The challenge for the FX industry and the code’s backers is: who is responsible for ensuring people adhere to the principles in anonymous environments?

It has been argued that it is for the firm that owns the platform providing the trading environment to do this, but there continues to be pushback from some providers. This is likely to be met with a strong show of force in 2018 – namely those firms that have signed the Statement of Commitment will demand that their adherence to the Code is mateched by all the participants on the venue. If the provider cannot assure them that it is a level and fair playing field, they are likely to vote with their business.

In other words, we have two distinct liquidity pools (both including the various platform models); one is “clean” and everyone has signed up, the other is a free-for-all. Again, it will be “buyer beware” and anyone using that liquidity will have to understand that if and when it goes wrong, they will be asked why they were in that pool in the first place?

They will be helped by the fact that good, deep and genuine liquidity is harder to find now than it has been for some years, thanks to the resurrection of random volatility. Yes, people can find a price most times, but the time they really need it – when something happens? That is a different matter and the major LPs know this, which gives them leverage with a platform provider and feeds their demand for a liquidity pool in which everyone adheres.

The interesting thing from June onwards will be the broader industry’s attitude to those firms that do not sign the Statement of Commitment. At the moment, people are making the right noises about not dealing with such firms unless there is a structural and broader reason to do so (for example a corporate relationship involving credit and other funding, or custody), but will they do so going forward?

While the spotlight remains on one or two major non-bank market making firms in FX, there are a host of others that are making inroads into the various liquidity pools and becoming a meaningful portion of flow. Of course, several are using last look – to give one example – as part of their business model which is predicated upon making a lot of small incremental profits through the day (yes that is HFT by another name), so will other players be willing to cut off these LPs?

If the market was very busy and these players were rejecting trades (and, importantly, the participant knew who was rejecting them), then the answer is simple. But in a quiet market where one-tenth of a pip can make a small difference, are firms going to be willing to ostracise the non- adherents?

It is here, on the periphery, that the greatest challenge lies for the GFXC and the code. Get these players fully onboard and you have a healthier ecosystem and one in which the major players are comfortable being full engaged. If, however, we have a great area in which a segment of the market is operating (to the detriment of adherers) the whole thing could fall apart.

This means that the priorities for the GFXC and the code going forward have to be establishing more examples and perhaps clearer guidance over who is responsible for ensuring anonymous environments operate fairly. This will take time, and in that window the Code has to maintain its profile – and that means the three key words for 2018 amongst members of the GFXC and associated committees will be “marketing”, “education”, and “evolution”.

Galen Stops

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