On 10 June 2015 the Final Report of the UK’s Fair and Effective Markets Review (FEMR) was published setting out the conclusions of the review and recommendations as to how to improve the wholesale fixed income, currency and commodities (FICC) markets.

The FEMR is the UK government’s flagship response to addressing the widespread perception that FICC markets are prone to abuse. HM Treasury, the Bank of England and the Financial Conduct Authority jointly published the final report, laying out six key principles and a wide-ranging set of recommendations.

Many of those recommendations overlap with EU policy initiatives already in development (the EU Benchmark Regulation, the Market Abuse Regulation and, to some extent, MiFID II). How they will eventually work alongside these EU laws remains to be seen.

Key proposals arising from the FEMR include:

  • FICC Markets Standards Board (FMSB) to help improve market-wide understanding and convergence of standards (by setting guidelines, producing case studies and other materials)
  • Establishing a new regulatory regime for spot FX activity (including civil and criminal market abuse sanctions and the establishment of a new global code of practice for spot FX activity)
  • Extending individual accountability (including extension of the Senior Managers and Certification Regime to more FICC firms and broadening the criminal sanctions for market abuse)

The FEMR’s terms of reference and key conclusions

The FEMR:

  • Seeks to identify the causes of the misconduct which have recently tarnished the reputation of the FICC markets
  • Considers the scope and impact of changes already being implemented in relation to how the FICC markets work
  • Seeks to identify where there were gaps and suggest how to fill them

Key areas of concern identified by the FEMR are:

  • Market structures
  • Standards of acceptable market practices
  • Systems of internal governance and controls
  • Limited reinforcement of standards through bilateral market discipline
  • Remuneration and incentive schemes
  • The perception that misconduct will go undetected

While acknowledging that steps have been taken, the FEMR identifies issues which are not addressed, or not fully addressed, by the current reforms, including:

  • Raising the levels of professionalism and accountability for individuals in FICC markets
  • The lack of an effective structure for agreeing and establishing common standards of practice
  • Gaps in the regulatory framework in FICC markets
  • Raising the general standard of conduct in FICC markets

The FEMR’s Recommendations

The Final Report sets out 21 recommendations under six key principles.

Below is a summary of the recommendations for each of the six principles.

PRINCIPAL 1 - RAISE STANDARDS, PROFESSIONALISM AND ACCOUNTABILITY OF INDIVIDUALS

  • Developing a global, and easily understandable, set of common trading practices in FICC markets which should be upheld in a consistent way
  • Imposing new training expectations and qualification standards for individuals operating in the FICC markets, and ensure that the training obligation is an on-going obligation
  • Putting in place a system whereby employers can identify any past regulatory or conduct issues in relation to new hires
  • Extending UK criminal sanctions for market abuse for individuals and firms to cover a wider range of FICC-related instruments
  • Raising the maximum sentence for market abuse from seven to ten years

PRINCIPLE 2 - IMPROVE THE QUALITY, CLARITY AND MARKET-WIDE UNDERSTANDING OF FICC TRADING PRACTICES

  • Establish a FICC Market Standards Board made up of senior representatives from a cross-section of global and domestic firms and end-users, which will:
    • Conduct horizon-scanning (for new trends and threats) and report on emerging risks
    • Address areas of uncertainty in specific trading practices by producing guidelines, practical case studies and other materials
    • Promote good practices on control and governance structures around FICC business lines
    • Contribute to international convergence of standards

PRINCIPLE 3 - STRENGTHEN REGULATION OF FICC MARKETS IN THE UK

  • Bringing seven additional UK FICC benchmarks into the UK regulatory framework (this has already been implemented by HM Treasury on 1 April 2015);
  • The creation of a new civil and criminal regime to deal with market abuse for spot FX;
  • Ensuring that there is proper management of conduct in the FICC markets through monitoring compliance with the standards required by the Senior Managers and Certification Regimes
  • The extension of the Senior Managers and Certification Regimes to cover a wider range of firms operating in the FICC markets
  • Improving the understanding of both firms and traders as to how competition law applies to the FICC markets

PRINCIPLE 4 - LAUNCH INTERNATIONAL ACTION TO RAISE STANDARDS IN GLOBAL FICC MARKET

  • Agreeing a single global FX code (including principles for conduct, standards for venues and tools for promoting adherence)
  • Improving the controls and transparency around FX market practices (including last-look and time-stamping)
  • Providing guidance to benchmark administrators and ensuring that adopt a more consistent approach to self–assessment against IOSCO Principles, with guidelines for benchmark users
  • Looking at improving the relationship between remuneration and incentives and conduct risk at a global level

PRINCIPLE 5 - PROMOTING FAIRER FICC MARKET STRUCTURE WHILE ENHANCING EFFECTIVENESS

  • Improving transparency while not limiting the benefits of having a diverse range of trading models
  • Promoting choice, diversity and access by monitoring, and taking action to prevent, anti-competitive conduct
  • Encouraging the market to lead reforms, previously held back by a failure of the private sector to co-ordinate

PRINCIPLE 6 - FORWARD-LOOKING CONDUCT RISK IDENTIFICATION AND MITIGATION

  • Quickly identifying conduct risks created by existing and new market structures and practices
  • Improving the monitoring of trading patterns and behaviours by firms and authorities
  • Adopting forward looking supervision of FICC markets

What does all of this mean in practice?

Where these recommendations will lead remains to be seen.

Key questions arise: What will be the legal and regulatory status of guidance produced by the FMSB? Will the FMSB’s existence coincide with a reduction in the level of available guidance from the FCA? How will the FMSB, FCA and ESMA interact?

But one thing is certain: We can expect a greater degree of oversight and more enforcement across the FICC marketplace. The FEMR represents another step in the general trend to focus on individual accountability. It would surprise few if this flagship reform were sooner or later to be accompanied by severe sanctions against some individuals operating in these markets