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FSB’s Cautious Welcome for Benchmark Reform Progress

The foreign exchange industry has made
“welcome progress” in implementing reforms to the benchmark fixing process,
however the Financial Stability Board in its latest report on the matter says
this progress has been “mixed” in some cases and that there is “
scope for further progress” in certain areas.

The FSB’s overall assessment in its Report on progress in implementing the
September 2014 recommendations
, is that there has been “good progress in implementing many of
the recommendations; however, in some cases progress has been mixed”.

In particular, the
report re-emphasises that the FSB recommendations are intended to apply to all
FX benchmarks, not just the WM/Reuters (WMR) 4pm London fix. “A more complete
implementation of the recommendations, particularly regarding other FX
benchmarks, would increase the likelihood of maintaining and extending the
improvement already seen,” the FSB states. “Regulators and FX market
participants must remain focused on achieving such an outcome.”

A striking aspect of
the progress report is that while the FSB believes that its
recommendations have seen “good implementation” among the largest players in the
FX market, some banks slightly outside the group seem to have been much slower
in adhering to the guidelines.

Partly this is
because, as Profit & Loss has
reported before, smaller institutions have struggled to collate the resources
to separate the fixing volume from the trading desk as well as to deploy TWAP
(Time Weighted Average Price) algorithms to execute Fix flows as their larger
brethren have. Indeed the report notes that some institutions have viewed the
cost of complying with the recommendations so high they have stopped accepting
fixing business, rather they have provided a portal in which their clients can
submit orders to other players.

While the report
acknowledges that the WM Company, which administers the WM/Reuters Fix, has
made progress in meeting the FSB’s recommendations, in some areas work is still
progressing to achieve full compliance. Specifically the progress report notes
that while WM – which is reportedly in the midst
of being sold by State Street to Thomson Reuters
– has widened the fixing
window and added more data sources, there is “scope for WM to include more data
feeds beyond these, provided they are of sufficient quality”

It adds that WM is in
the process of evaluating a number of platform providers, with initial due
diligence and data analysis underway.

WM has also indicated its intention to
form a user group with a remit to review and comment on proposed changes to the
policies and methodologies, which WM uses to calculate, administer and
calculate the benchmark rates. The report notes, “At the time of writing, a
Charter has been drawn up defining the scope and responsibilities of the user
group. Whilst the group does not yet exist, WM aims for the group to convene by
the end of 2015. The existence of such a group would assist WM with a more
complete implementation of the previous two recommendations.”

The progress report notes that some
banks have been reluctant to use netting facilities, at least in their current
form. “In some cases they have expressed sensitivity about concentrating
information on fixing flows; in other cases they have expressed the view that
clients expect them to execute fixing orders themselves,” the report states. “Overall,
the use of such facilities has increased as processes around fixing
transactions have become more automated. Many participants noted that a key
challenge is how to manage the residual balance that cannot be executed using
such a facility. Some indicated that the need to execute large residual
balances in the market could contribute to increased volatility and a reduction
in liquidity around the fixing window, particularly if there are fewer banks
participating in the execution of such orders.

“In light of the progress that is
occurring, it would seem appropriate for the industry-led process to run
further, though there is potentially some merit in the official sector
facilitating industry- wide discussion on the topic,” the report adds.

This finding supports anecdotal
evidence previously reported by Profit
& Loss
that while flows on facilities such as TruCross and EBS e-Fix
(which sources say is now handling in the region of $3.5 billion per day) are
increasing, there is still a problem of handling residual flows.

The reason for this is widely believed
to be the result of how banks are executing fixing flows. As the progress
report notes, the use of algorithmic execution of orders in the five minute
window has “increased substantially”.

Some participants who have not had the
resources to roll out algorithmic solutions have instead physically separated
the fixing trading desk from other desks. In other cases, the separation has
primarily been through establishing or enhancing separate processes for the
collection of fixing orders, giving customer orders a degree of anonymity, but
with those orders still being executed by a single spot desk.

Significantly, the FSB report says
that, “There is considerably enhanced internal scrutiny around fixing-related
transactions by senior front-office management and compliance functions. In
some cases this is supported by automated systems, though in other cases it
relies on manual processes. In most cases, banks now have in place clearer
policies, procedures and controls relating to the treatment of customer order

The report also notes the progress on
conduct risk around the fixing process, highlighting the FSB’s own work on the
global FX Code of Conduct due for final release in 2017. On asset managers,
while the report notes that there has been a “greater focus” on whether the
benchmark fix is appropriate to their business, it also warns, “there is scope
for greater follow-through in this area on the part of some market

Overall, with the report littered with
words such as “reasonable” and “mixed”, the general tone is one of satisfactory
progress but also a latent demand for further progress. This is highlighted in
particular by the FSB noting that while implementation of the recommendations
is acceptable for the London 4pm WMR Fix, for other benchmarks (including
central bank fixes) progress is “less advanced”. Equally, on the tricky subject
of charging for accessing the Fix, the report highlights how there is “scope
for further improvement”, again amongst providers outside the top group of

The report, which also includes
empirical analysis of market behaviour around the Fix, can be found here.  Twitter @lamboPnL 

Colin Lambert

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