The Global Foreign Exchange Committee (GFXC) has added a negative example for Principle 11 of the FX Global Code – which deals with pre-hedging – to the document’s Annex. The update has been released alongside the minutes from the GFXC’s recent meeting in South Africa as well as a paper – The FX Global Code at One Year: A look Back and a Look Ahead – that summarises the achievements around the Global Code over the past year, but that also looks ahead to the work to be done.
The Code already had two positive examples of pre-hedging but the committee has added the negative example because it considers it “a useful addition” to the Code. Pre-hedging is firmly in the industry’s spotlight as former HSBC FX trading head Mark Johnson appeals against his conviction and jail sentence for wire fraud, including front running, in New York in the coming months.
The additional example offers a useful, and less complex it has to be said, instance of where pre-hedging is unacceptable in that it represents clear front running as it has little or nothing to do with potential market disruption and does not meet one of the Code’s main criteria for pre-hedging – it is not to the customer’s benefit.
The example states,
“A Client asks a bank for a bid in 75 million USD/JPY. The bank has disclosed to its Client that the bank acts as Principal and may Pre-Hedge the Client’s anticipated orders. The bank then proceeds to sell 150 million USD/JPY in the market outside of their ongoing business before providing a bid, with the intent of taking advantage of the Client’s trade request information and benefitting from a potentially lower market price.
“Pre-Hedging is meant for the management of the risk associated with anticipated Client orders, designed to benefit the Client. Market Participants should only Pre-Hedge Client orders when acting as Principal. In this example, the amount intentionally sold by the bank as a part of the Pre-Hedge was not commensurate with the risk borne by the anticipated trade and is not designed to benefit the Client. The bank acted with the intent to take advantage of the Client’s trade request for its own benefit and potentially puts the Client at a disadvantage. A Market Participant should also consider prevailing market conditions and the size and nature of the anticipated transaction in assessing whether to Pre-Hedge the transaction.”
Away from the additional example on pre-hedging, much of the content of the Minutes and the published Paper reinforces the message from an interview with GFXC chair Simon Potter that was published in Squawkboxafter the Johannesburg meeting and focuses on increased engagement with the buy side, the establishment of working groups on “cover and deal”, disclosures, and the further embedding of the FX Global Code into the fabric of the FX market.
As Potter told Profit & Loss in June, the three main areas of achievement for the Code have been growing awareness and commitment to the Code – as witnessed by the more than 300 Statements of Commitment posted to the 12 public registers; the embedding of the Code into the market’s practices – something that had to be done before an SoC could be signed; and the work in evolving the Code – principally the rewriting of Principle 17 which deals with last look, in December 2017.
He also discussed some of the main themes for the year ahead, namely the continuation of the “cover and deal” work around Principle 17, as well as on disclosures; and the establishing of a working group focused specifically on buy side outreach.
The paper also reflects on feedback from the GFXC’s engagement with local FX committees and the feedback therefrom. The general tone was that adoption of the Code has been “solid” – with a notable increase in SoC signings ahead of the one-year anniversary of the launch of the Code.
There has been widespread recognition and adoption of the Code by sell-side institutions and central banks, and FX market infrastructure providers in large part appear to be adopting the Code’s principles. The feedback does note, however, that “A common perception is that the rate of adoption has been much slower on the buy side. One reason for the disparity is that the universe of buy-side firms is far more diverse than that of sell-side firms, with varying levels of resources in place to support FX business activity and varying degrees of engagement in such industry efforts historically.”
Some jurisdictions noted that the Code is a frequent topic at industry events and is being used as a benchmark for similar initiatives in other asset classes, while others attributed the perceived slowness in initial adoption by some Market Participants to regulatory priorities, such as MiFID II.
When asked if any industry-wide challenges to the practical adoption of the Code had arisen the local FXCs reported some common challenges in implementing the Code across all jurisdictions. Larger Market Participants reported that implementation of the Code was a lengthy, resource-intensive process and cited institutional complexity as a challenge to overcome. Deciding the appropriate level at which an institution would sign its SoC was also highlighted as a challenge.
Slower adoption by the buy side was also a common theme across jurisdictions. Some members attributed this trend to a lack of incentives, while others thought it was due to limited resourcing for compliance functions in these institutions relative to large banks.
Most felt it would be important to continue to raise awareness and engage with this segment to support the broad adoption of the Code throughout the industry.
Other common challenges noted regarded interpretation of certain Code principles and the practical application of the proportionality concept for some smaller Market Participants.
Some respondents also highlighted the overlap of the Code with regulation in some jurisdictions as a challenge as well as the difference in expectations around the world to demonstrate adherence. For example, some regions have issued addendums to the Code with different adherence expectations, which has been reported as confusing and could risk the perception that there are multiple versions of the Code.
The frequency with which Market Participants should update their SoC and what scenarios should prompt an update was also recognised as a potential challenge in the absence of further guidance on the matter.
Finally, the report asks whether there is anything the Code has got “clewrly wrong” and principles that may need re-considering? What the paper terms “the strong message” coming from the majority of market participants is that the Code is fit for purpose, and there was no commonly held view on the need to review specific principles apart from the ongoing work on cover and deal.
Feedback suggests that the market discussion on ‘last look’ and Principle 17 remains a keenly debated topic. Some believe that there are market participants that are not signing a SoC to the Code purely because of Principle 17.
Some feedback recognised that the two key challenges—disclosures and cover and deal—are already being addressed via GFXC working groups.
It was also noted that the Code will need to be dynamic and respond to changes in the market, such as increased use of electronic trading, algorithmic trading, artificial intelligence and cover and deal trading. Market participants acknowledged the consultation process used for the ‘last look’ feedback request as the appropriate way to update the Code going forward.