Conduct risk in FX markets

Speech by Edwin Schooling Latter, Head of Markets Policy at the FCA, delivered at FX Week Europe.

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Speaker: Edwin Schooling Latter, Head of Markets Policy
Location: FX Week Europe, London
Delivered on: 30 November 2016


  • In July 2016 we published details from supervisory work with 30 major firms to improve conduct in wholesale FX markets. We expect all firms active in these markets to consider and address conduct risks identified.
  • The FX Global Code is an opportunity to set higher minimum standards in areas where conduct risk persists.
  • The Code will be a key component of market conduct standards that staff in authorised firms will have to observe under the Senior Managers Regime.

Note: this is the speech as drafted and may differ from delivered version.

It’s a great pleasure to be here today, to talk at an event which attracts so many of those at the heart of the global FX market, a market which is itself at the heart of global financial markets more generally, and to talk about an issue – conduct – which is in turn at the heart of that market working effectively.

I want to share with you today some of our perspectives, as the conduct regulator of UK-based financial markets, on good – and poor – conduct, and where conduct risk lies in this enormously important market.  

This perspective is one that is shaped by the lens of the FCA’s single strategic and statutory objective – the objective given to us by Parliament – which is to ensure that financial markets work well.

At an operational level, that means we want the UK’s FX markets – which are, as you know, over one third of the global FX market – to be characterised by market integrity that is second to none, and by competition working in the interests of market users. It means we want FX markets which are effective in meeting users’ needs and in which those users are appropriately protected from misconduct.

In short, we want the UK’s FX markets to be the world’s best.

Which I imagine is what many of you here want too. 

As some of you will know, spot FX sits in an interesting place on what we call our regulatory perimeter. Spot FX trading is only within the perimeter in certain circumstances, for example where a spot trade is ancillary to a transaction in a regulated ‘financial instrument’ (for example, when buying currency to purchase a bond), or where manipulation of prices on spot FX markets impacts the prices on regulated markets such as those for FX derivatives, or impacts on a benchmark. Most other FX trading is, in formal terms, outside our perimeter.

This does not mean that we as conduct regulator, or, and more importantly, you as market users, should accept lower standards of behaviour or conduct than in regulated markets.

It does not mean that the FX spot market is not of acute interest to the FCA as a regulator.

It does mean, however, that there is not such a well elaborated body of regulations and rules as there is, for example, in equity, fixed income or derivatives markets. 

This makes FX a test case of whether, without the extensive rule books applying to markets in assets classified in law as financial instruments, the market will or will not be characterised by the high standards that are expected and demanded of it by authorities and users alike.

I know from the many conversations that colleagues and I have had with many of you how deeply most of you care about high standards of conduct, and the pride you take in delivering good outcomes for customers.

But we are all also painfully aware of how revelations of poor conduct have damaged trust, and will continue to do so unless we can collectively prove that the cultures and behaviours that led to them have been decisively addressed.

In this month of November two years ago, the FCA had just published details of the largest ever fines imposed by the FCA, or its predecessor the FSA. We announced fines on five banks – and later a sixth – that had failed to control business practices in their FX trading operations. Among other misconduct, their staff had been attempting to manipulate the FX fix.  

In this month of November last year, we heard about the New York Department for Financial Services (DFS) US$150m fine on Barclays for providing insufficient information, and for misrepresentation in disclosures to clients about its so-called ‘last look’ practices.

Not so many weeks ago, in July of this year, the US Department of Justice announced its charges of front running of client orders by staff at HSBC.

This November, just five days ago, we saw the announcement of fines for Macquarie and ANZ for trying to rig the benchmark rate for the Malaysian ringgit.

It is evidence of these types of behaviours that is the driver for the work, organised through the Bank for International Settlements, to develop an FX Global Code.

This is, in effect, an invitation and challenge to the industry to articulate what high standards of conduct look like.

It is an invitation for firms to join forces with each other, with official support, to create and apply standards, without the fear that a firm acting alone might find its efforts to achieve better conduct undermined by competitors superficially offering better terms to clients, or perhaps more generous incentives to their trading staff, but only able to do so because they are finding undisclosed ways to make inappropriate profit from those clients’ trading intentions.

I will come back to some of the issues under consideration in that Code later.

But first, I’d like to return to November 2014. You all know about the fines. The FCA imposed fines totalling well over £1 billion. The CFTC and Swiss authorities levied additional penalties.

We have seen material improvements in control environments, and the quality of governance arrangements in response to the remediation exercise.

At the same time as the fines, we announced a remediation programme to ensure UK firms addressed the root causes of the failings identified, and to drive up standards across the market. That grabbed fewer headlines, but was probably even more important.

I’d like to give you an update on where that FX remediation work has taken us, and then to connect this back to the work on the Global Code.

We required senior management at more than 30 firms – covering about 70% of the UK-based FX market – to take responsibility for delivering necessary changes, and to give personal assurances, in writing, that this work had been completed.

The result of that remediation exercise is that we have seen material improvements in control environments, and the quality of governance arrangements in those firms.

That brings me to the first important message I want to leave with you today.

If you work in one of the 30 firms covered, you will likely have personal experience of the process. But this message is aimed in particular at those who were not among those 30.

Even if you were not one of those 30, we expect you to consider the issues we identified, and to implement your own remediation plans, as appropriate to your FX business.

For that reason I am going to give a little more detail of the exercise.

The participating firms were asked to carry out a detailed assessment of whether their culture, governance, policies, procedures, systems and controls were appropriate and adequate to manage the risks in their FX businesses, covering front office, recruitment policy, risk and control environments relating to day-to-day trading activity, compliance, audit and risk functions, financial incentives, performance management and training, communications monitoring, conflicts of interest management, and benchmarks.

The programme focused on trader misconduct, breaches of client confidentiality and the failure to manage conflicts of interest, including but not limited to a number of specific risks that we asked firms to address. These were:

  • attempting to manipulate or control fixes
  • misleading clients by implying they are getting the best rate, when in fact the rate they received may have included a significant ‘hard mark-up’
  • engaging in coordinated trading to gain an unfair advantage
  • performing partial fills of client orders and not passing to the client the full fill when prices moved in the client’s favour
  • using ’layering’ or ’wash trades’
  • deliberately triggering client stop loss orders
  • front running
  • sharing confidential information with clients and traders at other firms
  • unfairly assigning clients the worst rate available in relation to ‘transaction window’ trading
  • inappropriately using personal dealing accounts, including spread betting

That’s a significant list. You can find it in full on our website.

These are risks that are directly relevant to some of the important issues on the table in the FX Global Code discussion. I would therefore like to give some observations on those issues from what we learned through our remediation work.  

Work on the Global Code is, as you know, continuing following the publication of a first batch of ‘Phase 1’ material in May this year. ‘Phase 2’ is being worked on now, with the target date for completion of the Code of May 2017.

‘Last look’

One of the issues being grappled with as part of that Phase 2 work 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. 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 – ie 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.

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.

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.

As one client in the New York DFS case graphically put it:

‘We kept receiving top of the book rates from you and hitting your rate, but we got rejected by you 9 times out of 10 where we could have been well filled by other liquidity providers who have been providing competitive rates’

You will also have heard arguments that last look protects market makers against predatory HFT firms sniping stale quotes, and so enables the market maker to offer a better deal to ’real economy’ market users, allows a greater range of firms to act as market makers, and so helps to sustain liquidity in this important market.

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.

I noted earlier how FX spot trading is in some respects outside the formal regulatory perimeter. You will have gathered from my earlier remarks that this is not because FX is not an important market. Arguably, this situation may be justified by the relative simplicity of spot FX – the instrument is easy to understand, and problems of asymmetric information might be considered less severe than in the case of more complex or bespoke instruments. 

But if the case for spot FX sitting outside the regulatory perimeter rests on this market not being characterised by unacceptable information asymmetry, that must apply to last look too.

And transparency does not just mean an ex ante disclosure that the dealer might take a last look. It also requires post-trade transparency, at a minimum statistics made available to all clients on the proportion of all trades, by value, that were rejected following a last look check, so that clients can make informed choices about which market maker or platform is offering the best trading opportunities, and whether they are treated fairly compared with other clients. 

Pre-hedging and then rejecting client orders through a last look engine carries a clear risk of detriment to clients.

There is also an important issue about how the market maker uses the information on the client’s request to trade if it subsequently chooses to reject that request. Purchasing currency on the back of the client order, but then declining to sell that currency to the client at the requested price, will, all else equal, have moved the market price against the client. The client is left with an unfilled order, and needing to meet their needs in a market now less favourable than it would have been. That looks uncomfortably like the point where ’pre-hedging’ turns into front running of a client order. It has uncomfortable echoes of the risks we identified in our remediation work around trading ahead of a client order.

Further, going back to the justification often given for last look, ie the market maker protecting itself from sniping by high-frequency traders, I can see that rejecting an HFT firm’s incoming request to trade against a quote you could not quite withdraw in time might serve that purpose. But trading yourself on the back of the client’s request – and then rejecting that request – is not necessary to protect against predators. Indeed, it begins to look rather like the very behaviour that HFT firms are sometimes accused of – sniffing out an order on one trading venue and racing ahead of the same customer’s orders sent elsewhere.

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.

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.


Another area we found to carry significant conduct risk was practice around mark up. This was an issue we discussed extensively in roundtables we held with industry as part of our remediation work. One, in some ways remarkable, feature of some FX trading practices is how price and remuneration for the dealer are sometimes not agreed bilaterally between dealer and client ex ante, but determined unilaterally by the dealer, and ex post.

Conduct risks are bound to be lower where a client has agreed the price it will pay up front. That could be a pre-agreed rate of commission to an agent which also carries a best execution duty. Or it could be an all in price to a counterparty acting as principal after having requested and accepted a firm quote.

Where a dealer is working an order and choosing what mark-up to apply ex post, however, perhaps justifying this on a tendentious argument that the client could, in theory at least, reject the fill, conduct risk will be significantly higher. There are obvious risks of taking advantage of clients, perhaps to flatter profits and bonus, perhaps to make good losses on a bad day, or perhaps to reward one favoured client at the expense of another.

The first phase of the Global Code contains some important material on being clear up front on the factors determining mark-up, on not misrepresenting any aspect of the mark up, and on monitoring mark up to see that it is applied consistently with policies. Time will tell if that is sufficient. One piece of good practice we saw in our remediation programme was the use of pre-set mark-up ranges or pricing matrices that effectively removed the scope and temptation to charge unfair or inappropriate mark up.


Time-stamps showing the point of execution should always be provided.

A third important area is time-stamping. This is obligatory in regulated markets. It is self-evidently vital to being able to track with appropriate precision when a client order is received, and filled, and the sequence of these and other actions. In our remediation work we identified, for example, the risk of assigning unfavourable rates to a client who has placed an ‘at best’ or ‘transaction window’ order which has been worked by the dealer over a period of time. The trader might buy, for example at 15, 16 and 17 for a 16 average price, while the trading range over the period as a whole was 14 to 24. If the trader can freely price at 23, or 24, i.e. well above the price achieved, we have conflicts of interest between dealer and client, and between one client and another (as mark up on one can be used to compensate losses or favourable rates given to another). Good record keeping, and time stamping, are important to managing and reducing the conduct risk that such conflicts create.

The Fair and Effective Markets Review here in the UK rightly concluded that time stamps showing the point of execution should always be provided.

The Global Code again provides an opportunity to establish a common standard of good practice in this area. It is an opportunity to define and embed practices which avoid the conduct risks the FCA identified in our remediation work.

The Global Code and the Senior Managers Regime

The final point I want to make is around embedding the Global Code.

It is not, of course, the first code of conduct for FX. Past experience of codes has too often been that the good work put into compiling standards has not been sustained in maintaining and applying those standards.

The UK’s Fair and Effective Markets Review noted that it had become clear from enforcement cases that few firms had integrated the provisions of codes into their internal control systems.

Market participants can reasonably expect the Code to be a key component of proper standards of market conduct.

Market participants are going to need to do better on adherence to codes in the future. The central banks and market participants involved in the Global Code work are developing various ways of strengthening adherence.

To reinforce the importance of this, and why market participants need to take adherence seriously, I want to draw a link between the Code and another important change in the regulatory framework since those FX conduct failings I described earlier. This is the Senior Managers and Certification regime. Senior managers at banks are already covered by that regime and we will soon be rolling out the core elements of the regime to authorised investment firms too.

Our conduct rules which apply to staff in these firms meanwhile require that individuals ‘must observe proper standards of market conduct’.

The Global Code is not yet complete, but as we announced when Phase 1 was published, market participants can reasonably expect the Code to be a key component of these proper standards of market conduct.

Individuals, whether senior managers, or traders, would therefore be ill-advised to forget this Code. And authorised firms should be prepared for future FCA interest in how they have made sure that their staff are aware of the Code and behave in accordance with it. 


The picture of FX market practices in front of us two years ago – in November 2014 – was not a pretty one. Much important work has been done over the past two years to bring conduct standards back to where they should be.

I would like to commend the time, thought, effort and expertise put into that by many here today – by the firms responding to our remediation exercise, by the market participants contributing to the Global Code work, by those who fed into the excellent work by the FICC Markets Standards Board on the stop loss standards.

The task now is to ensure that we don’t just think the job’s now done. Instead, every individual in this important market needs to make living up to these standards a part of their ongoing day-to-day work. This is up to individuals as well as the firms they work for. The new framework brought in with the Senior Managers Regime will be there to make sure those individuals are clear on that responsibility, and that individuals, as well as firms, are accountable for their actions.