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FSB Reveals Range of Global Responses to FX Benchmark Proposals

The Financial Stability Board (FSB) has published the various responses to its FX benchmarks consultative report, revealing the diverse range of global industry opinion on the subject.

Over 30 interested parties including major FX banks, brokers, asset managers and industry associations provided written comments to last month’s publication of 15 proposals around suggested reforms to key FX benchmarks, including the WM/Reuters Fix.

As reported by Profit & Loss earlier this month, while the industry generally supports the notion of widening the fixing window, it is also hesitant of the potential increase in risk from such a move (Squawkbox, 14 August).

Daniel Trinder, Deutsche Bank’s global head of regulatory policy, echoes this in his response, stating that, “any widening of the time window needs to balance the objective of reducing opportunities and incentives for market manipulation with the consequences of increased market – and execution – risk for dealers, and ultimately, clients.”

The bank also publically supports the development of a volume weighted average price (VWAP) as a possible alternative benchmark, while also recognising that “current data availability makes replicating VWAP challenging”.

But in contrast, Commerzbank’s response states that it is “generally not convinced” that the widening of the fixing window would significantly reduce manipulation risk in the FX market.

While it does believe that shifting to a different benchmark is therefore necessary, its preference is for the time-weighted approach, which it believes “would be at least doable”. However, the bank is strongly supportive of the proposed global/central utility, provided it was prudently supervised, as it “would help to reinstate the credibility of the FX market and its participants”.

Yet Deutsche Bank says it has concerns about the feasibility of creating a central utility and its “impact on competition and choice” which may be to the detriment of innovation.

CME Group in turn supports the recommendation as helpful. “This should prevent large orders needing to be traded prior to the fix by netting all shorts and longs and if it worked should only result in small balances not matched before the fix,” CME says. “We are already seeing the proliferation of FX ECNs and matching platforms catering predominantly to retail SMEs, but there is an increasing number of larger players offering matching services to institutions as well.”

While the buy-side responses appear to agree with each other to a large extent, a number of key differences in opinion remain relating to certain proposals.

The Bundesverband Investment and Asset Management (BVI), which represents 82 members in the German fund industry, agrees with the need to explore whether the current width of the fixing window may be too narrow to meet aggregate demand of orders, but thinks that a substantially expanded width may also entail important risks.

In addition, it supports the suggestion for alternative benchmarks, “only if they are tradable in practice because otherwise the buy side would lose the ability to trade at the Fix,” it says.

Like many other asset managers, BVI doesn’t suggest changing the time of the fixing on the hour.

Although agreeing with the proposal for additional sources of data, BVI stresses that not all price sources are of equal quality.  “In order to ensure ‘real’ prices which are not skewed by credit, settlement or other operational risk (eg duplicated prices from different request driven venues), only such venues/sources should be considered which accept only regulated financial service providers as traders,” BVI says in its response to the FSB consultation.

BVI supports the proposal to move to a regulated trading and netting venue. “An ‘equity trading venue’ type of approach seems to be useful to consider,” it recommends. “To avoid conflicts of interest and manipulation (eg front running), the aggregation of trade orders should be performed by a body which is separate from the body matching the orders, eg through an auction.”

It believes that such a trading utility “can ensure that the fixing price is determined by demand/supply orders and will prevent more market prices from going beyond what is determined by liquidity providing orders”. However, it acknowledges that a regulated trading/matching venue runs the risk that not all orders can be filled at the fixing.

Similarly to BVI, the European Fund and Asset Management Association (EFAMA), which represents 27 member associations and 62 corporate members, agrees that the industry needs to re-evaluate the width of the current WMR window, advising that it be “a balance between sufficient time/volume available and capacity to generate a replicable market price”.

EFAMA stresses that the methodology on the calculation of the benchmark is closely related to the development of a global/central utility for order matching, which it supports. It repeats much of the same arguments as the BVI in response to the FSB’s sixth recommendation to support the development of industry-led initiatives to create independent netting and execution facilities.

The Investment Management Association (IMA), which represents the UK asset management industry, agrees with the recommendation to widen the time window to a limited extent. “If it is in fact decided to widen the window significantly, we believe that it should suffice to extend it to 20 minutes and certainly no more than 30 minutes, 15 minutes either side of 4pm, ie a maximum window width of between 3.45pm and 4.15pm London time.”

The IMA links the move to widen the fixing window to an “effective execution mechanism”, which it believes will help to “mitigate conflicts of interest and introduce a greater degree of transparency”.

The IMA also ties the need for alternative benchmark calculations, such as volume weighted or time weighted benchmark price calculated over longer time periods, to a new trading mechanism. However, it says that such an independent entity will not be easily created, “because of the scope of issues likely to arise around the breadth of participation and the fees needing to be charged”.

Similarly to the BVI and EFAMA, the IMA suggests an intraday auction as a way to solve this issue.

The PGGM, a Dutch a pension fund administrator and investment manager, believes that widening the Fix window by five minutes would suffice, but that if the interest in benchmark-related products increases further in the future, the window might have to be increased further as well. “However a bigger window will lose significance as a reference rate at a specific point in time (or the close),” it says in its response to the FSB.

Although it says that using alternative benchmarks in certain situations can help, “they will most likely be more difficult to explain and other benchmarks would also be likely to have flaws and challenges”.

PGGM is in favour of releasing constituent data of multi-currency benchmarks “more freely/easily”, which it believes could spur innovation leading to the creation of alternative FX benchmarks.

On the proposal for a global/central utility for order matching, PGGM supports innovation that could lead to efficient and effective netting and execution of FX (fixing) flows. It says: “A central netting vehicle only makes sense if there is for the net flow that has to be executed. Otherwise the net flow might create an even bigger impact.”

Vanguard, a US asset manager, believes that an auction or “some type of natural crossing mechanism” on a consolidated trading venue, much like an equity or swaps trading exchange, is the optimal solution. “Such a venue could conduct a closing auction (eg an auction during the final 10 minutes of the trading day) and the price derived therefrom would eliminate the potential manipulation presented by the current WMR Fix. Through conducting an auction at the market close, a market-clearing rate would be achieved,” it says.

However, it also thinks that the widening of the fixing window is “an appropriate measure to address the potential for market manipulation prior to, or concurrent with, the rate fixing”.

It advocates a calculation window of no less than two minutes and no more than five minutes for most major liquid currency pairs. “It would also be appropriate for the width of the calculation window to vary based on the relative liquidity of the currency pairs with less liquid pairs afforded a slightly longer calculation window,” it says in its response to the FSB. “It is extremely important to asset managers that any benchmark solution is achievable, tradable and trackable. As noted above, introducing a significantly longer time period for the calculation window could serve to compromise the tradability of the benchmark fix and thereby heighten tracking error risk for index funds.”

The Benchmark Group will present its findings to the FSB at a meeting in Cairns in September.

nicola@profit-loss.com and joy@profit-loss.com

Profit & Loss

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