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UK Authorities Weighing Up Changes to Market Making in FX

A senior official at the Bank of England (BoE) has said that regulators are looking at making changes to how market making practices are controlled in the FICC markets.

Speaking at a conference in London yesterday, Andrew Hauser, director, markets strategy at BoE, said that the UK regulators are looking at the principal market making model as part of its Fair and Efficient Markets Review (FEMR).

“Many of the market practices at issue relate to the operation of the principal-based market making structure that still forms the heart of many parts of FICC,” said Hauser, who also noted that “It seems likely that this model will remain a key component of many FICC markets.”

“At the same time, it does give rise to conflicts of interest, reflecting the fact that market makers provide services to counterparties but also, as principals, have a direct interest in the level of market prices. These conflicts have long been understood – but they require effective controls if the benefits of the model are to be delivered without harming the interest of counterparties, or wider market integrity,” he added.

It is not only the perceived conflicts in the principal-based market making model that regulators will be looking at as part of FEMR.

Hauser said that several respondents to the FEMR consultation have claimed that the practice of “last look” has the potential to be abused, giving firms the opportunity to reject losing trades or use the opportunity provided in the rejected trade for their own purposes.

“Respondents generally agreed that the Review’s consultation document had identified a number of other areas of uncertainty in practice associated with market making, including the use of the information, uncertainty over when counterparties are operating in a principal or agency capacity, and the boundaries of acceptable pre-hedging activity,” he commented.

Hauser concluded: “Simply put, the challenge for the review in this area is as follows. Can such market structures or practices be effectively controlled, by putting in place new conduct standards (or reinforcing existing ones) that credibly outlaw unacceptable behaviour whilst providing sufficient certainty over acceptable behaviour to allow legitimate business to operate effectively?

“Or is more profound structural change required, either to ban certain practices or to bring about changes in market structures that remove the scope for such abuse? The costs and benefits of these two approaches need careful analysis.”     Twitter: @Galen_Stops

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