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More info, but no teeth in new foreign exchange code

Some say it's still 'buyer beware' for asset owners

James Singleton
James Singleton said the FX code has good intentions but needs regulation to have a full impact.

Later this month, money managers, pension funds, brokers, banks and other participants in the foreign-exchange market will be asked to sign off on an FX Global Code of Conduct that industry sources said will result in more information to assess execution quality and trading cost.

However, more information won't necessarily translate into better execution or cost savings for pension funds and other asset owners that will continue to have the responsibility for monitoring their FX trades, they said.

“The real takeaway from the code is "buyer/seller beware,'” said James Singleton, founder and CEO of Curex Group Holdings LLC, a New York-based FX execution services and data analytics provider. “It's not focused enough on the resolution of conflict and fairness ... If I'm an asset owner or a buy-side manager, what does the code do for me other than warn me?”

Added Alex Dunegan, CEO and founder, Lumint Currency Management, Boston, “It's a good start, but with these principles — and they're good principles — you have to have some teeth and be able to enforce this. There's a lot of leeway in there. It'd be difficult for a pension fund or an endowment to look at what a manager or custodian or broker does and say that they're sure the code is being followed.”

A final version of the code is scheduled to be released May 25. According to a final draft provided to Pensions & Investments, the code will have six principles for the FX industry:

  • Ethical behavior, to avoid conflicts of interest;
  • A governance framework for market participants, including internal oversight and controls by signatories;
  • Fair and transparent execution of trades;
  • Guidelines for what data can be disclosed and what must be held confidential, such as client information;
  • Risk management and compliance, with regular reporting and maintenance of robust compliance mechanisms; and
  • Efficient and transparent confirmation and settlement processes.

Started in 2015

The code is the result of efforts begun in 2015 by the Bank for International Settlements and 21 central banks to create a set of principles of acceptable behavior for any firm, government or individual participating in the global FX market. It followed a rash of charges since 2012 against banks that they manipulated the London interbank offered rate, the benchmark used to value more than $300 trillion of FX and other securities worldwide.

Lawsuits filed by pension funds in the past several years against custodians over the timing and pricing of FX trades also drove the code's creation, sources said.

“A lot of stuff in the code is really directed at the icky stuff that's happened in the industry, which is mainly on the sell side,” said Willa Cohen Bruckner, partner, financial services, Alston & Bird LLP, New York. “It looks to me that the things for the buy side are to stay on top of operations and good practice, as opposed to shaking a finger at the buy side and telling them to clean things up. The buy side should read it, but from a best-practices perspective.”

Following the code

The Bank for International Settlements expects market participants — all institutional banks, brokerages and money managers as well as pension funds, endowments, sovereign wealth funds, insurers, exchange operators and money exchangers — to agree to be code-adherent within six to 12 months of the code's final release, with most firms following the code by the end of 2017.

But the code is not a set of regulations; it establishes best practices for market participants without any enforcement capacity. Foreign exchange is the largest unregulated, over-the-counter market in the world, said Tod Van Name, global head of electronic trading for foreign exchange and commodities at Bloomberg LP, New York, and any effort to make the code enforceable would have failed.

“The death knell of this code would have been if they would have tried to move into all sorts of jurisdictions with this,” said Mr. Van Name. “It would have been mind-boggling to get every jurisdiction to agree on a single set of rules. The code is really more about behavior, setting guidelines for the proper way FX traders should act in the marketplace.”

While there are no enforceable elements to the code, James McGeehan, co-founder and CEO of FX Transparency, Framingham, Mass., said what gives it “teeth and credibility is that you have several central banks and the BIS behind it. Those central banks say they'll adhere to the code, and they'll expect others they work with to do the same. What firm will tell them they don't want to follow the code?”

Still, there are those who think the code doesn't go far enough in addressing FX industry activities that they find questionable or oppose.

Lumint's Mr. Dunegan said he was concerned the code didn't address the practice of last look, when liquidity providers have the option of rejecting an order even when the order matches the provider's quoted price. That's an issue, Mr. Dunegan said, because last look can lead to slippage, forcing the order to be executed at the less optimal price. The code only says participants using last look must disclose it.

“Some say this is how the market works, that (last look) is needed to be able to trade fairly,” Mr. Dunegan said. “But others say this goes against the concept of best price or best execution. But the code doesn't ban it; (the code) says you have to let people know you're doing it.”

Curex's Mr. Singleton agreed. “The code allows for last look and non-transparent price markups; how does that support best execution?” he said. “At the end of the day, what does this code do? It's a well-meaning document, even important, but not legally binding. Its intention is good but only regulation mandates behavioral change.”

Not specific enough

James Economides, director for Amaces Inc., a Park City, Utah, custodial consultant to institutional investors, said the code is not specific enough when it comes to what is disclosed. He said the code “says all the right words and sounds jolly good. But I'd like specificity. It's fine for banks to earn money from FX, it just has to be reasonable: What are the spreads; what are the bases for costs? We need hard numbers to benchmark and track.”

That sentiment was echoed by Mr. McGeehan of FX Transparency, who said the code doesn't require providing “high-integrity trading data to asset owners. Our clients traditionally have not been provided consistent data by custodians. External money managers' transactions, which typically have better time stamps, are not provided in the custodian files to the asset owners ... This issue sits under the covers in the code — if you can't understand when a trade was priced, you don't have real transparency and it's more challenging to measure for best execution.”

Mr. Singleton also said the code doesn't define FX best execution. “The authors didn't take on the issue of best execution and define it. This code should set off alarm bells that asset owners will have to take more responsibility for their executions. The quality of the FX trade underlying a stock and bond purchase for a portfolio is just as important as the trade execution for that stock or bond purchase. The code spends a lot of time on settlement and risk assessment issues. Settlement has worked great in this market. I think more time should have been spent on execution and the issue of fairness.”

Satnam Sohal, principal, markets, at Greenwich Associates in London, said the code will help maintain a recent trend among asset owner clients to use more transaction cost analysis in FX trades. In a survey of 323 managers in a December report by Greenwich on transaction cost analysis, 30% said they use a TCA tool in FX. That's up from 22% three years earlier. “The growth is modest, but the fact that there's growth at all says something,” said Mr. Sohal.

That interest in FX TCA shows more participants understand the need to keep close watch on FX costs, said Paul Sachs, principal, Mercer Sentinel Group, Philadelphia. “I don't see any substitute for monitoring cost.”

This article originally appeared in the May 15, 2017 print issue as, "More information, but no teeth in new FX code".