How to maintain high ethical standards in the FX market
Corporate risk management must address the reputational damage that can stem from misconduct. Sarah Boyce explains how two voluntary codes can help
Treasury is really all about risk management.
As corporate treasurers, we spend our lives identifying and managing the financial risks that crop up in the organisation – whether that’s a case of needing to raise or invest money, buy currency, or even, and here’s a new one for those of you who have only been in treasury for the past 10 years, manage interest rate risk.
These are seen as an accepted part of the treasurer’s role.
But there are other (operational) risks, more nebulous, but nonetheless important, with which the treasurer has to grapple, and which increasingly are the focus of the board and other key stakeholders.
These operational risks include both accidental (human error) or deliberate (fraud) actions that place the organisation at risk of financial and reputational loss.
Corporates dedicate considerable time and resource to considering how they should structure and manage treasury activities to protect the organisation from these risks.
One approach is to consider:
- Segregation of duties (and what used to be called the ‘four eyes’ principle);
- Development of, and adherence to, treasury policies and procedures;
- Establishment of clear delegated powers or authority from the board;
- Regular reporting and interaction with senior management; and
- Use of audit – both internal and external.
All of the above put safeguards in place both for the organisation and for the individual, but the challenge may be where to start. This article offers some thoughts on the development of treasury policies and procedures.
Codes of practice
Turning to the financial markets, the Fair and Effective Markets Review (FEMR) of the fixed income, FX and commodities markets was commissioned by the UK government after numerous banks were fined billions of pounds for trying to rig the benchmark interest rate, Libor, and manipulate FX reference rates.
The FEMR found that the informal codes of practice that had traditionally existed across these markets had often been misunderstood or disregarded. A lack of internal controls and personal accountability had furthermore contributed to what the FEMR rather kindly called ‘ethical drift’.
In short, the market was not acting transparently or ethically and the regulator wanted this resolved. This resulted in various working groups comprised of a combination of public (central banks) and private parties (market participants) developing codes of good practice.
For example, an FX Global Code has been drafted under the auspices of the Bank for International Settlements. In the UK, the development of the FX Code meant that the Non-Investment Products Code had sections that were no longer relevant, and so the opportunity has also been taken to refresh guidance on the UK unsecured deposits and repos markets through the publication of the UK Money Markets Code.
(Possibly less relevant for many corporates, a Global Precious Metals Code has also been published.)
Both the FX Global and the UK Money Market Codes are voluntary, but drafted to encourage the broadest possible range of market participants to become involved by signing up to the statement of commitment.
The codes have been drafted to encourage participants to actively think about their behaviours
One might be forgiven for thinking that these codes of conduct have been developed purely to address the misdemeanours of the banking world, but, as well as setting out good practice in the various financial markets, these codes also set out the behaviours that a corporate can expect from its banks.
And they are relevant for corporates, as they are classified as market participants.
In June, the Bank of England hosted a launch event for the ACT specifically for corporates at which they presented the background to, and rationale for, these codes – a clear demonstration of the importance that the Bank of England places on reaching out to corporates as participants in the financial markets.
The overarching principle of both of these codes is that market participants should strive for the highest ethical standards. Let’s consider how these codes of good practice might also be a useful source of information and ideas for anybody developing treasury policy and procedures for a corporate treasury.
The FX Global Code
Taking the FX Global Code as an example: the purpose of the FX Code is to promote the integrity and effective functioning of a robust, fair, open, liquid and transparent FX market in which market participants can confidently and effectively transact in a manner that conforms to acceptable standards of behaviour.
The FX Code is principles based, to encourage active consideration of how best to integrate the desired behaviours into the day-to-day activities of market participants, and this makes it particularly useful for corporates looking to develop policies and procedures.
It is organised around the following six leading principles:
- Ethics Market participants are expected to behave in an ethical and professional manner to promote the fairness and integrity of the FX market.
- Governance Market participants are expected to have a sound and effective governance framework to provide clear responsibility for, and comprehensive oversight of, their FX market activity and to promote responsible engagement in the FX market.
- Execution Market participants are expected to exercise care when negotiating and executing transactions in order to promote a robust, fair, open, liquid and appropriately transparent FX market.
- Information sharing Market participants are expected to be clear and accurate in their communications and to protect confidential information to promote effective communication that supports a robust, fair, open, liquid and appropriately transparent FX market.
- Risk management and compliance Market participants are expected to promote and maintain a robust control and compliance environment to effectively identify, manage and report on the risks associated with their engagement in the FX market.
- Confirmation and settlement processes Market participants are expected to put in place robust, efficient, transparent and risk-mitigating post-trade processes to promote the predictable, smooth and timely settlement of transactions in the FX market.
Each principle in the FX Code is predicated on transparency and disclosure; ie providers of services need to be transparent about the products they offer and the ways in which they execute a transaction.
Similarly, the buyers of those services must ensure that they understand what they are purchasing, to ask questions about how an order will be executed, and, when necessary, to provide clear guidance about their preferences.
The codes have been drafted to encourage participants to actively think about their behaviours rather than just complete a box-ticking exercise and, as a result, a clear benefit is that a treasury can work through each of the principles, decide not only how it might apply in their dealings in that particular market, but also consider how it might be reflected in internal policies and procedures.
To summarise: whether you are an active participant in the FX market or the various UK money markets, whether you need to understand what your banks should be doing when transacting with you in these markets, or whether you are looking for resources to develop in-house policies and procedures, the Global FX Code and the UK Money Markets Code are valuable resources for treasurers.
Details about the codes can be found on the ACT website.
About the author
Sarah Boyce is associate policy and technical director at the ACT.