Now that MiFID II is in force and the industry has had time to digest the Global Code of Conduct, platform providers will face less distractions in 2019, says Galen Stops.

In the second half of 2017 it seemed as though many FX market participants, on both the buy and sell sides, were forced to shelve any business plans that they might have as resources were diverted to help ensure compliance with MiFID II ahead of the deadline on January 3, 2018.

Preparations for MiFID II cost an estimated $2.1bn in 2017 alone, according to a report by Expand, a Boston Consulting Group company, and IHS Markit, and this does not account for the amount of manpower and time that was also devoted to ensuring that everything was ready within these firms ahead of the deadline.

“One thing that made the MiFID II experience unusual was not only the scale and scope of the regulation, but that the penalty if you were wrong could be pretty catastrophic. Nobody wanted the FCA to come to them and inform them that they botched one area of compliance and therefore you can’t trade. The reputation risk was huge,” recalls one banker in London.

And yet for all this, January 3 passed rather uneventfully – there were no high-profile horror stories of platforms that didn’t work or counterparties that were suddenly unable to trade with one another.

“Some people have compared MiFID II to Y2K because there was so much concern in the build-up to each, but then in the end nothing bad happened as a result of either. So did we over-egg the problem, given how smoothly everything went? Well the answer for both Y2K and MiFID II was no, things went smoothly because the whole industry basically focused on this for two years and did a lot of work to prepare for it,” says Neill Penney, co-head of trading at Refinitiv.

On the multi-dealer platform side, spot FX was exempt from the MiFID II requirements and therefore it might seem as though trading venues that only offered this product would be able to continue with business as normal. The reality is, however, that it was challenging for them to introduce any significant upgrades or changes because many of the users of their platforms were too consumed with MiFID II preparations to allocate the time or the resources to making the adjustments that would be required on their end for these upgrades. For the multi-dealer platforms offering FX products that did fall within the scope of MiFID II, it was a very different experience, and elsewhere in this report some of them detail the huge lift that was required by them to make sure that their platforms were ready ahead of January 3.

“All of these requirements were brand new, they had never been done before, and when you look at the scale of the amount of trades and trade information that we were all trying to collect and send through to the FCA, this was a big deal,” says Tod Van Name, global head of electronic FX at Bloomberg. “Then you look at the interoperability between all the different systems, including on the bank side for all of their risk metrics, their deal capture, deal confirmation and confirmation matching settlement. Everyone in the industry uses different systems and they all had to talk to one another. We think that the market actually did pretty well in terms of making sure the MiFID II go-live date went smoothly.”

Not only did some of the platform providers’ worst fears regarding MiFID II prove to be unfounded – namely that trading activity would be disrupted around the implementation date and that liquidity might subsequently fragment along region

al lines as non-EU market participants sought to avoid being swept up in the regulatory requirements – some of the hopes that they harboured about the potential for it to push more activity onto electronic platforms came to fruition.

For example, Penney says that firms which have tended to lag behind in terms of e-commerce, such as global wealth and global macro funds, have increasingly begun trading on electronic platforms as a result of MiFID II. He explains that these are customers that are typically trading very large amounts, while ecommerce has traditionally been about efficiency and accuracy, but on smaller amounts, and hence they have tended to avoid these channels. But now, with MiFID II imposing best execution requirements on market participants, Penney says that the analytics and audit trail provided by electronic platforms, combined with the growing sophistication of algo tools available in the market to help execute larger trades on these platforms, is encouraging these client segments to increasingly trade via electronic platforms.

Impact of the Code

Elsewhere, 2018 saw the one year anniversary of the FX Global Code and a continued concerted effort from central banks, national authorities and certain individuals and firms within the FX industry to pro

mote adherence to the 55 principles contained within it.

At the time of writing, 149 firms have signed the Statement of Commitment to the Code, although it’s been well documented that sell side firms and trading platforms make up the vast bulk of this figure. As Van Name explains, however, part of the reason why these firms have been quicker to commit to the Code is because even though it does not have the same status as regulation, it can still consume a lot of time to ensure that all the necessary internal policies are in place and aligned with the Code’s principles, and that buy side firms often don’t have the same resources available with which to do this.

“I think that the challenges for us, and many other firms when the Code first came out, was that even though it’s not regulation, if I commit to the Code I’m basically saying that my firm and my people are prepared to follow the policies laid out within it. And that’s a big undertaking, because firstly you have to make absolutely sure that every part of your firm is following the guidelines, and secondly, because in many cases that commitment is associated with a person who may be acting on behalf of the firm. And those individuals take this very seriously, I know that I did when it came to Bloomberg committing to the Code – I spent months with a team of legal and compliance people here, going through all 55 guidelines and looking at where each one touches Bloomberg and what policies we do and don’t have in place amongst our multiple entities,” he says.

Van Name adds: “It took a long time for us to go through this process and sign the letter of commitment, and we were fortunate that our internal policies covered most of what was in the Code. We also have legal and compliance resources available. I think that a challenge for many firms without the resources of a firm like ours is: where do you find the time and the people to go through this process when there may only be four, 40 or 400 people in the company? We’re all hoping that we get greater buy side adoption because, after all, the Code was implemented to make sure that they were comfortable with the practices of the industry, but I think that as an administrative obligation it’s not an easy lift and we have to be mindful of that.”

While continued adoption of the Code is important, perhaps more significant in the short-term is to consider whether it is actually changing behaviour within the FX market, something that multi-bank platform providers should be well placed to observe.

When questioned on this issue, some of the platform providers unsurprisingly default to simply insisting that there was never any bad behaviour on their venue to begin with and therefore there hasn’t been any significant change that they’ve observed since the official launch of the Code. Others highlight that the level of disclosure in terms of how liquidity providers interact with their buy side clients has improved significantly since its introduction. Specifically, they point out that it has prompted more in-depth discussions between each side around how last look functionality is applied and what exactly constitutes pre-hedging. In addition, these platforms report that the Code has driven an increased interest in trade analytics, with buy side firms increasingly wanting to use data to inform these discussions with their counterparties.

In some cases, though, it’s not necessarily obvious whether or not the changes in market behaviour observed on these platforms would have occurred independently of the Code.

“I can tell you that there’s a correlation, but I’m not sure where the causality is,” says Seth Johnson, CEO of cash markets at CME Group, which owns EBS. “What I mean by that is that, yes, since the Global Code has been released we have seen spread compression, lower reject rates and lower holding times on our platform, but we’ve also been giving people access to much more data about how their counterparties are behaving, and it’s not at all clear to me which one is driving these outcomes, or whether the two are symbiotically helping towards this.”

He adds: “One thing that is quite interesting to note though is that we have given people on our platform the ability to declare whether they have signed up for the Global Code or not, and nobody has decided not to continue dealing with someone who has disclosed that they haven’t signed the Code.”

Turning Towards Innovation

Although MiFID II and the Code will almost certainly continue to influence the behaviour of FX market participants, undoubtedly the heaviest lift required by the industry on these fronts is over. With Dodd-Frank in the US and MiFID II in Europe now both live, there doesn’t appear to be any “whale” pieces of financial regulation on the horizon, most of the major multi-dealer platforms have now committed to the Code, and even the legal cases involving cases of alleged misconduct in the FX market appear to be winding down – as evidenced by the fact that the now infamous “Cartel” traders have been acquitted on the charges brought against them, the case against Mark Johnson seems to be floundering and the New York Department of Financial Services (DFS) has issued its final fines in conjunction with its FX market manipulation probe.

Whisper it, but perhaps this means that the FX industry can finally shift its focus away from legal and compliance concerns and get back to the business of foreign exchange? This is certainly the hope of many and the expectation from Penney.

“The industry really went on hold for about a decade, since the financial crisis. Regulatory reform was one part of that and conduct reform was another. So e-commerce was evolving very quickly until about 2008 and then it sort of flat lined in terms of innovation for about a decade while these issues were sorted out. But now I have the sense that those issues are largely behind us now and the industry can turn its attention towards innovation again,” he says.

Penney continues: “The other thing to think about is: what’s happened in the rest of the world over the last decade? Well, cloud technology has matured and transformed itself from something that people claimed they would never put sensitive data in to something that they can’t put sensitive data in fast enough because they recognise that there are more security experts working at Amazon now than any bank or platform could hire. AI and machine learning is another area that has progressed significantly in the past decade, while blockchain is just around the corner. So there’s actually this whole set of technologies that have been perfected by other industries that FX can now receive in basically a mature state. So I think we’re going to see some evolution of the market due to exactly that, which I think is exciting because it’s been a long time since we’ve seen this.”

Not everyone shares this level of optimism though. A source at one platform provider says that while compliance seems like less of a burden now, that’s mainly because the rules and requirements are understood, not because they’re less of a financial drain. They argue that the real issue in the build-up to the MiFID II go-live date was that it was unclear exactly how many parts of the requirements would be interpreted and implemented by the industry. Now, they say, the reporting processes are bedded in, the connectivity needed is in place and firms know what they need to do, but the cost associated with doing these things hasn’t diminished.

“It’s probably less of a burden and more of a cost now. This is just the cost of doing business today, but ultimately someone is paying for that and it’s impacting your margins,” they add.

Similarly, David Mercer, CEO of LMAX Exchange, isn’t buying the idea that the FX industry can put regulation in its rearview mirror.

“I don’t think regulation is done by any stretch. In capital markets there’s always new regulations coming down because the regulators are always having to play catch-up. Allegedly, there’s already talk about MiFID III and there’s going to be a lot of work needed around equivalence or passporting, or whatever is agreed between the UK and the European Union post-Brexit,” he says.

Certainly Mercer raises a valid point that Brexit will pose a new regulatory challenge for multi-dealer platforms operating in Europe, with the difficulty there being that it remains unclear exactly what sort of regulatory framework will replace the current EU rules once the UK leaves the Union and how this framework will interact with those on the Continent.

Aside from this though, it seems likely that 2019 will present platform providers and their clients with less regulatory and compliance headaches than the past two years, but this will only hold true if the FX industry is able to avoid any more scandals like the ones that inspired the creation of the Code in the first place.

As Mercer puts it: “The reality is that, certainly on the spot side, we’re still as an industry allowed to be mostly self-regulating. So this is really the last throw of the dice, we can’t have too many more scandals that are dated post-2018, otherwise we could be facing much more regulation.”

Galen Stops

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