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FEMR and the Mounting Calls for Time-Stamping FX Trades

Proponents of time-stamping have long highlighted the potential benefits of the practice in helping to en- sure best execution, creating a secure audit trail and potentially countering claims of malpractice in the market. But how practical would it be for banks and the buy side if time stamps were made mandatory for all FX trades following the FEMR recommendations later this year? Nicola Tavendale finds out.

 

Earlier this year the UK Treasury took the unusual step of writing to the Bank of England (BoE) requesting that it consider introducing a requirement for all types of FX trading, including spot trades, to be time stamped in a bid to increase transparency in the market. The Financial Times reported that Andrea Leadsom, then economic secretary to the Treasury (city minister) wrote to deputy BoE governor, Minouche Shafik, urging the Bank to consider the role of time stamps as part of the Fair and Effective Markets Review.

Shafik is serving as co-chair of FEMR and that review is currently considering its recommendations, which will be published in June. Sources tell Profit & Loss that the lack of a public release of this correspondence would seem to indicate it may be part of the documentation under review. A spokesperson for Leadsom confirmed that she raised the issue prompted by a Westminster Hall debate with Austin Mitchell MP who “raised some serious concerns” regarding the absence of time stamps.

“I recognise that market structure and transparency do play an important role in making markets fair and effective,” Leadsom says in the letter. She adds that, while she does not want to prejudge the review, she would be grateful if in the context of this work Shafik, who is heading up FEMR, could “ensure these concerns are considered”. The BoE declined to comment. 

Proponents of the practice argue that time stamps help to create an audit trail and can enable bank customers to see the rates offered at the time of transaction. In Europe, there is also a requirement being introduced for all cleared transactions to be time-stamped. According to Simon Wilson-Taylor, president and CEO of Molten Markets, the fact that this will be taking place suggests that anybody using those time-stamps will then have an expectation that all FX trades are time-stamped, not just the reportable swaps, forwards and NDFs.

“The principal finding from the so-called Fix scandal was there is a control issue rather than an execution issue with the banks,” he adds. “But it is very hard for banks to interpret what constitutes a ‘control issue’ going forward. I think they will be over-cautious and therefore they are going to try to get ahead of this. Time-stamping is a good thing to do as you can be very clear about what you did with a trade, when you did it, who had the information, etc.”

Wilson-Taylor believes this kind of audit trail will increasingly be required by regulators as part of their ongoing investigations into alleged FX malpractice. “Whether it’s in the regulations or not, I think the banks are going to have to do this anyway,” he says. Outgoing MP, Austin Mitchell, who has also been urging the Bank to take up the issue, adds that pension funds could be harmed by any collusion between fund managers and traders, but this could be prevented with a requirement to use time stamps across the board. “We can’t have a BoE that’s negligent and that doesn’t enforce the responsibility of banks to know where their money is and how much they’ve got,” says Mitchell.

Last year, the Financial Stability Board (FSB) included a recommendation in its FX benchmarks report that asset managers use tools such as time stamps to provide “transparency of dealing rates”, but it added that many of the firms the FSB had spoken to already undertake such analysis. “This recommendation should be considered as part of ‘best practice’ within the industry and should be regarded as consistent with asset managers’ existing fiduciary responsibility to their clients rather than imposing a separate, new responsibility,” the report concludes.

James Wood-Collins, CEO of Record Currency Management which counts pension funds and corporates among its client base, says that retaining time stamps is already seen by the firm as essential best practice in FX execution He adds: “What I believe FEMR is calling for is for time stamps to be retained, and made available to clients such as pension funds and other asset owners, where they are executing as a “captive client” of a bank.” As a result, he warns that in such cases time stamps will not necessarily ensure best execution or even improve execution, but will allow poor execution to be identified after the fact and so might at least deter it.  “Best execution can only be ensured by negotiating and agreeing each rate, either directly by the asset owner itself, or by an independent agent acting on their behalf,” Wood-Collins says.

He argues that as a matter of routine, best practice should involve both parties in an FX transaction – typically the bank and their counterparty – retaining a time stamp for all transactions entered into.  Record’s understanding is that this generally already happens, claims Wood- Collins, and in particular banks will retain a record of every transaction including its time stamps as they have done for many years, if not decades.

But Wilson-Taylor adds that the buy side have, so far at least, avoided any detailed regulatory scrutiny, although in most of the scenarios that have arisen the asset managers are those who have the fiduciary responsibility to make sure things are done well. “They recognise this requirement and are doing an awful lot to make sure they have their own time stamps to document for themselves who knew about the trade and what their actions were on their side,” he adds. 

“They have to produce good transaction cost analysis for their clients – so purely in response to client expectations trades are being time-stamped in a way they haven’t been in the past.”

Furthermore, in the US legal action has been taken in the past over alleged overcharging of pension funds by banks that omit time stamps on trades, with the plaintiffs claiming this would have allowed the funds to ensure they were being charged at the correct FX rates. Under FEMR, Wood-Collins believes it may say that in circumstances where the non-bank counterparty to a transaction does not directly instruct the bank for immediate execution at a rate negotiated and agreed at the time, but instead leaves an order with a bank to be executed at a later fix rate or “at best”, then time stamps should be retained by both parties. Although banks will already be doing this, in some cases they have been historically reluctant to provide time-stamped data to their “captive clients”, he says, but adds that “some are getting better about this”.

“As an institutional currency manager, we directly negotiate – online or by voice – each of the thousands of transactions we undertake on our clients’ behalf, and we retain our own records of each transaction, including the time stamp,” Wood-Collins continues. “We see this as a minimum hygiene practice for a professional currency manager. We also undertake very little trading at fix rates, only doing so when that better suits a client’s objective for very specific reasons.”

Yet for clients and asset owners who transact relatively infrequently and so cannot justify the infrastructure and costs to ensure best execution themselves, he adds that there are two choices. Firstly, they can continue transacting as a captive client of one or more banks, in which case they will still need to monitor execution after the event to satisfy themselves as to the reasonableness of the rates they are receiving. In this case time-stamped data will at least provide a more accurate record for a specialist to undertake a retrospective currency transaction cost analysis, or currency audit, Wood-Collins claims. “However, it’s important to emphasise that time- stamped data does not in and of itself improve execution quality – all it can do is provide a better mechanism to identify poor execution after the event, even then assuming that the client is able to analyse this level of transaction data,” he says.

The second route available to pension funds and other asset owners, he adds, is to employ someone to undertake FX execution on their behalf with a duty of best execution owed to the client and as an independent agent who is absolutely not the bank on the other side of the transaction.  “We do this, in addition to trading within currency programs, for some of our clients, and other independent FX managers offer agency FX execution too,” he says.

Simon Jones, director of London-based consultancy PierrepointFX, also supports the UK Treasury’s suggestion, but warns that the downside may lie in the practical implementation. “There are a lot of problems around the world trying to get all system clocks to sync,” he explains. “This is another cost which the asset management community would have to bear.”

Jones adds that a sizeable amount of the trading which would benefit from time stamping, particularly in the investor space, is actually conducted over the phone. This in itself creates an additional problem of how to effectively time stamp such trades. “It’s a well-meaning idea, but it’s hard to see how it would be implemented without creating a really heavy burden for the end-user,” he concludes.

 

Helen Marsters

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