Has the Global Code Made Life Harder for the Buy Side?

On the day that the second and final phase of the FX Global Code of Conduct was released, panellists at Forex Network New York debated whether it puts an unnecessary burden on buy side firms.

Philip Weisberg, a member of the Market Participants Group (MPG) that helped craft the Code, stated that it “puts an enormous responsibility on the buy side”.

Giving an example of this responsibility, he pointed to last look, a practice that some platforms do not allow and others allow to be implemented in a variety of ways. The platforms must disclose their last look policies, meaning that buy side firms need “to have some type of framework for evaluating the efficacy of a venue or liquidity provider choice or execution choice”, Weisberg explained.

He added: “So I think that what we’re going to see is a rapidly emerging industry to help people digest this information, process, it, score it, and make objective, quantitative decisions.”

Meanwhile, David Mercer, CEO of LMAX Exchange, said: “The Code has created more complexity by the language in Principle 11 and Principle 17. I think we’re dodging the issue and pushing it back to the customer.”

Principle 11 of the Code deals with pre-hedging, and says that market participants should be allowed to pre-hedge client orders when they are acting as a principal and, providing that the client is going to benefit from them doing so, that it will not disrupt the market and that the client has been made fully aware of that firm’s pre-hedging practices.

Principle 17 states that market participants employing last look should be transparent regarding its use and provide appropriate disclosures to clients regarding this. However, Mercer argued that these disclosures will be hard for buy side firms to understand given the number of liquidity providers that they might trade with. 

Earlier in the panel, one speaker said that their firm had produced a 25-page execution document ahead of the Code’s publication, prompting Mercer to say: 

“My goodness, you’re talking about a 25-page execution disclosure document, and these buy side firms have 20 liquidity providers who all use last look in a different way. This can’t be the way that we operate – for the buy side to have to understand 20 different disclosure documents.”

But not everyone on the panel was in agreement that the Code puts an unnecessary burden on buy side firms.

John Cooley, head of FX buy side trading at Thomson Reuters (TR), pointed out: “That’s their job, to make choices how and when to trade and then evaluate the effectiveness of those choices. And certainly, there’s been a massive trend for buy side firms getting smarter about their execution, getting better tools and analytics, and I think that’s a very healthy thing.”

Lisa Shemie, associate general counsel at Hotspot, responded to Mercer’s comments by stating that more disclosure is a positive move for the FX industry and that platforms should have an obligation to be transparent about how their venue operates, and liquidity providers should likewise be required to ensure that their clients understand how they use last look.

“To argue that there’s too much disclosure because a client is required to read a 25-page document seems to be missing the point a little because, on the contrary, clients need to understand as a commercial matter how everything related to their execution works, because they have a multitude of different options available to them,” she said.

Shemie continued: “The Code is geared towards institutional market participants, so all it’s really doing is asking an increasingly sophisticated and intelligent market to do their own homework, but we have to ensure that they have the resources to be able to make their decision based on the disclosures available.”

Jim Iorio, global head of sales and head of FX Americas, NEX Markets (Nex), said that part of the challenge for buy side firms related to the disclosures being produced by platforms and liquidity providers is that – prior to the final publication of the Code – this was not a focus for them due to other regulatory priorities.

“Because of Mifid II, this hasn’t been on the front burner for the buy side so they’re just coming to grips with the complexity of it now,” he said. “Now that the Code is here, the issue of how people deal with their counterparties and how they engage with different venues becomes a more immediate priority. A lot more work has to be done to figure out how the Code applies to them, that they document their relationships with their different counterparties and that they’re adhering to the principles contained within the Code.”

He added: “There’s a lot more work that we have to do in the entire industry to answer these sort of questions.”

Not everyone on the panel was convinced that the buy side as a whole is making a significant effort to improve the sophistication of their FX execution in terms of where they trade and what counterparties they trade with.

“The buy side should always be measuring their execution, but there are a lot of firms still not doing this appropriately. I can’t tell you how many people still subscribe to the ‘three and done’ policy of best execution, where they get three prices, take the best one and don’t think that they need to do anything else,” said Chip Lowry, senior managing director of State Street Global Markets and chairman of the Foreign Exchange Professionals Association (FXPA).

He said that the FX market “would be a better place” if the buy side did improve their analysis of execution quality, but stated that in his experience, getting the mid- to small-size asset managers to pay the appropriate level of attention to their FX execution “has been challenging”.

Mercer countered the idea that some buy side firms are not making the effort to analyse and improve their FX execution by arguing that it is currently often too expensive and too complex for them to do so.

“Look at what we’re asking them to understand and have a heart,” he said. Determining which currency pair to trade in, at what size, at what time of day, to achieve optimal execution can be very difficult, he pointed out. Then, comparing trading with various banks to trading with non-banks, trying to utilise appropriate benchmarks and understand why they might be seeing market impact with certain liquidity providers and not others is even more complex, he added.

“The biggest asset managers in the world are doing this analysis because they have enough money and resources, but I think that we’re asking too much of the buy side in general, and specifically trading in the last look window is over-complicated for customers,” he said.

Likewise, Weisberg commented that “there are a limited number of people in the market who can understand and make all of those micro-level choices”. He then suggested that some firms need to move from “overly managing the market micro-structure to focusing on the outcomes that clients are looking for and working out how they measure against those outcomes”.

It’s not just the buy side that will have to grapple with complexities introduced by the Code. Lowry pointed out that for large organisations like State Street, it is not necessarily immediately apparent which part of the business should be signing the statement of commitment to the Code.

State Street has an asset management business, a sell side global markets business, it owns e-FX trading platforms, while its global treasury department, transition management business and currency management business all trade FX.

“How does the adherence piece work for an institution as complex as State Street? What does the Code mean for each of these businesses? It’s going to take some time to answer these questions,” said Lowry.

He then explained that State Street is approaching this challenge by comparing the principles contained within the Code to the various governing documents that it has internally, such as its professional services guidelines, compliance guidelines and standard code of conduct, and then ensuring that they match up for each of the different business lines.

Cooley emphasises that the fact that the new Global Code encompasses such a wide range of market participants is what sets it apart from previous codes of conduct.

“One thing that’s important about this Code is that it’s not just for dealers and buy side clients, it actually has a very broad definition of what market participants are subject to the code,” he said.

“So this definition of ‘market participants’ includes – in addition to the direct counterparties involved in FX transactions – the related service providers, electronic trading platforms, aggregation and algo platforms and confirmation and settlement platforms. We all share a role in terms of our own compliance with the principles of the Code and in terms of the compliance amongst our client base,” he added.

Galen Stops

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