FCA signals tougher stance on FX services

As Global FX Code takes shape, regulator’s policy chief warns players to prepare for heightened interest in their conduct

FX service providers can expect much closer scrutiny of their work from the UK Financial Conduct Authority (FCA), as regulators around the world work towards a Global FX Code.

That was the message of a 30 November speech by FCA head of markets policy Edwin Schooling Latter.

Addressing a London gathering of FX professionals, Latter explained that spot FX currently sits in an “interesting place” on the FCA’s “regulatory perimeter”, of interest only in specific circumstances, such as instances where:

• a spot trade is ancillary to a transaction in a regulated financial instrument – for example, when buying currency to purchase a bond;
• manipulation of prices on spot FX markets impacts the prices on regulated markets, such as those for FX derivatives; or
• price manipulation impacts upon a benchmark.

Latter noted: “This does not mean that we, as conduct regulator – or, more importantly, you, as market users – should accept lower standards of behaviour or conduct than in regulated markets.

“It does not mean that the FX spot market is not of acute interest to the FCA as a regulator. It does mean, however, that there is not such a well-elaborated body of regulations and rules as there is in, for example, equity, fixed-income or derivatives markets.”

That, he said, presents a “test case” of whether – without the extensive rule books that apply to markets in bona-fide financial instruments – FX can embody the “high standards” that authorities and users expect and demand.

Latter pointed out that, in the wake of damaging incidents of market misconduct, his organisation has conducted a two-year remediation programme with FX industry players.

In parallel, it has become deeply involved with other regulators and industry stakeholders in the development of a Global FX Code – Phase I of which was published in May.

With work on the second and final phase advancing, Latter stressed that the FCA will step up its vigilance on key, client-sensitive matters – in particular:

1. Time stamping According to Latter, during the FCA’s remediation work, it identified the risk of assigning unfavourable rates to a client who has placed an ‘at best’ or ‘transaction window’ order that the dealer has worked over a period of time. As he explained: “The trader might buy, for example, at 15, 16 and 17 for a 16-average price, while the trading range over the period as a whole was 14 to 24. If the trader can freely price at 23 or 24 – well above the price achieved – we have conflicts of interest between dealer and client, and between one client and another. Good record keeping, and time stamping, are important to managing and reducing the conduct risk that such conflicts create.”
2. Mark up On this issue, Latter said: “One, in some ways remarkable, feature of some FX-trading practices is how price and remuneration for the dealer are sometimes not agreed bilaterally between dealer and client ex ante, but determined unilaterally by the dealer, and ex post. Conduct risks are bound to be lower where a client has agreed the price it will pay up front.”
3. ’Last look’ A bait-and-switch practice, whereby a trader advertises a price, but reserves the right to reject a client’s order when eventually asked to trade at that price. In Latter’s view: “Purchasing currency on the back of the client order, but then declining to sell that currency to the client at the requested price, will, all else equal, have moved the market price against the client. The client is left with an unfilled order, and needing to meet their needs in a market now less favourable than it would have been. That looks uncomfortably like the point where ’pre-hedging’ turns into front-running of a client order.”

Latter acknowledged that the Global Code will not be the first set of rules for FX conduct. However, he pointed out: “Past experience of codes has too often been that the good work put into compiling standards has not been sustained in maintaining and applying them.”

Indeed, he said, during its research of enforcement cases, the UK’s Fair and Effective Markets Review found that “few firms had integrated the provisions of codes into their internal control systems”.

As such, Latter warned: “Market participants are going to need to do better on adherence to codes in the future. The central banks and market participants involved in the Global Code work are developing various ways of strengthening adherence.”

He added: “Individuals, whether senior managers or traders, would therefore be ill-advised to forget this Code. And authorised firms should be prepared for future FCA interest in how they have made sure that their staff are aware of the Code and behave in accordance with it.”