CLIENT ADVISORY Regulatory Fate of FX Market Still Evolving

Transcription

1 CLIENT ADVISORY Regulatory Fate of FX Market Still Evolving Last year, regulators uncovered serious misconduct and manipulation in FX rate setting among London traders. The discovery is part of a long series of benchmark rigging scandals that have emerged since the 2008 global financial crisis. Being the largest global financial market, the scandal naturally attracted enormous attention from international policy coalitions and domestic regulators. Investigations have already resulted in costly fines in excess of $4 billion and large-scale regulatory initiatives, with the final outcome still very much in play.

2 Benchmark Scandals Add Up Suspected misconduct in benchmark setting has percolated onto regulatory agendas, media talking points and congressional hearings since the financial crisis. The 2012 finding of manipulation of the London Interbank Offered Rate (LIBOR) set into motion a chain of benchmark scandals, from metal exchanges and other commodities, including aluminum and the London Gold Fix, on the London Metal Exchange (LME) and London Bullion Market Association (LBMA), to foreign exchange (FX) and currency markets. Alleged collusion in currency markets is the most recent development, including the WM/ Reuters (WMR) London 4:00 pm Closing Spot Rate and the European Central Bank (ECB) Fix, which set the exchange rate for the euro against the dollar as well as other currency benchmarks. The suspected misconduct among some of the world s largest financial institutions surfaced last year, triggering a dozen regulatory investigations. Regulators Respond with Enforcement Action Investigations found that London traders from several institutions conspired to influence rates to their benefit, immediately before and during the one-minute rate setting window. The group of traders, referring to themselves as the cartel or mafia, colluded via online chat rooms and other correspondence to front-run client orders and manipulate the benchmarks set during the 4:00 pm fix. Regulators also cited governance shortcomings, as financial institutions failed to monitor FX trading and establish internal controls to limit misconduct. In a coordinated effort last November, the United States (US), United Kingdom (UK) and Switzerland brought enforcement actions against participating financial institutions. UBS, Royal Bank of Scotland, HSBC, JPMorgan Chase, Bank of America and Citigroup settled for a combined penalty of $4.25 billion. Participating regulators included the US Department of Justice (DOJ), Office of the Comptroller of the Currency (OCC) and the Commodity Futures Trading Commission (CFTC). In the EU, the UK s Financial Conduct Authority (FCA) and the Swiss Financial Market Supervisory Authority (FINMA) joined the enforcement efforts. In response, the European Central Bank (ECB) removed certain financial institutions from the ECB Foreign Exchange Contact Group. In a separate development, the New York Department of Financial Services (NYDFS) began a probe into Barclays and Deutsche Bank s use of algorithms in their trading platforms to rig FX rates in December Global regulators quickly mobilized preliminary steps to police FX market conduct. Additional investigations are underway at the Federal Reserve, DOJ, and the Serious Fraud Office (SFO). Further enforcement actions against new financial institutions and responsible individuals are expected in 2015, similar to the course of LI- BOR investigations and enforcement. Financial institutions have already acted independently to suspend the roles of nearly 30 traders. Page 2

3 Establishing Regulatory Frameworks Regulators now face the Herculean task of reforming the largest global financial market, with more $5.3 trillion in daily transactions. International coalitions and individual governments have stood up multiple policy initiatives to address FX manipulation and restore market integrity. G20 The Group of Twenty (G20) tasked the Financial Stability Board (FSB) with international benchmark reform, including FX rate setting. The FSB and other international policy groups, including the International Organization of Securities Commissions (IOSCO), focused primarily on interest rate benchmarks. The regulatory principles put forth by these coalitions have proposed several universal reforms for benchmark oversight including benchmark administrators, regulating conflicts of interest, establishing controls around rate setting, audits and monitoring, and compliant procedures. To specifically address manipulation in FX markets, the FSB has proposed broadening the rate-setting window to five minutes. In a report on currency benchmarks, the FSB identified problematic areas within the setting process. Increasing the current one minute rate-setting window would help to alleviate the heavy volume of orders immediately before the fix and expand the data sources used to establish exchange rates. The report also recommends establishing codes of conduct for traders, the review of the index calculations, and new guidelines for collecting, executing and handling fixing orders. The FSB has taken a soft approach with these recommendations, encouraging industry participants, including banks, FX intermediaries, governments, and foreign exchange committees, to adopt and implement the final rules. FX Market Committees Following the FSB s findings and recommendations, major global FX committees are poised to adopt new standards, The Global Preamble: Codes of Best Market Practices and Shared Global Principles. According to media reports, FX committees agreed last month to a set of reform principles. Participants include the Bank of England s Foreign Exchange Standing Committee, New York Foreign Exchange Committee, Hong Kong Treasury Markets Association, Tokyo Foreign Exchange Market Committee, Canadian Foreign Exchange Committee, Singapore Foreign Exchange Market Committee and Australian Foreign Exchange Committee. The principles extend prohibitions on information sharing amongst traders, including client identity and other order information. New codes of conduct will also restrict the use of certain trader jargon. These developments have not yet been made public, but will likely be disclosed in the very near future. European Commission Independent of other international efforts, the European Commission is working on a Benchmark Regulation. The regulation will govern FX, interest rate, and commodity rate setting. The proposed regulation was published in 2013, and is expected to be finalized this year. Adopting the proposals of the FSB and IOSCO, the European Commission s proposed rules require the Page 3

4 development of strong codes of conduct and establish new requirements for benchmark administrators. The proposed rules also prohibit unauthorized benchmarks. EU regulators have been granted expanded authority to investigate and enforce benchmark misconduct, with the ability to assess penalties as high as 10 percent of annual revenue. UK The UK is concentrating on reforming benchmark setting as well. In the FCA s 2015 and 2016 Business Plan, the agency announced plans to study information sharing in benchmark setting as well as work towards significant enforcement outcomes from benchmark investigations in FX reform is also part of the UK s Fair and Effective Markets Review. Launched last summer by Chancellor George Osborne, the Fair and Effective Markets Review is expected to reflect FSB recommendations to revise global FX codes, and identify areas for enhanced oversight. Final recommendations will be published this June. Future of FX Benchmarks With $4.25 billion in penalties already assessed, the resolution of last year s FX rigging scandal has only just begun. After initial enforcement actions, regulators have pivoted to regulatory reform. FX review and reform has since been swept into the larger landscape of benchmark regulation, including commodities and interest rate setting. Efforts to date have resulted in a myriad of overlapping international and domestic rules, recommendations and principles with major investigations still ongoing. It is unclear where and when these reforms will settle. Although current trends suggest that most policy and governing bodies are following the FSB model of establishing robust codes of conduct, there are many surprises that likely lay ahead for this market, including new regulations, fines, firings and probes. Additional Developments Other countries are also looking at FX regulation. India and the Monetary Authority of Singapore are developing and implementing regulatory frameworks for currency markets. At the present time, the US appears to be focusing on enforcement, however, US regulators may transition to regulatory reform later this year or next year. Page 4

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