The Fair and Effective Markets Review today published its Final Report (see link at bottom of post), which sets out 21 recommendations to help restore trust in the wholesale Fixed Income, Currency and Commodity (FICC) markets. The Review was established by the Chancellor of the Exchequer and Governor of the Bank of England in June 2014 to help to restore trust in those markets in the wake of a number of recent high-profile abuses. Back in October the FEMR published a consultation document, (available on the Bank of England website), on what needs to be done to reinforce confidence in the fairness and effectiveness of the FICC markets.
The final report from the FEMR is centred on the following principles:
Near-term actions to improve conduct in FICC markets:
1. Raise standards, professionalism and accountability of individuals
a. Develop a set of globally endorsed common standards for trading practices in FICC markets, in language that can be readily understood, and which will be consistently upheld (IOSCO: 4.3.1);
b. Establish new expectations for training and qualifications standards for FICC market personnel, with a requirement for continuing professional development; (FMSB: 5.2.3)
c. Mandate detailed regulatory references to help firms prevent the ‘recycling’ of individuals with poor conduct records between firms; (FCA and PRA, FMSB: 184.108.40.206)
d. Extend UK criminal sanctions for market abuse for individuals and firms to a wider range of FICC instruments; (HMT: 6.3.1)
e. Lengthen the maximum sentence for criminal market abuse from seven to ten years’ imprisonment. (HMT: 6.3.1)
2. Improve the quality, clarity and market-wide understanding of FICC trading practices.
Create a new FICC Market Standards Board with participation from a broad cross-section of global and domestic firms and end-users at the most senior levels, and involving regular dialogue with the authorities, to: (Market participants and end-users: 4.3.2)
– Scan the horizon and report on emerging risks where market standards could be strengthened, ensuring a timely response to new trends and threats;
– Address areas of uncertainty in specific trading practices, by producing guidelines, practical case studies and other materials depending on the regulatory status of each market;
– Promote adherence to standards, including by sharing and promoting good practices on control and governance structures around FICC business lines;
– Contribute to international convergence of standards.
3. Strengthen regulation of FICC markets in the United Kingdom
a. Extend the UK regulatory framework for benchmarks to cover seven additional major UK FICC benchmarks accepted and implemented by HM Treasury on 1 April 2015; (HMT and FCA
b. Create a new statutory civil and criminal market abuse regime for spot foreign exchange, drawing on, among other things, work on a global code (see recommendation 4a); (HMT and FCA: 4.3.3)
c. Ensure proper market conduct is managed in FICC markets through monitoring compliance with all standards, formal and voluntary, under the Senior Managers and Certification Regimes; (Firms and FCA: 220.127.116.11)
d. Extend elements of the Senior Managers and Certification Regimes to a wider range of regulated firms active in FICC markets; (HMT and FCA: 18.104.22.168)
e. Improve firms’ and traders’ awareness of the application of competition law to FICC markets. (FCA:2.4.2)
4. Launch international action to raise standards in global FICC markets
a. Agree a single global FX code, providing: principles to govern trading practices and standards for venues; examples and guidelines for behaviors; and tools for promoting adherence. The Review strongly welcomes the recent announcement by central banks to work towards those goals; (BIS and national central banks including the Bank of England 4.3.3)
b. As part of that work, improve the controls and transparency around FX market practices, including ‘last look’, ‘time stamping’ and ‘internalisation’ (BIS and national central banks including the Bank of England 4.3.3)
c. Explore ways to ensure benchmark administrators publish more consistent self-assessments against the IOSCO Principles, and provide guidance for benchmark users; (IOSCO: 3.3)
d. Examine ways to improve the alignment between remuneration and conduct risk at a global level. (FSB: 5.4.3)
Time stamping: the absence of ‘time stamps’ on some client orders can make it difficult for investors to assess the efficiency of their FX executions, creating potential opportunities for abusive practice.
“The Review has concluded that time stamps should always be provided, ….regulatory steps are also sensible, as part of a broader statutory market abuse regime discussed later in this section”.
Given the international character of FX markets, discussions around the global code would offer the most effective mechanism for establishing consistent standards on time stamping, including any practical challenges that may arise. But in light of those discussions, regulatory steps are also sensible, as part of a broader statutory market abuse regime discussed later in this section.
Last Look: On the point of Last Look (see previous post), the report makes the following comments:
The new global code should address the practice of ‘last look’, which gives market makers a final opportunity to reject an order after a client commits to trade at a quoted price. As set out in Section 2.4.1, this practice developed out of the need to protect market makers against unanticipated market movements and predatory trading practices.
“the global code should also set out clearer standards on the use of last look, including whether it should remain an acceptable market practice”.
However, in its current form, it can potentially be abused by market makers, either by asymmetrically accepting or rejecting orders based on market moves after the order is placed, or by using the order to inform other trading activity prior to acceptance. In addition to the transparency measures discussed in Section 2.4.1 the global code should also set out clearer standards on the use of last look, including whether it should remain an acceptable market practice.
Internalisation: The increased use of ‘internalisation’, where market makers match trades across their own books rather than through an external broker. Most market participants responding to the Review agreed that internalisation may enhance market effectiveness to the extent that it enables tighter pricing for clients. However, the lack of transparency associated with internalisation could limit the ability of clients to assess the quality of execution they receive. Further transparency measures would help to evidence the fairness of the order execution process and the efficiency of the client’s resulting execution.
Principles to guide a more forward-looking approach to FICC markets:
5. Promoting fairer FICC market structures while also enhancing effectiveness, through:
a. Improving transparency in ways that also maintain or enhance the benefits of diverse trading models, including over-the-counter; (Authorities and firms: 2.4.1)
b. Promoting choice, diversity and access by monitoring and acting on potential anti-competitive structures or behaviour; (FCA and CMA 2.4.2)
c. Catalysing market-led reform held back by private sector co-ordination failures. (Authorities and firms: 2.4.3)
6. Forward-looking conduct risk identification and mitigation, through:
a. Timely identification of conduct risks (and mitigants) posed by existing and emerging market structures or behaviours; (FCA and FMSB 2.5)
b. Enhanced surveillance of trading patterns and behaviours by firms and authorities; (Firms and FCA 6.3.4)
c. Forward-looking supervision of FICC markets (FCA 6.3.3)
According to the report, it is now time for individuals and firms to step forward and play a central role in improving standards in FICC markets. The Review has been greatly encouraged by firms’ commitment to the project over the past year, most notably through the Market Practitioner Panel chaired by Elizabeth Corley, CEO of Allianz Global Investors. The challenge now is to turn that into action. If firms and their staff fail to take this opportunity, more restrictive regulation is inevitable.
Full report is available here: FEMR Final Report – Jun 2015