Amid concerns about the risk of market manipulation, global policymakers are calling for a variety of reforms to foreign exchange (FX) rate benchmarks.
The Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) published reports Tuesday detailing their reviews of the current FX benchmark process, which set out a number of recommendations for reform in the FX markets themselves, and in the major benchmark rates, particularly the WM/Reuters (WMR) 4pm London fix. The recommendations address the calculation methodology of the WMR benchmark rates; the publication of reference rates by central banks; market infrastructure in relation to the execution of fix trades; and, the behaviour of market participants around the time of the major FX benchmark settings (primarily the WMR 4pm London fix).
The FSB says that this work was launched in response to concerns about the integrity of FX benchmarks. “These concerns stemmed particularly from the incentives for potential market malpractice linked to the structure of trading around the benchmark fixings,” it says. As a result, it formed a working group to examine the FX market structure and incentives that may promote particular types of trading activity around the benchmark fixings.
The group’s study of these issues resulted in the recommendations released Tuesday. Among other things, the FSB recommends that the fixing window be widened from its current one minute duration. It doesn’t prescribe the proper duration, saying that WM should determine the appropriate width in consultation with market participants; adding that the median suggestion from market feedback was for a five-minute calculation window for the major (trade) currencies, and wider windows for less liquid currencies.
The FSB report also recommends that WM should incorporate price feeds and transactions data from a broader range of sources to further increase its coverage of the FX market during the fixing window; that WM should expand its consultation activities to ensure the calculation methodology remains appropriate; that the transparency of fixing transactions be improved; and, it calls for industry-led initiatives to create independent netting and execution facilities for transacting fix orders.
IOSCO’s review assessed WM’s policies and practices, which found that WM had implemented some of IOSCO’s new principles for financial benchmarks, but that it still needs to do “substantial work” to implement others. It recommends actions that WM could take to improve its implementation of the principles, adding that WM is already in the process of implementing many of these reforms. With that in mind, it recommends a follow-up review in mid-2015.
The FSB report also proposes that banks establish internal guidelines and procedures for collecting and executing fixing orders; that they devise systems and controls to address potential conflicts of interest arising from managing customer flow; that market-makers should not share information with each other about their trading positions beyond what’s necessary for a transaction; and, that market-makers also shouldn’t pass on private information to clients, or others, that might allow them to anticipate the flows of other traders, including around the fix.
“Codes of conduct that describe best practices for trading foreign exchange should detail more precisely and explicitly the extent to which information sharing between market-makers is or is not allowed. They also should, where appropriate, incorporate specific provisions on the execution of foreign exchange transactions including fixing orders,” it says.
For index providers, it says they should review whether the foreign exchange fixes used in their calculation of indexes are appropriate; and, it says that asset managers, including those passively tracking an index, should conduct appropriate due diligence around their foreign exchange execution.
The FSB indicates that it believes that all of its recommendations can, and will, be implemented. “This should deliver a substantial improvement in market structure and conduct. But investigations into alleged misconduct are ongoing across a range of markets, and it is possible that the authorities will ultimately conclude that regulatory change is needed,” it says.