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Strengthening Principles & Code of Conduct Standards in FX Markets

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Last Look & Pre-Trade Transparency

The Foreign Exchange Working Group (FXWG) is currently working on finalising Phase 2 of the FX Global Code.

“The Global Code should serve as an essential reference for Market Participants when conducting business in the wholesale FX Markets and when developing and reviewing internal procedures”

Phase 1: Material for Global FX Code May 2016, FXWG

Conduct Risks in FX Markets:

With the FX Global Code due to be finalised and released later this year, there has been much discussion on the subject of conduct in FX markets. In particular, two market conduct issues are being hotly discussed by some in the industry who would like to see them tackled within the Global Code – namely ‘last look’ and pre-trade hedging.

Last month on the 7th February 2017, David Mercer, the CEO of LMAX (a London-based fintech company and Multilateral Trading Facility for FX Trading), issued a public release informing that “It’s very hard for LMAX Exchange to support the global code, and be asked about how we can measure adherence to this global code whilst these two abuses [‘last look’ and pre-trade hedging] in the marketplace are permissible by the global code.”

Mr Mercer continued to request “for all those in charge of the global code, please end this practice most open to abuse in the FX market.”

FX Market Conduct: ‘Last Look’ and Pre-trade hedging

It seems Mr Mercer is not the only one with such concerns. At FX Week Europe in November of last year, the Head of Markets Policy at the FCA, Mr Edwin Schooling Latter, also spoke about Conduct Risks in FX Markets and in particular raised the issue of ‘last look’ and pre-hedging.

“One of the issues being grappled with as part of the phase two of the implementation of the ‘Global Code’ is the practice of ‘last look’ – advertising a price, but reserving the right, when a client asks to trade at that price, to reject the client’s order.”

Mr Schooling Latter continued, “All else equal, a quoted price is clearly of more use to the client if it can also actually trade at the quoted price. This is also good for the wider market – for price discovery and for accurate valuation even for those who do not intend to trade. That is why in some other areas of financial markets regulation there are regulatory requirements for certain prices advertised through the systems of a trading venue to be firm – i.e. executable – and pre-trade transparent. Some stakeholders argue that last look should therefore be prohibited altogether. They consider that is has no place in a market as liquid as FX.”

He further added, “On the other hand, indicative prices will continue to be permitted in some other situations in regulated markets, providing that their indicative status is unambiguously clear to potential counterparties”.

It is clearly a contentious issue within the FX Market and one that both industry participants and regulators alike are deliberating.

Mr Schooling Latter continued in his speech by saying “You will have heard arguments that allowing last look enables a market maker to offer tighter spreads. But the key for clients is, of course, the spreads that can be achieved rather than those that are quoted”.

He continued by saying, “I would not jump directly to the conclusion that last look should be prohibited altogether. I think there is an argument for letting market discipline and customer choice determine if and where last look continues to exist, but if market discipline is to work, there must also be transparency about the practice”.

In addition, Mr Schooling Latter said that “If FX spot were a regulated market we would consider a policy of pre-hedging and then rejecting client orders to be inconsistent with the regulatory obligations to avoid a conflict of interest with the client. If, for example, a dealer used information from its equity dark pool on a client’s buying intention, not to fill that client’s order, but to take a proprietary position, that would be a breach of conduct rules.”

He concluded by saying that “Pre-hedging and then rejecting client orders through a last look engine carries a clear risk of detriment to clients. There is an opportunity through the FX Global Code to eliminate this conduct risk without fear of competitive disadvantage – if the Code establishes strong safeguards against misuse of client information, and transparency meaningful enough to allow market discipline to work”.

Other Concerned Parties:

And it’s not just LMAX and the FCA that are concerned about ‘last look’ and pre-trade hedging.

A number of other FX market participants have raised their concerns over the market practices. One such participant is XTX Markets, a computerised trading firm based in London and Singapore.

XTX Markets informs they have developed a tool for investors that is more transparent with regards to the cost of ‘last look’ and thus believe it may spell the end of this practice. Jeremey Smart, the Head of distribution informed that their “objective is to achieve a more transparent spot FX market which is fair for all market participants.”

But what will the Global Code include?

In January this year Guy Debelle, chair of the FX Working Group (FXWG) charged with issuing the FX Global Code gave a speech that provided an update on Phase 2 of the code, with the final version of the FX Global Code expected to be published in May 2017.

It seems, from David Mercer’s release last month that Mr Debelle shares the same concerns as LMAX about both ‘last look’ and pre-trade hedging, however “it appears the global code will allow last look, and it appears that pre-trade hedging, will be permissible, as long as they’re disclosed to the client.”

Next Steps:

With many FX Market participants believing that ‘last look’ and pre-trade hedging undermine the trust in the FX Market it is surely important that the FXWG carefully consider what is to be included within the final FX Global Code and whether steps should be taken across the market to put an end to these practices or not.

We await the final FX Global Code with anticipation.

21.03.17 Last Look & Pre-Trade Transparency

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