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NBIM urges improvements in foreign-exchange markets

Oystein Olsen, governor of Norges Bank

Norges Bank Investment Management, the manager of the world's largest sovereign wealth fund, has called for improvements to three areas of the foreign-exchange market.

In a paper published Friday, NBIM, which runs the assets of the 8.2 trillion Norwegian kroner ($1 trillion) Government Pension Fund Global, Oslo, said the FX Global Code "is an opportunity to revisit common market practices in global foreign exchange markets." The code was developed by the Global Foreign Exchange Committee, an association of FX committees, and released in May.

NBIM has identified three FX market practices "where informational asymmetries are particularly relevant." It said the FX markets, which had an estimated daily turnover of $5.1 trillion in April 2016, are "critical to the functioning of the global economy as they enable cross-border, international transactions."

While NBIM does not advocate the abandonment of these FX market practices, it said greater transparency and verifiability regarding their implementation would help.

The first area is "last look," used in FX spot markets to deal with the instantaneous price risk of stale quotes, the paper said. This allows a dealer to renege on an earlier quote under certain circumstances, such as a failed credit check. "More commonly, it is due to an adverse price move, which could indicate the possibility of latency arbitrage," NBIM said.

NBIM said greater transparency would enable a comparison of quotes, and "there needs to be a robust governance structure around the Last Look implementation, to provide for an audit trail. This is an area the FX Global Code should consider elaborating on."

The second practice relates to the implementation of algorithmic execution strategies, a transaction that is "ultimately still a bilateral transaction between client and dealer."

Suggested improvements relate to robust risk controls and transparency.

The third area relates to "an apparent disconnect between dealer quotes and the prevailing prices in the interdealer market. This can protect dealers from temporal price risk due to a particular client's actions. On the flip side, the general lack of post-trade transparency can make verification of prices challenging, particularly for algorithmic execution strategies." Regarding this final area, NBIM said making the state of the interdealer market more broadly known, possibly with a delay, "would significantly help in improving accountability in FX markets."

The paper, "Managing Informational Asymmetries in Foreign Exchange Markets: Asset Manager Perspective" is available on NBIM's website.