FX Code of Conduct: Reasons for Optimism

What is widely seen as one of, if not the,
biggest challenge surrounding the BIS FX Working Group’s work on developing the
Global Code of Conduct – adherence – was addressed by Chris Salmon, executive
director, Markets at the Bank of England earlier this week and Salmon – the man
responsible for the adherence piece in the Code – was optimistic that it would
be effective.

Addressing ACI UK’s Square Mile Debate,
Salmon noted, “
It is no secret
that all has not been well in FX or FICC markets more generally.”

He cited the erosion
of trust in markets to preface his speech but identified an “ethical drift”
resulting from “structural weaknesses” that presented opportunities for

Salmon observed these
structural weaknesses ranged from poorly designed infrastructure through to
guidelines about what constituted acceptable market practice that were
sometimes poorly understood, adding that this poor culture prioritised
short-term financial gain above all else. This was “perpetuated and normalised”
he said, adding, “The breakdown in market practice norms was clearly very
important in the FX markets.”

Salmon noted that this
combination of factors means that the information asymmetries and potential
conflicts of interest inherent in all FICC markets are also acute in FX
markets. “This in turn creates a particular premium on establishing commonly
understood and accepted market standards to guide behaviour,” he said.

Turning to what is
undoubtedly a degree of scepticism in the market over the effectiveness of the
Code, Salmon acknowledged those that sceptics” might question the prospects for
the success of this initiative”.

He added, “After all,
this is not the first FX Code – it will supersede a number of existing regional
FX Codes, some of which ended up gathering dust in market participants’
drawers. So, why will this Code work where others have failed? In a market
where information asymmetries have been exploited for selfish motives – what
good can a voluntary code of conduct really achieve?

“This is a good
challenge, and in the end only time will tell if the Code initiative will
succeed in minimising future incidents of misconduct,” he continued

Salmon set out four
reasons for people to be optimistic, however. “The first reason for optimism –
and perhaps the most important – is the substance of the Code itself,” he
argued. “It will directly address the complexity of the FX market and, informed
by the misconduct of the past, provide guidance where it is necessary. For
example, the interim publication established the important principle that
‘where the acceptance of an order grants the Principal executing the order some
discretion, it should exercise this discretion reasonably, fairly and in such a
way that is not designed or intended to disadvantage the Client’. And while
acknowledging that pre-hedging may be a legitimate risk management tool it is
clear that it should only be undertaken ‘in a manner that is not meant to
disadvantage the client or disrupt the market’.”

Salmon explained that
during phase two of the work programme the Working Group will deal with other
areas, such as the provision and use of ‘last look’ and time-stamping that were
highlighted by the Fair and Effective Markets Review as areas where market
practices in the FX market could be improved.

He said that in doing this
work, the group strikes the right balance between setting out such high-level
principles and providing concrete guidance. “Let me illustrate this point
summarising how phase one dealt with the vexed issue of information sharing,”
he said. “The May 2016 text sets out, upfront, a broad, overarching principle –
‘Market Participants should communicate Market Colour appropriately and without
compromising Confidential Information’. And it then sets out in detail, how
this principle should be applied to different types of information: for
example, ‘Client groups, locations and strategies, should be referred to at a
level of granularity that does not allow Market Participants to derive the underlying
Confidential Information’. This will be augmented in the final Code with
stylised examples to demonstrate how this guidance can be applied to practical
situations – examples of both effective and ineffective aggregation of

Salmon’s second reason
for optimism was the fact that the Working Group and global authorities are
alive to the importance of keeping the Code up to date. “From start to finish
the Code will have been completed in just two years,” he said. “A benefit of
this compressed timeline is that the Code should be relevant for today’s market
when published. And importantly we are committed to developing an appropriate
review mechanism so that the Code stays up to date and evolves as the market

“Further details will
be announced next year, but the new Code will not be allowed to stagnate,” he

The third optimistic
factor is the process for developing the Code is “inclusive”, Salmon said,
adding that it was, to his knowledge, unprecedented. “Its development is very
much a partnership between public and private sectors, with broad-based, senior
engagement from all types of key market participants,’ he told attendees. “This
should help get buy-in for the final product. The Code is for everyone in the
FX market – it covers the buy-side, sell-side, non-bank participants, trading
platforms and other market infrastructure – and therefore our engagement has
necessarily been as diverse.

“During phase two we
are further broadening our engagement to ensure that the voices of all
different market participants are heard and taken account of,” he added. Salmon
also told attendees that the Code is one of a suite of important initiatives
which have launched in recent years to improve conduct in FICC markets.
Initiatives such as the UK Senior Managers and Certification Regime, soon to be
extended beyond banks to all FCA authorised firms, will aim to raise standards
of market conduct by strengthening the accountabilities of senior management.

“This is particularly
pertinent for FX given that London accounts for over a third of global FX
market turnover,” he observed. “Reforms to remuneration structures will aim to
reduce the incentives to cheat for short-term profit. And in the UK the FICC
Market Standards Board, created as a direct consequence of the Fair and
Effective Markets Review, has been established to champion good conduct across
the whole range of FICC markets. These initiatives, combined with a greater
focus on conduct, create a supportive environment for the objectives of the

Salmon did accept that
his four reasons for optimism are not enough to ensure success, suggesting that
will require consistent widespread adherence by market participants. “The Code
will only rebuild trust if it is actively used by market participants to drive
a market-wide shift in culture and attitudes – one that embeds behavioural
norms that are consistent with both the letter and spirit of the Code,” he
stressed. “This type of cultural shift is not something that can be mandated.
The official and private sectors will work together to achieve this, but there
can be little doubt that change, fundamentally, must come from firms
themselves. In my view at least, it is in market participants’ individual and
collective interest to make that change.

“Individually, firms
that assimilate the Code fully are likely to benefit, over time, from greater
trust in the marketplace, a stronger reputation, and a higher long term
franchise value,” he added. “In a world where competition for market share
remains fierce, winning the trust of your clients matters financially.

“Collectively, if
standards of behaviour throughout the market are higher, it is easier for any
one firm to maintain its own high standards and avoid getting embroiled in a
‘race to the bottom’,” he continued. “All firms can then benefit from a
reduction in future regulatory and legal risk. Moreover, enduring adherence to
the Code’s higher standards of behaviour will likely lead to improved
functioning of the market as a whole: if widely followed, the Code should
facilitate more effective and consistently appropriate information sharing than
has been the case.”

Salmon reiterated a
line that has been a mantra from the Working Group’s chair, Guy Debelle by also
noting, “An efficient and effective market can make a positive impact on
everyone’s bottom line – leading to better volumes, fewer disputes and better
outcomes for all market participants.”

This then left the question
for market participants, how can you, collectively and individually, make use
of the Code to realise these benefits? “There are three key elements that need
to be in place. First, the Code needs to be embedded in firms’ practices:
training and education will be important here,” he said. “Second, firms should
have the right policies and procedures in place to ensure that they are able to
monitor how successfully they have embedded the Code.

“The text of the Code
itself provides some practical suggestions but ultimately firms will need to
consider what the appropriate framework is for their business and level of
activity in the FX market,” he added. “Third, firms should be able to
demonstrate publicly that their behaviour and practices in the FX market are in
line with the Code’s principles. The widespread use of a common public
attestation could be a powerful tool in this respect. It would provide a strong
signal of a firm’s commitment to following good practices and help focus the
mind of the firm’s senior management who would be asked to sign the

Salmon further
stresses that the embedding, monitoring and demonstrating adherence requires
concrete action. “The central banks are leading the way, both by demonstrating
their own commitment to the Code and by setting incentives for others to follow,”
he said. “BIS central banks have announced their intention to embed the
finalised Code within their own practices – with the expectation that their FX
counterparties will do likewise.

“We are also working
towards establishing a link between a firm’s formal commitment to adhere to the
Code and membership of regional FXCs,” he continued. “In this context, we have
been developing an attestation form, which could be adopted more widely, and
could be viewed as a public good. Given the breadth of FXC membership – there
are over 200 FXC members within the 8 major regional FXCs, representing the
buy-side, sell-side, infrastructure, associations and others – the potential
importance of this link should not be underestimated.”

Salmon did accept,
however, that central banks action alone cannot solve the problem and can only
be part of the broader picture. “The market itself needs to consider how to
engage with the Code both collectively and individually,” he said. “The process
has already started at a collective level. David Puth’s MPG has recently
created a dedicated sub-group to consider market-based methods to support the
Code. I am sure the MPG group will reach out to industry associations, like the
ACI, about the potential to develop common education modules, provide training
and seminars or facilitating workshops to deepen knowledge of the Code. We will
share thinking about the use of attestations with the MPG team, and I am
confident that they will identify a number of market-based initiatives to
support adherence.

“One idea the group is
exploring, which is not without challenges but could be developed through time,
is the creation of an industry kite-mark, which firms would be awarded if their
public attestation to the Code was buttressed by a threshold amount of
independent assurance work,” Salmon suggested.

He reiterated that individually,
firms, and particularly senior management, should start considering the steps
they will take to support the Code. “Over and above questions about policies
and procedures and training modules the key question senior management should
be asking is how can they set a strong positive tone and ensure that their
firm’s incentives and promotion policies are aligned with responsible
engagement in the market and the long-term reputation of the firm? Part of this
conversation will involve a discussion on how firms can monitor their adherence
to the Code, reward good behaviour and penalise bad behaviour,” he said.

Salmon acknowledged
that when the final Code is released in May 2017 it will no doubt be subject to
much scrutiny. “Sceptics will look for clear commitments from firms to adhere
to the Code,” he said. “Central banks are playing their part in catalysing
those commitments, but what will really count is the response of market
participants. Words alone will not be enough.

“The Code should not
be seen as, and indeed it is not created to be, a tick-box exercise,” he
concluded. “The Code is not written primarily for compliance departments but
for all the FX market – including front, middle and back office and senior
management who should want to adhere. It is a tool for rebuilding trust and


Twitter @lamboPnL


Colin Lambert

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