A global code of conduct (“the Code”) for the foreign exchange (“FX”) market was published in May 2017. Defined as ‘a set of global principles of good practice in the foreign exchange market,’ the Code provides a common set of guidelines to promote the integrity and effective functioning of the FX market, which has a turnover of more than $5 trillion a day. Developed by a partnership between central banks and Market Participants from 16 different jurisdictions which are international FX trading centres around the world, the Code supersedes and updates existing guidance for participants in FX markets, provided in the UK by the Non-investment Products (NIPs) Code.
By establishing a common set of guidelines, the Code’s practical objectives are to promote integrity and to ensure the effective functioning of the FX market. To deliver this, it aims to promote an FX market which is robust, fair, liquid, open, and appropriately transparent. The Code further recognises the diversity of the FX market and confirms that the Code will apply to all. No legal or regulatory obligations on Market Participants are imposed by the Code, nor does it substitute for regulation; instead it is designed to serve as a supplement to relevant local laws, rules and regulations by identifying global good practices and processes.
A strong health warning is given in relation to its scope and authority: ‘The content of this guidance in no way supplants or modifies Applicable Law. Similarly, this guidance does not represent the judgement nor is it intended to bind the discretion of any regulator, supervisor, or other official sector entities with responsibility over the relevant markets or Market Participants, and it does not provide a legal defence to a violation of Applicable Law.’
The Code will be maintained and updated by a new Global Foreign Exchange Committee (GFXC). This new body will meet regularly, replacing a more informal commitment from eight foreign exchange committees from Australia, Canada, Euro Area, Hong Kong, Japan, Singapore, UK and the US. The expanded, formalised GFXC will also include representatives from existing, or soon to be established, foreign exchange committees or similar structures in Brazil, China, India, South Korea, Mexico, South Africa, Sweden (representing the Scandinavian market), and Switzerland.
Because the Code is entirely voluntary, there is no power vested with any authority or organisation to enforce it. However, several prominent organisations have voiced their support. The European System of Central Banks welcomed the publication of the Code, while a separate statement of support was issued by governors of the Bank for International Settlements Global Economy Meeting.
The Financial Conduct Authority (“FCA”) in the UK also issued a statement of support for the Code when it was released stating that it “expects firms, senior managers, certified individuals and other relevant persons to take responsibility for and be able to demonstrate their own adherence with standards of market conduct.”
Looking ahead, it is very likely that the FCA will use the Code as an additional measure of assessing how firms engaged in the FX market have conducted themselves. One element contained within the Code is a “Statement of Commitment”, which invites firms to adopt it not only as a demonstration of their commitment to adopting the good practices contained therein, but also as a means of assessing and benchmarking the commitment of other market participants.
As with so much regulation, the Code evolved in response to events that preceded it. It is an attempt to prevent any recurrence of the significant damage caused by the benchmark rigging scandal which engulfed the market in 2014, leading to widespread allegations of collusion and market manipulation. The main focus of the ensuing scandal was revealed to be alleged collusion by traders relating to the 4pm London WMR Benchmark Rate. This caught the attention of global media when chat rooms with names such as “the Cartel” and “the Mafia” were said to have been deployed.
The regulators’ response was swift and severe. In November 2014, the FCA fined five banks a combined total of £1.1 billion for failing to control their business practices relating to G10 spot FX trading operations. In announcing the fines, the FCA stated that these were the largest ever imposed by the authority to date. Notably, this was also the first occasion that the FCA had ever pursued a simultaneous group settlement with banks in this way. The principal allegations were that, as a consequence of ineffective controls, the banks had allowed their G10 spot FX traders to put their employers’ interests ahead of those of their clients and that the banks had failed to manage or mitigate obvious risks in relation to confidentiality, conflicts of interest and trading conduct.
The Code is governed by six leading principles in the following areas: Ethics, Governance, Execution, Information Sharing, Risk Management and Compliance and Confirmation and Settlement Processes. Parts of the Code are extremely high level in the terminology and language used, offering little by way of detailed practical guidance. For example, the section on Ethics outlines a number of generic principles, such as “market participants should identify actual and potential conflicts of interest that may compromise or be perceived to compromise the ethical or professional judgment of market participants,” that will undoubtedly already be covered in Codes of Conduct already in place at firms. It is therefore doubtful as to how useful the information given will be to market participants seeking detailed and practical reference points.
To remedy this deficiency, Annex 1 of the Code seeks to offer illustrative examples that aim to discuss different situations in which the key principles might arise and how a market participant should, or should not, behave in response. However, this is accompanied by the usual caveats cautioning market participants that such examples should not be “understood or interpreted as precise rules” and nor do they provide “safe harbour.”
Is information sharing still allowed?
The controversial issue of information sharing, and the extent to which it was alleged to have been abused, lay at the heart of the 2014 FX scandal. While the Code does not specifically proscribe information sharing between market participants, it seeks to offer guidance on when and how such information can legitimately be shared.
Information Sharing is dealt with in Principles 19 – 23 of the Code: Principles 19 – 20 outline the handling of confidential information, while principles 21 – 23 cover communications. The principles covering confidential information (19 & 20) are largely generic, referencing broad concepts that arguably would not greatly assist individual market participants. For example, Principle 19 advises market participants that they “should not disclose confidential information except to those internal or external parties who have a valid reason for receiving such information, such as to meet risk management, legal and compliance needs.” Principle 20 outlines some examples of when disclosure of confidential information might arise, although these are not exhaustive. In providing further assistance, Annex 1 gives examples for market participants relating to confidential information, leaving them to consider these and apply them to their own firms.
Market colour, dealt with by Principle 22, is a concept that has attracted much attention in the wake of the FX scandal. In simple terms, it is information that tells traders what is going on in the market. A key issue arising from the FX scandal was the line between the sharing of market colour and the sharing of confidential information between traders. The Code attempts to draw a clear distinction between sharing market colour which is permissible, as opposed to the sharing of confidential information, by detailing a series of bullet points intended to offer guidance on what is and is not permissible. Thankfully, some clear lines are drawn. For example, communications should not reveal individual trading positions and flows should be disclosed only by price range and not by exact rates. Ultimately, however, the onus falls on firms to provide their employees with clear guidance on the appropriate sharing of market colour. Since the FCA will undoubtedly expect firms to have this in place already, it will therefore be imperative for firms to act accordingly.
The release of the Code, nearly three years after the FX scandal first emerged, raises the inevitable question as to how useful it will really be, especially when firms will already have been obliged to significantly strengthen their previous compliance procedures. Manifestly, the Code provides a good starting point for an industry obliged to show its full commitment to promoting ethical working practices. Nevertheless, the burden of implementation remains fixed on firms: it is their duty to ensure that they have detailed compliance procedures in place and that they adhere to the Code’s principles. It is anticipated that the Code will develop over time and in doing so, it is hoped that it will also evolve to provide more detailed practical guidance for market participants.
This article was originally published in Compliance Monitor and can be accessed here, behind a paywall.