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The foreign exchange industry faces anumber of challenges as the FX GlobalCode of Conduct is fully implemented,MiFID II hits the statute books andparticipants continue to deal with theaftermath of conduct issues fromseveral years ago. ACI FMA’sManaging Director, Brigid Taylor,believes the Association has to tools andservices on offer to not only help theindustry face these challenges, but toovercome them.

“There is so much needed in a shorttime, around reporting, TCA and bestexecution for example, but there is alsothe principle of changing peoples’behaviour,” she says. “Everyone needs tobe aware of the Global Code and how weneed to nuance the culture of theindustry. ACI FMA saw the need for thischange and has worked on developingsolutions, which are now coming tomarket at the right time.”Prime amongst those solutions is theELAC (E-Learning and Certification)portal, which has been steadily rolledout globally over the past two years.“Firms are thinking about their internalprofile,” observes Taylor. “They areasking the question: Are my staff allaware of the Global Code? The troubleis whereas these firms once built theirown compliance tools, MiFID II hastaken so many resources, they don’thave the capacity to map the GlobalCode to their internal policies – ELACand ACI can do that for them, itrepresents the complete solution to whatis a growing challenge.”While ELAC is a robust and scalable tool,

a lot of firms have the challenge in thatthey have completed the initial work toshow they adhere to the Code but there islittle more after that in terms ofcontinuous professional development(CPD). Taylor, however, stresses thatELAC can fill that gap as well.“Especially as the Code changes overtime, there will be a real need for CPDand ELAC helps,” she explains. “We canadd or take away themes as the Codeprogresses. As an update to the Code isrolled out, ACI can update ELACautomatically for all users.“This provides a lot of comfort forinstitutions because it shows that Codeadherence is not a one off issue, thesefirms can stand in front of theirregulators and specifically show howtheir firm and staff adhere to the Code,”she continues. “We are having a lot ofmulti-lateral discussion about ELAC,with the business heads, such as salesand trading, mainly on the sell side atthe moment but also buy side treasuriesand execution desks are gettinginterested, but then also with thecompliance and legal function. Theseteams in particular have a real interestin what we are doing and what we arecapable of.”ELAC offers high level reporting and canoversee team performance and then drilldown to individuals and measure what hasbeen achieved. It can also offer peercomparison for the Global ForeignExchange Committee (GFXC). “Ouranalysis from ELAC can be fed to theGFXC,” Taylor explains. “For example,are there areas in which there is a realimbalance between those getting it right

and wrong? If a large number of peopleare getting a question wrong it could bebecause the Code is ambiguous, thiswould highlight it. “Equally if there was a close balancebetween getting a question right andwrong the same could be said, so ELACcan be a very important tool forfeedback to the GFXC about the Codeand can identify areas that may needfurther clarification,” she adds. “TheCode is a fantastic and important pieceof work and successfully evolving it isvital to the industry’s interests. Webelieve ELAC is one of the few data-based resources that can help thatevolution – it is live real time feedbackand it can hopefully change behaviourwhere it is needed.“We are not in the business of wantingpeople to get it wrong, if the wording isunclear we can highlight it and enablebetter discussions going forward,” Taylorcontinues. “We have to stress that ELACis not only about preparing people for theCode – it does that – but it is also asupport tool for the work the central

ACI to Smooth Transition to New Era

ACI BrIefIngNEWS FROM THE FINANCIAL MARKETS ASSOCIATION

www.acifma.com

ACI to Smooth Transition to New Era....1

ACI FMA Creates Two Professional Education Roles ...................3

ACI Provides Feedback on Principle 17 .....4

GFXC to Adjust Language on Principle 17...............................................5

ACI Russia to Lead Formation of Local FXC ..............................6

ACI Adjusts Examination Suite ................6

What Does an Adherence Register Mean?..............................................7

ELAC to Engage with Regional Codes .....8

RegAT is Dead But Fast Markets Still a Challenge for Regulators ...............8

Predicting the Unpredictable: Was the EUR/CHF Break Signalled? .....10

FMSB Annual Report Highlights Progress made in FICC Reform..............11

Q4 2017 VOL 19, ISSUE 117 ISSN 1469-2031

ACI BRIEFING IS PUBLISHED BY:

Contents

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PROFIT&LOSSIN THE CURRENCY & DERIVATIVE MARKETS

ACI Head Office: 8 rue du Mail, F-75002 Paris,

Tel: +33 1 42975115Fax: +33 1 42975116

BRIGID TAYLOR

ACI BRIEFING I NEWS FROM THE FINANCIAL MARKETS ASSOCIATION I Q4 2017 VOL.19, ISSUE 117 I www.acifma.com

banks and big institutions are doingglobally.”

The Challenge of Regulation

As time progresses from the officiallaunch of the Global Code, the periodallowed to sign the Statement ofCommitment is being eaten up, with justunder six months left for firms to sign thestatement. Taylor says she is hearing froma lot of people that while they are happyto sign for the Code, their legal teams areasking whether they are able to prove theycan maintain the appropriate oversightand protection policies.“We are taking lot of calls about ACI’ssolutions for this, specifically ELAC andour new Global Code Certificateexamination,” she says. “This isespecially important as firms battle to hitthe MiFID II deadline. MiFID has been ahuge resource consumer, so inevitably theinvestment has not been available forother projects.“My view is the Code sits alongsideMiFID,” she continues. “It is the spirit ofthe law and the letter of the law – they areinter-linked. I also think this is reflectedin the relationship between the industryand ACI – the industry is naturally veryfocused on implementing MiFID II, but atthe same time ACI has deployed itsresources to help them maintainmomentum in other crucial areas.”Issues related to inappropriatecommunications over chat mechanismshave understandably taken manyheadlines in the foreign exchangeindustry, however they have also servedto heighten the emphasis on bestexecution – and the imminent roll out ofMiFID II has reinforced that trend.“While there have been a lot of technicaladvances in the area of best execution,including increased adoption of algoexecution strategies, another factor inproviding best execution is transparencyand behaving appropriately,” Taylor says.“Sometimes this is overlooked, so ourGlobal Code Certificate can play a role inhelping people understand the full process– it is not only about deploying the rightstrategy, it is doing the right thing for thecustomer, that has to be paramount in anyservice provider’s ethos.”

The Model Code

ACI FMA’s Model Code has played animportant role during the past twodecades in providing detailed principles

for best practice, but inevitably the pushfor one global code of conduct has seenthe spotlight drift away. This does not,however, mean that The Model Code hasno role to play going forward.“Our intention now is to use it for detailaround the over-arching principles,” saysTaylor. “The Model Code has beenaligned with the Global Code butobviously it has much more depth whereit is required so people can use it for moredetail around the Code’s principles.Taylor also says ACI FMA is extendingits previous work on market principles toother asset classes such as moneymarkets. “The Model Code is alsoproviding some good input to ELAC inthat it offers real life examples on bestmarket practice. If you don't score wellenough on ELAC it refers back to theCode, so if you are uncertain on any issue,you can refer to The Model Code formore in depth guidance.”

New Values, New Culture, New Market

While historically ACI FMA has not had aspecific CPD programme, it has had aprogression of examinations, culminatingin the ACI Diploma. Taylor believes thatELAC will provide a strong element of anindustry-wide CPD programme, however.“The market is changing and the industryis changing and we need to be able torespond to that,” she says. “CPD willbecome a cultural foundation of themarket in my view but we don't want it tobe too onerous – tools like ELAC willhelp ensure it doesn't become so. CPD isnow a big part of the education effort atACI and is part of our continuingeducation build out.”There is also the global nature of themarkets as well as the increased mobility ofworkforce to consider. Taylor says that ACIFMA will continue to incorporate localcodes into ELAC, meaning staff can bechecked out on – and learn about, regionalnuances regarding codes of conduct. “If people move to Singapore, forexample, having ELAC can help becausethere will be a passporting element to it,but also they can tap into ELAC and learnand test themselves on local regulations,such as the Blue Book in Singapore,”Taylor says. “We need to be able to dothis as people and businesses work acrossboundaries and industry segments, weneed to be able to show they can adhereand behave in all markets, and preparingthem for a move is one way.”Taylor also believes ELAC works toanother coming trend in financial markets.

“I think accreditation is coming globally,”she asserts. “There are some places whereit is in place and I think more will follow.If that is the case ACI needs to be at theforefront of that move, we need toposition ourselves for this but we need tobe properly prepared on a global basis.”Conduct and operational and compliancerisk has grown in the industry’sconsciousness over the past three yearsand this is only likely to grow further.“There is a real chance that people whohave not qualified under ELAC for CPDcredits will become an employment andpossibly even a counterparty risk,” Taylorsuggests. “Will people trade with them oremploy them? I am not sure how thatplays out but it is a risk that everyoneshould be aware of.”Continuing the theme, Taylor points toarguments in some circles that saycounterparty risk analysis will, in thefuture, incorporate an element ofadherence to MiFID as well as otherregulations out there, such as the FXGlobal Code. “This is a cross borderissue,” she says. “It is not just aboutdomestic markets, institutions globallyneed to have access to information aboutwho is adhering to the Code.“ACI FMA is looking at hosting a registerof those that have signed the Statement ofCommitment,” she continues. “I believewe are uniquely positioned to provide thisbecause we have the reach in certainjurisdictions that others don't havethrough our members in 64 countries.”As to why she wants ACI FMA to be acentral plank in the reform process, Tayloris keen to stress the importance of gettingthe new industry structure right. “ACIFMA has been doing all of this workbecause it is important for everyone thatsomeone facilitates change by providingtangible solutions for all participants.“We represent, so have to be thinkingabout, the whole industry around theglobe,” she adds. “It is important we getthis right because we went from anenvironment where everything seemed tobe alright to one where nothing was – weskipped over the middle ground which isprobably close to where we should be. Itis important that we operate with anappropriate amount of transparency thatallows people to do their job.“Circumstances have brought aboutbottlenecks – liquidity is still an issue butif people know how they are able to talkand how they are able to trade it will openup better liquidity,” she continues. “Wewill take the fear factor out of the foreign

Smooth Transition. Continued from p.1

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exchange industry and that will help itoperate – within clearer guidelines.” Ultimately the foreign exchange industryis changing for everyone. Market andexecution risk is shifting in many cases tothe buy side from sell side, newparticipants are entering the market andthe technology revolution shows littlesign of slowing. This brings challenges to

participants, but it also representsopportunity. Underpinning everything isthe need to give individuals andinstitutions the confidence to operatewithin broad, but mutually agreedparameters. It is a changing industry andACI FMA is playing a key role infacilitating that change.“ACI FMA’s values have not changeddramatically over the six decades and

more of our existence – they remaineducation, professionalism and ethicalconduct,” Taylor says. “What has changedis the range of tools and services we canoffer to a radically changed industrylandscape. It has been a painful processfor the industry but we are advancing andit will get better still. We havetransparency in a controlled environmentwhere everyone knows the rules.”

ACI – The Financial MarketsAssociation has announced theappointment of two additionalprofessional roles to enhance itseducational and attestation offerings.

Paul Chappell has been appointedDirector of Education and will besupported by Deputy Director forEducation, Rui Correia. Together, ACIFMA says, the two men will beresponsible for delivering theassociation’s strategic educationalinitiatives to its global membership.ACI FMA has gone through a period ofevaluating and streamlining its vision andfocus to reflect the current needs offinancial markets and the individualmembers it represents. The internalchanges reflect the evolution in financialmarkets, global regulatory reforms andthe industry’s focus on conduct, educationand training.Chappell was long time Global Head ofForeign Exchange at Bank of Americabefore leaving to establish his owncurrency management firm C-View, ofwhich he is currently Chairman.Correia spent 26 years in a variety ofmarkets related roles in internationalbanks before becoming a certified trainerfor financial markets in Portugal, wherehe is also a member of the Board of ACIPortugal.Brigid Taylor, ACI FMA ManagingDirector, says, “We are delighted to haveacquired the expertise of two experiencedprofessionals to take up the roles ofDirector of Education and DeputyDirector of Education. Theseappointments reiterate ACI FMA’s focuson educating and training our members,and ensure efficient and optimal value iscreated for our members, who arerepresented across 64 financial centresglobally.“ACI FMA seeks to meet the educationalneeds of its members by developing

relevant education and training solutionsthat are accredited and valuable across allfinancial markets where the association isrepresented,” she continues. “These full-time positions will add valuableleadership to our efforts as we continue todevelop and implement a dynamic andrelevant education offering ofprofessional qualifications, drivinglearning and development solutions forfinancial market participants worldwide.”ACI FMA Board of Education ChairOliver Madden, says, “ACI FMA’s suiteof qualifications and learning tools, suchas our long-established DealingCertificate and Dealing SimulationCourses, the more recent ACI FMA FXGlobal Code Certificate qualification andour ongoing e-learning and attestationservices portal, ELAC, fully supportcurrent market pressures to demonstrateknowledge of, and adherence to, industrystandards of conduct and best practice.“With dedicated resources and the benefitof Paul and Rui's market knowledge andexpertise, we will be able to deliver betterproducts and solutions and support marketparticipants to meet internal and externalcompetence and adherence obligations,”he adds.Chappell says, “I took on the job becauseI firmly believe the industry has arequirement for more education andguidance as it faces evolution andchallenges in the current environment andI consider that I can make a contributionto this. The industry needs to realise thevalue of the educational tools availablefrom ACI FMA, from exams, through theon-line attestation facility ELAC, tospecialist and higher education in theDealing Simulation Course and Diploma– they are essential in an era of Codes ofConduct and adherence- and I want to getthat message out.“We face a period in which not only doesa new generation need training andeducating to a much broader and deeper

level than before, but we have therequirement to maintain our levels ofcompliance and knowledge as marketsand technology evolve, and that’s whereELAC really helps,” he adds. “ACI FMA recognises that whilstvolunteers remain vital to the associationand its work, there is simply too muchinvolved now in ACI’s education suite totry to do it all on an ad hoc basis,”Chappell continues. “Together with Rui,we wish to ensure the Association is at theforefront of helping the industry preparefor the next challenges, not just the onesthey face today. One of the easiest waysto show you are doing something aboutunderstanding evolving markets is byhaving staff take the Global Code examand use ELAC.“The ELAC questions have to be currentand relevant and, probably, more complexthat the Global Code examples,” he adds.“ACI FMA is in a great position to dothat.”Correia says “Financial markets areglobal, so ethical conduct, good practicesand adequate training for professionalsneed to have a global reach as well. AsACI FMA, through its core values, is theentity that creates and delivers the besttools to address these topics, I amdelighted to be part of the team that willwork on the development of oureducation suite and I certainly lookforward to helping ACI FMA furtherexpand its international reach.”

ACI FMA Creates Two Professional Education Roles

3

PAUL CHAPPELL

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ACI FMA’s new Director of Education,Paul Chappell, also chaired ACI’s sub-committee to respond to the feedbackrequest regarding any possible changesto Principal 17 of the FX Global Code,specifically the language around thepractice of last look.

The feedback was requested by the GlobalForeign Exchange Committee (GFXC), aforum comprising central banks andprivate sector market participants part ofwhose brief is to promote, maintain andupdate the FX Global Code.The text of the Code was finalised in May2017 and provides recommendations thatreflect a broad set of global views bothfrom public and private sectorparticipants. The GFXC encouragesmarket participants to adopt the finalCode and incorporate it into theiractivities. ACI FMA provided members ofthe Market Participants’ Group thathelped create the Code and publiclywelcomed its full release in May.At the time of the launch of the Code, theGFXC stressed its commitment toevolving it to maintain its relevance andsaid it intended to periodically requestfeedback from market participants andothers on specific topics. The first suchrequest focused on last look, specificallytrading activity during the last lookwindow related to a trade request. The Code defines “last look” as “apractice utilised in Electronic TradingActivities whereby a Market Participantreceiving a trade request has a finalopportunity to accept or reject the requestagainst its quoted price”. Principle 17 provides guidance on fourrelated topics: (1) the purpose(s) of lastlook; (2) governance and controlsdesigned to limit the use of last lookbeyond its intended purpose(s); (3) use ofinformation obtained from a Client traderequest, including through trading activityin the “last look window”; and (4) Clienttransparency regarding the functioning oflast look, including minimum disclosures. The GFXC noted that input receivedduring the Code’s drafting processreflected a wide range of views onfeatures of last look. Some marketparticipants object to the use of last look,arguing that it is not necessary as a riskcontrol mechanism and moreover that itcan negatively affect the outcome for theclient. Others view last look as beneficialfor market liquidity and pricing.

The text in Principle 17aims to encourageimproved transparencyand controlssurrounding the use oflast look, however oneparticular area of debatewas around “tradingactivity that utilises theinformation from theClient’s trade request,including any relatedhedging activity” duringthe last look window.The Code states that itis “likely inconsistent with good marketpractice” and the GFXC says thislanguage reflects input that expressedconcern that hedging activity during thelast look window could be to the client’sdetriment.With that in mind it issued a request forfeedback on two specific questions.Respondents were asked to specifywhether they, or their members, provideprices subject to last look, or not; andwhether the respondent, or its members, isa client that places trade requests subjectto last look, or not. The core questions were:“The Code states that “During the lastlook window, trading activity that utilisesthe information from the Client’s traderequest, including any related hedgingactivity, is likely inconsistent with goodmarket practice because it may signal toother Market Participants the Client’strading intent, skewing market pricesagainst the Client, which (1) is not likelyto benefit the Client...” Do you agree ordisagree? “Are there specific situations where thistrading activity benefits the Client? In thosesituations is such trading activity related tothe validity or price checks that the Codestates as the purpose for last look? Pleaseprovide reasons for each response.” The second question was based upon theresponse to Question 1: “Do you considerthat the language set out in the Code onthis activity should be modified (forexample, should it be strengthened furtheror provide further detail as to what may ormay not constitute good practice)? Pleaseprovide reasons.”

Process

ACI’s immediate response to the feedbackrequest was to establish the new sub-

committee under Chappell’s leadership. Infact ACI had updated its own Model Codein the area of last look at the end of 2016and the members of the new Committeewere predominately the same experiencedprofessionals . “There were manydifferent characters on the committeewhich meant we could cover the topicfrom a variety of angles,” explainsChappell. We had a great spread fromdifferent types of banks, through platformproviders and brokers, to buy side andnon-bank market makers, I chaired as anindependent. In some ways we mimickedthe composition of the MPG. “We set outto answer the two specific questions askedby the GFXC – a lot of the 33 responseswere lengthy and didn't answer thequestions – rather they tried to reimaginelast look from all sides – that wasn’t whatwas asked. Unsurprisingly, given the rather emotivenature of the subject, and its potentialfinancial ramifications, Chappell saysthere was quite a diverse range of opinionfrom those who wanted it banned to thosethat thought there was little wrong withhow last look is used. “The best way to start in thesecircumstances is to recognise what weagree on and how, if required, we canreinforce that consensus,” he says.“Everyone thinks differently about lastlook and we wanted to narrow the focusdown, so we managed to get agreementthat generally speaking there is a need fortime to credit and risk check as well asallow for system latency and in thosecircumstances last look was justified.“This meant it really came down to onecore issue, “ he continues. “Is there anyjustification beyond these criteria fordelays in accepting the trade – so-calledrate last look? We ended up without a

ACI Provides Feedback on Principle 17

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4


The Global Foreign ExchangeCommittee (GFXC) met to consider theresults of its consultation over thewording in Principle 17 of the FXGlobal Code of Conduct, specificallyrelating to the use of last look, and saysit has concluded that Principle 17“should indicate that marketparticipants should not undertaketrading activity that utilises theinformation from the client's traderequest during the last look window”.

At the same time, however, the GFXC hasrecognised the concerns by some involved

in the feedback process that such anaction would negatively impact the quote

and cover, or riskless principal model. Assuch, the committee says it has agreedthat Principle 17 should clarify theconditions under which certain tradingarrangements, often referred to as "coverand deal", may be distinguished from thelast look guidance.In reaching this judgement, the GFXCsays it balanced the feedback thathighlighted the potential for tradingactivity in the last look window to benefita client with other feedback thatemphasised the risk that clients could bedisadvantaged by such trading and that it

consensus but we did have a majority thataccepted that rate last look was notconsistent with best practice and that’swhat we said in our response. “We got to the point where we recognisedthat there was no real argument for ratelast look – no one could come up with aconvincing reason why it is needed,” headds.

Formal Response

Following the deliberations and hardwork of the Committee, ACI FMAformally submitted its response ahead ofthe deadline in September.In it, the association says, “ACI FMAagrees that trading activity that utilisesinformation from the trade request isinconsistent with good market practice.Furthermore, it considers that suchactivity, when undertaken by marketparticipants acting as principals as definedin Principle 8 of Global Code, isinconsistent with good market practice.As such, the word “likely” should beremoved.”The response also went on to suggestgreater definition in the wording of thePrinciple as follows: “During the last lookwindow, trading activity undertaken bymarket participants acting as principals asdefined in Principle 8 of the Global Codeof Conduct, that utilises the informationfrom the Client’s trade request, includingany related hedging activity, isinconsistent with good market practicebecause it may signal to other MarketParticipants the Client’s trading intent,skewing market prices against the Client.”ACI FMA also noted that there is “no firmevidence or specific situations where

there is any likely benefit to Clients fromtrading activity by market participants inthe last look window” and that anysuggestion that it might lead to tighterpricing was circumstantial. The Association further believes that thelanguage as set out in the Code should bemodified and strengthened to providefurther clarity on the specificcircumstances that might constitute‘legitimate’ use of last look, andsuggested;“There is a legitimate use of last look as itpertains to rejection of a stale quote andthus a failed match; the checking ofcredit, permission, risk and liquidityexposure; system and message integrity,along with price latency. All other uses oflast look, including the delaying ofacceptance of a trade by a marketparticipant in relation to price, arepotentially open to inappropriate behaviorand are discouraged, unless adequatesafeguards to detect any form of abuseagainst the Client or the market exist; norshould any attempt be made to takeadvantage of the other marketparticipant’s intentions.”

More Work

Chappell says the work undertaken by thecommittee, while occasionally difficult,was very rewarding. “Everybodyparticipated freely and with the same goalof providing a considered, properlyanalysed response,” he says. “ACI FMAwas the only respondent that representedthe interests of individuals operating infinancial markets, and we believe ourresponse offers a good representativeview of market participants.”It is unlikely to stop there, however, for

with clouds possibly looming over thepractice of pre-hedging thanks to theconviction of former HSBC FX tradinghead Mark Johnson in a New Yorkcourtroom, another round of feedbackcould be forthcoming.Chappell is prepared for that, declaringhimself ready and willing to help shapeACI FMA’s response to the industry’sdemands, but he also believes other issuesalready exist.“We probably only spent one quarter ofour time on the committee discussing thetraditional last look issue,” he reveals.“The rest – which was many hours – wasspent on calls and meetings discussing thequote and cover model as it pertains tolast look. “People are taking liquidity and passing itout as their own and then cherry pickingthe flow using last look and we are notsure that is right,” he adds. “At the veryleast we believe it is a practice that needsmore clarification and transparency fromthose using this model and we plan tostart our discussions around this trickyissue and others, including ordermanagement such as the appropriateprocedures for pre-hedging.“This is a great example of how ACIFMA can demonstrate its leadershipcapabilities to the industry,” heconcludes. “By recognising potentialrisks and discussing and creatingsolutions before some people have evenrealised it is an issue at all. Mostnotably, as markets develop and evolve,the ACI ELAC education platformrapidly produces new Scenarios andQuestions directly covering the practicalapplication of Principles; thus seeking toprovide further guidance to its membersand users.

Feedback on Principle 17. Continued from p.4

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5

CHRIS SALMON

GFXC to Adjust Language on Principle 17

6


ACI Russia has unveiled a Russianlanguage version of the FX GlobalCode as well as plans to create theMoscow FX Joint StandingCommittee, which it says will bebased upon the Self-RegulatoryOrganisation National FinanceAssociation (SRO NFA).

The Association says the newCommittee will be supported by thecountry’s central bank, the Bank ofRussia, and will participate in theactivities of the Global FX Committee(GFXC). At the time the Global Codewas launched earlier this year theGFXC publicly encouraged regional andlocal markets to form their own FXcommittees as part of the process ofhelping to ensure the Code reached allgeographical locations and customersegments.The Russian language version of the Codewas originally created by the Bank ofRussia and then reviewed and finalised bythe editorial group of the ACI RussiaCouncil. The new FX committee will includeexperts from banks, brokerage firms,corporates, market infrastructure andmarket services companies, market

software suppliers and representatives ofthe Bank of Russia. “This platform is to become the essentialforum for the development of nationalstandards of professional ethics in theRussian FX market based on the GlobalFX Code and for the interaction betweenmarket participants and regulatorybodies,” ACI Russia says. Sergey Romanchuk, President of ACIRussia, has been proposed as the firstchair of the Committee and Russianrepresentative on the GFXC, togetherwith a representative from the Bank ofRussia. The announcements were made at anevent in Moscow, which featuredpresentations by Romanchuk; ExecutiveDirector of ACI Russia, KonstantinZyryanov; President of SRO NFA, VasilyZablotsky; and Director of Departmentfor Countering Misconduct at the Bank ofRussia, Valeriy Lyakh. The event also hosted a panel discussionwhich focused on the implications of theadoption of the Global FX Codeprincipled in the day-to-day business viasigning the letter of adherence, as well asthe potential consequences of violationsof those principles. The following experts shared their views

on the Code: Head of the LegalDepartment of Moscow Exchange,Alexander Smirnov; Thomson Reuters’Regional Business DevelopmentManager in the Financial Markets ofRussia/CIS Anna Senina; andRomanchuk. Additionally, Lyakhresponded to questions from theaudience and presented the views of theBank of Russia as to the use of the newapproach (the Code) to prevent unfairmarket practices. Due to the multitudeof questions from the audience the paneldiscussion stretched well into theevening hours. Upon the conclusion of the officialpresentations and panel discussion, theparticipants enjoyed the buffet providedby the two sponsors of the event,Thomson Reuters and the MoscowExchange. The latter also tookresponsibility for offering the inauguralprint edition of the Russian languagetranslation of the FX Global Code. Theguests received their individual copies,which were offered to be signed by theMembers of the Editorial Group: DariaDergunova, Konstantin Zyryanov,Dmitry Piskulov, Asiya Rafikova,Sergey Romanchuk, Anna Senina andMaxim Khrustalev.

ACI Russia to Lead Formation of Local FXC

Following the success of the newly-created ACI FMA FX Global CodeCertificate, to meet the requirement formarket participants to attest to theCode, the Association has taken thedecision to remove the code of conductsections from its Dealing Certificateand Operations Certificate syllabuses.

This allows current Dealing or Operationcertificate holders to take the Global CodeCertificate to prove their understanding ofit in addition to their current certifiedknowledge, and for new candidates to

build their knowledge through thisspecific certification.This will create a specific suite ofstandalone professional and behaviouralexaminations.The Association has also announced arevised pass mark for the OperationsCertificate, which is now aligned with thesame pass mark required for the DealingCertificate. Updated versions of each syllabus arepublished on the education section of ACIFMA’s website.Additionally the ACI Diploma continues

to be a valuable advanced levelcertification for financial market’sprofessionals, as it includes more complextopic such as Market Analysis and RiskManagement.The announcement is the latestenhancement to the ACI FMA educationsuite of attestation and certificationproducts that are specifically designed tosupport market participants meet theircode of conduct commitments.The new syllabi and other information onACI Education can be found athttps://acifma.com/about-education

ACI Adjusts Examination Suite

could undermine the overall integrity ofthe FX market.In line with the GFXC's review process,finalised language will be shared withlocal FX committees before beingpublished by the end of this year. ChrisSalmon, Chair of the GFXC, says, “TheGFXC has made a number of decisionsthat will help to strengthen and embed the

Code across the global market. I amgrateful for the detailed feedbackprovided by market participants on lastlook in response to our Request forFeedback.”The GFXC has also commissioned furtherwork on two areas. These are “cover anddeal” trading arrangements anddisclosures regarding last look onanonymous e-trading platforms. “In both

cases the objective is to determinewhether the GFXC should enhance itsguidance about good market practice,potentially through the development ofadditional illustrative examples for theCode,” it says in a statement.Separately, the GFXC reaffirmed theimportance of expanding the global reachof the Code and agreed a number of stepsto secure this outcome.

GFXC. Continued from p. 5


7

One of the key issues raised during thecreation of the Global FX Codeconcerned adherence – how were marketparticipants to know that theircounterparties had adopted the Code?This was especially pertinent given howa group of central banks and,provisionally, members of the FXWorking Group’s sub-committee theMarket Participants’ Group havecommitted to avoiding dealing with firmsthat decline to sign up where possible.

Part of the solution came with thepublication – along with the full versionof the Code – of a Statement ofCommitment that market participantswere expected to sign within one year. Atthe same time as the Statement ofCommitment was issued, ideas werebeing touted around of a central registrythat participants can access to ensure theircounterparties were Code adopters.The Global Foreign Exchange Committee(GFXC) has published initial guidance onthe establishment of registers.The GFXC stresses it supports market-ledmechanisms that raise awareness of theCode and aim to promote its widespreadadoption by market participants. To thisend, it adds it is aware that some marketparticipants have expressed interest in thecreation of and having access to publicregisters which would facilitate marketparticipants making their use of theStatement of Commitment public, and theirattendant recognition of, and commitmentto adopting the good practices set forth inthe FX Global Code; as well as to assistinterested parties in identifying marketparticipants that have done so. The GFXC says it anticipates that publicregisters could be established using avariety of operating models. For example,one model might be a website which liststhose market participants that have self-published their Statement (for example,on their own website) and provide a linkto the Statement. An alternative modelmight host market participants’Statements, however the GFXC states ittakes no view on the most appropriateoperating model. The guidance takes the form of a short setof non-binding considerations as to therecommended characteristics of a publicregister that would most effectivelyachieve the aforementioned purposes. The GFXC says that should multipleregisters develop over time, it will

consider establishing and hosting a GlobalIndex of Registers, likely accessible viathe GFXC website, that will provide alink to all participating public registers. The GFXC says it considers that publicregisters should be established with theoverarching objective of increasing thetransparency around market participants’use of the Statement. As such, in providinga platform for market participants to makepublic their use of the Statement, publicregisters should make it clear to userswhat a market participant’s presence onthe public register represents and whatreliance should or should not be placedupon a market participant’s inclusion onthe public register. The committee adds it does not expectpublic registers to assume responsibilityfor verifying the accuracy or validity of amarket participant’s Statement;monitoring adherence to the Code bymarket participants listed in the register;or verifying whether market participantsare within the defined scope of marketparticipants covered by the public register. With this in mind, the GFXC says it hasconsidered possible features of publicregisters from the perspective of bothmarket participants that may wish to beincluded on the public register and usersthat may wish to identify marketparticipants included on the publicregister, in providing the non-bindingrecommendations. The recommendations state that publicregisters should consider providing fairand open access to those that may wish touse the public register to identify marketparticipants included, as well as - subjectto the operating model adopted - make thefollowing details publicly availableregarding the Statement; market

participant name, Statement date andmarket participant type; admission date ofthe market participant to the publicregister; and a link to the market’sparticipant’s Statement (as hosted by thepublic register, or as published elsewheree.g. market participant’s website).Further, the GFXC says a register should:• Clearly set out the process by which

market participants are admitted to orremoved from the public register.

• Clearly set out how a market partici-pant’s inclusion on the public register ismaintained through time, including howfrequently a market participant mightrenew their Statement and expectationsfor how future updates to the Code willbe taken account of, for example,whether renewal of the Statement is re-quired following a comprehensive re-view of the Code.

• Define the scope of market participantsthat are eligible to be admitted to the pub-lic register (for example, whether all mar-ket participants are eligible or whetherthe public register only applies to a spe-cific jurisdiction or market sector).

• Provide a link to the Global Index (ifrelevant).

The committee adds that public registersmay also consider developing a searchfunction to enhance usability. In the event that a Global Index isestablished by the GFXC, it is expectedthat alignment with the recommendationsabove will be a relevant factor fordetermining a public register’s eligibilityfor inclusion. “Initial feedback to the GFXC suggeststhat multiple entities, both from the publicsector and private sector, may haveinterest in establishing a public register,”

What Does an Adherence Register Mean?

ACI to Offer Code Adherence RegisterACI FMA is currently constructing a Global Register for financial marketparticipants who wish to publicly display their commitment to the FX Global Code.of Conduct This is in response to the requests by both global central banks, whom ACI FMA engagesdirectly with, as well as members of the Global Foreign Exchange Committee (GFXC). The register will be intended to support both ACI FMA members, as well as those marketparticipants who are not members and would like to display their commitment to theGlobal Code publically. ACI FMA will be hosting a publically accessible register, that isexpected to be in full adherence to the GFXC recommendations (see main story). “ACIFMA supports the FX Global Code and the core values of instilling ethical conductbehaviours into financial markets globally,” says Brigid Taylor, Managing Director ofACI FMA. “As such the Association will continue to provide solutions to meet therequests of the GFXC and financial market participants, large and small, to help createopportunities for all who choose ethical behaviour as a common value.”

continued on p.8 w


the GFXC says. “Multiple registers maybe able to capture a larger cross section ofFX market participants given the diversityof the wholesale FX market. “In order to support a morecomprehensive view across differentregisters, the GFXC will considerestablishing a Global Index,” it continues.“In considering the establishment of aGlobal Index the GFXC is in no waydiscouraging others from developing sucha service. The GFXC’s initial thinking isthat the Global Index will not provide thenames of individual market participants,but will provide a list of and links to each

of the public registers that are aligned withthe aforementioned recommendations. “The GFXC may also explore providing asearch functionality, whereby members ofthe public could search for institutionsacross all public registers that provided theGFXC with the ability to include theregisters’ contents in the search function,”it adds. “The Global Index will not collector publish Statements from marketparticipants. In addition, the Global Index(and hence the GFXC) will not assume anyresponsibility in (a) verifying that theinformation contained in the framework ofpublic registers is accurate, true or reliablyreflects the circumstances of any market

participant, (b) monitoring adherence bythe market participants that are listed in theframework of public registers, or (c)verifying whether market participants arewithin the defined scope of marketparticipants covered by the public register.”Reinforcing its stance that it does notwish to be responsible for the localregistries, the GFXC says it anticipatesworking constructively with entities thatestablish public registers and wish to beincluded in the Global Index. This mayinvolve standardising certain detailsprovided by individual public registers tofacilitate an effective global searchfunction across multiple registers, it adds.

Adherence Register. Continued from p.9

The changing mood amongst USregulators towards the regulation ofautomated trading was reflected in aspeech by CFTC Commissioner BrianQuintenz in October, when the newly-confirmed regulator said the controversialRegAT rule was “D-E-A-D”.

Commissioner Quintenz, who wasappointed in August 2017, spoke of “oneof the most serious missed opportunitiesof the agency’s prior pendingrulemakings – Regulation AutomatedTrading, or “Reg AT”.He argued the CFTC’s process on this ruledevelopment was “so confused” becausewhile the regulation is titled RegulationAutomated Trading the entities it wouldrequire to register were classified asAlgorithmic Trading Persons. “Those arenot interchangeable terms,” he said. “Notall algorithmic trading strategies have

completely automatedfunctionality.“This is more thansemantics – itdemonstrates a top-leveldisregard for theenormity of the tradingmethod spectrum and,therefore, a disregardfor the properassessment of marketrisk posed throughoutthat broad spectrum,”Quintenz continued.“Evidence of that disregard permeates theoriginal proposal.”Quintenz further observed that in itsoriginally-conceived form, an AlgorithmicTrading Person, or an AT person, wasdefined so broadly that anyone usingsomething as simple as a trailing stop – oranything with a similar, limited amount of

automated functionality would have beencaptured, forced to register with theCommission, and subject to the same rulesand requirements as the most sophisticatedHigh Frequency Trading firms.“That is poorly-crafted and flawed publicpolicy,” he stated. “While the agency’s

RegAT is Dead But Fast Markets Still a Challenge for Regulators

In addition to its main focus on the FXGlobal Code, ACI FMA’s ELAC willalso support education and certificationon several regional codes of conduct.

These will include the UK’s MoneyMarkets and Precious Metals Codes, bothof which will be ready for ELAC users tohave the option to include in their PARscore and demonstrate their understandingof the expectations of these codes in early2018.Whilst five of the six themes in the GlobalCode speak to addressing expectationsacross all functions and responsibilitieswithin financial market firms, the section

on ‘execution’ deals specifically with FX,as such the Bank of England hasproactively generated two new codes todeal specifically with money markets andprecious metals execution in the UK.Although the twi new codes have beenestablished for UK markets, ACI FMAbelieves UK counterparts would be welladvised to consider ensuring that theyfully understand the requirements whentrading directly with a UK counterpart, ortrading in these UK assets – this can nowbe achieved by using ELAC.In addition, ELAC will support theSingapore Blue Book following theSingapore Foreign Exchange Markets

Committee decision to update the it tofully incorporate the Global Code. Thiswork is currently in progress and is beingdriven by Lam Chee Kin of DBS andexpected completion of the first draft istowards the end of this year.With over 60 ACI National Associationsrepresenting ACI globally – ACI FMA iscommitted to including any new conductcodes of conduct that may be published,on the ELAC portal – to ensure thatglobal market participants have theoptions available to them to understandthe expectations and prove adherence toany codes that may be relevant to them atany time in their career.

ELAC to Engage with Regional Codes

continued on p.9 w8


lame-duck re-proposal of Reg AT inDecember of last year attempted toaddress the breadth of the AT persondefinition by including a tradingfrequency threshold, it was still aregistration scheme.“I don’t believe the right answer is toregulate and dictate all algorithmictrading activity,” Quintenz continued.“The right answer is to understand andaddress automated trading risk. Theagency needs to reset its posture on thisissue, and we need to have a seriousdiscussion about the finite circumstancesunder which automated, algorithmicactivity can create large-scale marketdisruptions. Only then should we examinewhat, if any, additional regulatorysolutions are necessary to address thoseconcrete and specific instances.”Significantly, while Quintenz issued theusual disclaimer about the speechreflecting his views and not necessarilythose of the CFTC, he closed the sectionof his speech on automated trading with avery strong statement. “Lastly, let me usethis opportunity to say that the prioradministration’s massively over-reachingand highly concerning “source coderepository” proposal is D-E-A-D.”

The Challenge of Fast Markets

The dropping of RegAT does not meanthat the advance of technology and itsimpact on financial markets is leaving theregulators’ agenda. Quintenz himselfhighlighted how the CFTC is discussingthe challenges of monitoring markets inwhich AI and machine learning are takinga bigger role, and just days after, ChrisSalmon, Executive Director, Markets, atthe Bank of England, discussed thechanging market microstructure, inparticular the advent of “fast markets”.Salmon stressed it was “incumbent” uponauthorities to keep up with developmentsand highlighted three recent flash eventsin financial markets, the equities marketflash crash of 2010, the US Treasuriesflash rally in 2014 and last year’s Cableflash crash and while he observed thatsharp moves in asset prices are nothingnew, “the speed, and the typical near-totalreversal” is new.“What is clear is that flash crashes arelikely just one symptom of materialchanges in the structure of certain marketsand the nature of their participants,” hesaid. “Although these changes areongoing, we need to understand them andtheir drivers, if we are to succeed in

correctly identifying any implications forfinancial stability.”In line with general thinking on the issue,Salmon noted that three main drivers ofthe shift to fast markets were e-trading,better data and regulation, however healso observed that one result of thischange was less need to warehouse risk. Agreater number of participants meant itwas easier to find a “near instant match”,Salmon observed, and identified the riseof non-bank market makers as a result ofthis. Another impact was how somebanks, who were unable to compete withthe smaller, nimbler firms, had shifted toan agency model – something of a creditintermediator between end-user clientsand the non-bank firms.Although Salmon highlighted the benefitsof the presence of high frequency traders– noting that empirical research hasfound, on average, the presence of thesefirms has been associated with improvedheadline measures of liquidity, at least fortrading in small size – he also noted theconcerns over increased transparency oforder and resulting slippage.Discussing the benefits from themicrostructure changes, he said, “Theseare potentially important benefits. Theability to undertake transactions at – orclose to – prices that reflect economicfundamentals facilitates the properallocation of capital, as well as themanagement and transfer of risk. It alsogives borrowers the confidence to plan,and savers to finance, productiveinvestment. Efficient markets also allowfor the transmission of monetary policyby allowing changes in policy interestrates to be reflected quickly acrossfinancial markets and assets.“The rise in automated high-frequencytrading has, however, also increased theincentive for market participants to protectinformation that could signal their tradingintentions,” Salmon continued. “This is toreduce the risk of being disadvantaged bytrading with other – faster-moving –market participants, and thus receiving aworse price (a phenomenon sometimesreferred to as ‘slippage’)”This interaction has manifested itself intwo observable trends, Salmon noted.First, there has been a partial reversal inthe trend toward greater pricetransparency as market participantsembrace other forms of trading, whichdiffer to traditional exchanges either byoffering less price transparency and/or anarrower range of counterparties.Second, market participants’ desire toavoid revealing information on their

trading intentions and seek the best pricehas led them to split up large orders,including via the use of algorithms. Thiscan be seen in a reduction in trade sizes, aswell as an increase in the rate at whichorders in some markets are updated orcancelled,” he added. “Here at the Bank wewant end-users to both benefit from and beconfident in the effectiveness of financialmarkets. So whilst these behaviours arepresumably rational – and cost-effective –for individual market participants, we aremindful that an aggregate reduction intransparency has the potential to hamperefficient price discovery.“Moreover, the steps some participants aretaking to conceal information raisesquestions about how the aggregateefficiency benefits from faster markets areshared,” he warned. “Finally, theoccurrence of flash crashes indicates that,even if fast market prices are more efficientin general, they are not always so.”Salmon summarised by suggesting thatthe headline conclusion that fast marketsare more efficient should be tempered,because, “as is often the case, the storyhere is somewhat nuanced”.Salmon noted that having less reliance ofrisk warehousers meant that during the2008-09 financial crisis, stresses wereconcentrated in those markets that hadrelied on dealer balance sheets. Thequestion of a intervention by theauthorities in equity or FX markets simplynever arose, he said.And while he accepted that flash crashesare headline grabbing, and occasionallysleep-denying, they have so far hadlimited systemic impact, “I doubt we canfully understand what conditions maytrigger similar future events or completelyanticipate how they might unfold.”Interestingly, Salmon pointed out thatfuture flash episodes, “May interact withaspects of financial market infrastructurein a way that gives rise to longer-lastingdisruption. Suppose, for example, that afuture flash episode happened to coincidewith benchmark fixings in foreignexchange markets, or a margin call relatedto equity or derivative markets. Theresulting impact on the recorded values ofa range of assets might risk mechanicallyprompting further sales and price falls.”As well as calling for regulators andmarket authorities to better understand therisks in modern markets, Salmon alsoargued that fast markets alter the patternof risks that individual market participantsare exposed to. “There are good groundsfor concluding that more needs to be done

RegAT. Continued from p.8

continued on p.10 w

9

A paper published by the Bank forInternational Settlements (BIS) studiesevents in the FX market leading up tothe removal of the EUR/CHF floor bythe Swiss National Bank in January2015, and while it is not conclusive, itdoes find evidence that some optionmarkets were predicting the breaklower in the cross.

The working paper, The discontinuationof the EUR/CHF minimum exchange ratein January 2015: was it expected? waswritten by Michael Funke, JuliusLoermann and Richhild Moessner fromthe BIS Monetary and EconomicDepartment. Following the removal of the floor,EUR/CHF collapsed quickly from 1.2000,hitting an official low of 0.8500 beforesettling around 1.0500. There were,however, several trades below the officiallow, including one trade – which was re-papered – at 0.0125.The authors attempt to quantify howunexpected the removal of the exchangerate floor was. They derive risk-neutral

probability density functions (pdfs) forEUR/CHF rates as implied by the pricesof options with maturities of one to 12months, using both parametric and non-parametric approaches. The study shows the evolution of theprobabilistic expectations, in the form ofthe probability of breaching the Swissfranc floor (break probability), and theassociated higher-order moments(skewness and kurtosis), over the courseof several important market events andexchange rate regime changes. It also studies the forecasting performanceof option-implied pdfs for EUR/CHFreturns during the time the floor was inplace, considering the forecastingperformance of an error-correction modelaugmented with break probabilities incomparison with a random walkbenchmark model, as well as theforecasting performance of the entireoption-implied pdfs. The authors find that that financialmarkets attached “some credibility” to theSwiss franc floor, since the breakprobabilities never significantly exceeded

50% while the floor was in place, butespecially at longer maturities there wassome doubt. Break probabilities increased fromJanuary 2014 for all maturities,suggesting that the credibility of the Swissfranc floor somewhat decreased, althoughthis also coincided with a strong test ofthe SNB’s will. “We also found that thecredibility of the Swiss franc floordecreased to some degree as the spotexchange rate approached the lowerbound of 1.20 CHF per euro,” the authorswrite, and again this is to be expected.The research highlights a shift in marketbeliefs between April and August 2012towards expectations of a Swiss francappreciation, although this calmed down at

to ensure market participants take accountof this consistently,” he stressed.“Use of algorithms does not change thefundamental risks associated with tradingin financial markets (e.g. market,counterparty and operational risks), butuse of high-frequency trading algorithmsdoes change their relative intensity andcan materially increase the potential tobuild up significant intraday positions,”he said. “This latter point is mostobviously true for those bank and non-bank intermediaries that specialise inhigh- frequency trading. And though thesefirms should be expert in managing suchrisks, history shows this is not a given.”Salmon continued by noting that end-users – corporates and asset managers –are increasingly splitting up larger tradesinto smaller pieces and trading them overa longer period. “Doing so exposes themto more execution risk; that is, the riskthat prices move against them before theyhave finished transacting – whichtraditionally was more the preserve ofintermediaries,” he warned. “Some end-users are also now automating this tradingprocess through the use of algorithms

[and] in so doing they swap one set ofrisks for another, and the examples oflosses by specialist firms in periods of fastmarket turbulence cautions againstassuming that all end-users willeffectively manage the new risksassociated with the use of algorithms.”In addition to the users of moderntechnology, Salmon also highlighted theneed for banks’ prime brokerage andclearing businesses to maintain substantialinvestment in technology andinfrastructure, including that to facilitatethe real-time monitoring of exposures andrisk management. “The costs associatedwith this are high, and serve as an effectivebarrier to entry,” he observed. “As fewbanks provide these services, this leads to aconcentration of nodes of market accessfor short-term liquidity providers.The changing role of banks/dealers in fastmarkets prompts the question whether thenature of potentially disruptive risks isalso changing. One obvious concernwould be if a prime broker or clearingbank was paralysed, including for reasonsunconnected to its activity in fast markets– say because of a cyber attack. I think itis fair to say that our understanding of

how market functioning would respond insuch a scenario – i.e. one in which anumber of, in particular high-frequency,liquidity providers were denied marketaccess – remains relatively limited.”Salmon concluded by noting that if thereis a common theme across all of hisexamples, “it is the limits of ourunderstanding”. But while he reiteratedthe need for the authorities to betterunderstand fast markets, he also arguedthat it is better for them to “remainvigilant and deepen our understanding, sothat we can take appropriate action in thefuture if required – be that from a macro-prudential or supervisory perspective”.He added, “For the authorities, we need todig deep to understand what this meansfor the financial system as a whole: bothto appreciate the benefits and to remainvigilant as to the risks. It is important forus to ensure that regulation – both ofindividual participants, marketinfrastructure and the financial system asa whole – keeps pace with the changes inthe type and distribution of risk. Onlythen can it provide an adequate guardagainst risks to prudentially regulatedinstitutions and their counterparties.”


Predicting the Unpredictable: Was the EUR/CHF Break Signalled?

RegAT. Continued from p.9

continued on p.11 w

10


The UK’s FICC Markets StandardBoard (FMSB) has issued its 2017Annual Report setting out the progressit has made to enhance standards ofbehaviour in the wholesale fixedincome, currencies and commoditiesmarkets.

FMSB was established in 2015 followingthe recommendations of the Fair andEffective Markets Review (FEMR),which was conducted by the Bank ofEngland, the UK Treasury and the UK’sFinancial Conduct Authority.FMSB says it has achieved “significantmomentum and has received strongsupport from market participants andpublic authorities”. It adds thatmembership now represents all sectorsand users of global FICC markets andaccounts for over 80% of sell sidewholesale FICC market activity.The report highlights 27 issues identifiedby FEMR and says FMSB has analysed400 UK and international conduct issue,prompting another 26 issues to beidentified. It has also carried out an

“initial horizon scan”that has identified 20issues.FMSB says it hascompleted the initialhorizon scan andsegmentation ofpotential practice areaswhich requireclarification by way ofstandards and/orstatements of goodpractice and hasproduced threestandards and two Statements of GoodPractice. The Board is presently workingon the production of five Standards andfive statements of good practice, itcontinues, noting it is also engaged inthematic work in relation to electronictrading and technology in markets and inrelation to the identification of commonrecurring abusive trading practices.“The impact of technology on FICCmarkets is a key area of interest forFMSB,” the report states. “Key issues forconsideration include principles for

controls and responsibilities in themanagement of trading algorithms,controls and risk management relating tothe deployment of algorithms, versioncontrol and change managementprocesses and record keeping, and thetraining of responsible staff. Also underconsideration is the examination oftrading rulebooks and system outages.”The report also discusses the relativemerits of regulation versus principles-based guidance. It notes, “Many people

the end of 2012, not coincidentally whenthe cross moved away from the floor. The authors also find that expectations ofa rise on the Swiss franc grew throughout2014, they note, “From January toDecember 2014 the skewness of thedensities turned from positive to negativeindicating a change in the directionalviews of financial markets. Moreover, atthe end of 2014 the kurtosis increased,indicating that financial markets saw largemovements of the exchange rate as morepossible.” The authors calculate break possibilitieson a daily basis to look for indications thefinal fracture was coming – under theseconditions a possibility under 50% is seenas indicating the market saw the currencyfloor as “credible” and vice versa above50%. Interestingly, even in the monthleading up to the removal of the floor, thebreak probabilities converged to 45-50%,but they did not exceed it.Overall the paper looks as though itconfirms, empirically, the psychology ofthe FX market – as the market felltowards the artificial floor so expectations– or hopes maybe – of a break increased.Given how price reflects traders’ opinions

and all publicly available information, itis to be expected that the more the marketlooked for a break, the closer to the floorit traded.The authors appear to suggest optionsmarkets could have predicted the event,but not with any accuracy, especially intemporal terms, which is the all-importantaspect of trading. They note, “In thispaper we compared the forecastingperformance of a random walkbenchmark model with an error-correctionmodel (ECM) augmented with option-implied break probabilities. For the one-month parametric and non-parametricbreak probabilities, we found someevidence that the ECM has aninformational advantage over the randomwalk, while we found that the ECM hasno informational advantage over therandom walk for the three-monthmaturity. Considering the forecastingperformance of the option-implied pdfs,we found that the one-month option-implied densities cannot predict the entirerange of exchange rate realisations.”In other words, the move could bepredicted to happen at some time, butshort term predictive signals didn’t reallywork. Ultimately, the paper confirms what

most traders can tell a layman – financialmarkets are notoriously difficult to predictand trade effectively for profit (outside thesphere of the market makers of course).This is accepted by the authors, whowrite, “Some economists argue thatfinancial markets are an excellent windowinto future developments and thus help usto understand economic policy andpolitics – but markets are hardlyomniscient. For example, they recentlystruggled to forecast the Brexit vote.They continue. “It is well-known thathigh-frequency exchange rates arenotoriously difficult to predict. Theassociated difficulties of such anundertaking are neatly expressed in thefollowing still valid phrase, [coined byEconomist Michael Mussa in1979] ‘In myjudgement, a model that was consistentlyable to explain 10 percent of the actualquarter-to-quarter changes in exchangerates...would be a successful model....amodel that was able to explain more than50 percent of quarter-to-quarter changesin exchange rates should either be rejectedon the grounds that it is too good to betrue or should be reported to the Vaticanas a miracle justifying the canonisation ofa new saint’.”

FMSB Annual Report Highlights Progress made in FICC Reform

EUR/CHF. Continued from p.9

continued on p.12 w

11

12


assume that the legal framework, and thedetailed regulation that has beendeveloped to complement this over time,provide a clear description of practices inmarkets – and how markets should work.In fact, this is not the case.“The advantage of high level principles isthat they are concise, adjust to marketdevelopments and allow for innovation,”it continues. “However, their applicationto market practice requires judgement andthis may create uncertainty about howprinciples apply to particular issues. Incontrast, detailed rules are more precise,but their precision means that they mayhinder innovation, need to be regularlyupdated to address new developments inmarkets and can incentivise “gaming”behaviour. As a result, there cansometimes be a tendency for rulebooks tobecome increasingly long, legalistic andcomplex.“The result of this is that both the law andregulation are silent on significant areasof market practice and cannot cover all ofthe detailed scenarios and complexpractices that arise in innovative andrapidly evolving global wholesalemarkets,” it adds. “Rules may mean that itis legal or illegal to conduct certainpractices but do not specify what thosepractices are or should be. Goodregulation and a sound legal frameworkare necessary pre-conditions for marketsto operate fairly and effectively, but moreis required to ensure that users of marketswill always receive the best of outcomes.Regulation and the law need to becomplemented by market standards whichlay out the principles of market practiceand how practitioners should deal witheach other in situations where regulationand the law are not able to guide them.”The FMSB also observes that the“repeating nature of market conductproblems is also a function of the frailtyof collective memory”. It adds that nomatter how intense the experience offailures, as time passes memories recedeand those who were witnesses move onfrom the industry. “The lessons learnt byone firm or one generation do notnecessarily pass to the next,” it states.“Creating clear and widely adoptedmarket standards which set out best andunacceptable market practice in enduringform will help to perpetuate marketStandards over time and across markets.”To this end, FMSB says it is attempting toclarify “grey areas” of market practicewhere ambiguity as to (for example) theappropriate assessment of conflicts of

interest between counterparties to a tradecreates poor outcomes for market usersand undermines fair and effectivemarkets.It adds that much attention is inevitablypaid to high profile cases of conductabuse, often perpetrated by an individualor a network of individuals who findloopholes in the legal or regulatoryframeworks and firm controlenvironments. “Regrettably, there willalways be incentives and opportunities forthis; the determined actors may find waysaround even the best designed controls,”the report states. “These types ofdeliberate, intentional, abuse are unlikelyto be eliminated solely by marketstandards. Nevertheless, by clarifying greyareas of market practice, our standardsshould help to pre-empt such malpracticeand make it harder to engineer.”One of the issues raised by FEMR wasthat market discipline was not operatingeffectively. Part of the role of FMSB is toprovide a structured forum within whichmarket discipline is restored anddeveloped. “Market Standards make iteasier for market users to insist onappropriate practices and to take theinitiative in doing so,” the report states.“In the past, market participants have notnecessarily understood the significance ofambiguous practices or have relied onmarket regulators to address these. Butthe size, speed and cross-bordercomplexity of trading relationships inwholesale markets makes thischallenging.“Markets will be fairer and more effectiveif users, as well as liquidity providers,understand how trading protocols shouldoperate and market discipline operateseffectively alongside the regulatoryframework,” it continues. “Bypromulgating clear market protocols,standards take an important step to re-establishing market discipline.”The report also contains “behaviourcluster analysis” of the previouslymentioned 400 cases over a 200-yearperiod, although significantly and ratherominously the FMSB says that some 250of those cases have occurred this century.FMSB says an extensive time period isused to capture potentially relevantpatterns and to indicate the recurringnature of those patterns. “This work hasestablished that malpractice behavioursare consistently similar over time, acrossasset classes and across jurisdictions,” itsays, explaining that there are some 26behavioural patterns evident in marketmisconduct cases. “These patterns repeat

and recur over time and across marketsdespite the continuing promulgation oflegislation and regulation,” it says.Unsurprisingly given the globalisationtrend, the report finds “These behaviouralpatterns do not respect national orjurisdictional boundaries – they areevident internationally.”The patterns are not specific to particularasset classes and are evident in differentasset classes. “This is rational: assetclasses do not generate conduct risks –people do,” the report states.Interestingly, the report also claims thatbehavioural patterns “readily adapt to newmarket structures and technologies” andsays that FMSB will publish materialsindicating each relevant pattern and thesource cases from which these arederived, case studies for each pattern andthe database of the relevant enforcementcases for reference purposes.“The analysis has established that anumber of behavioural clusters repeat andrecur over time and adapt to marketstructural change,” the report states. “Thisis not new. It is notable that the US SenateCommittee, which examined the conductcauses of the 1929 Crash and which led tothe Securities and Exchange Act 1934,took over 10,000 pages of evidencerelating to market conduct. The marketconduct patterns identified by the USSenate Committee in 1934 are strikinglysimilar to those evident in conduct casestoday.”Mark Yallop, Chairman of FMSB says,“In the past 12 months we have madesignificant progress in our central aim: toraise standards of conduct in thewholesale financial markets and improveoutcomes for market participants bymaking them more transparent, fair andeffective. Everything we have seen anddone so far has strengthened ourconviction about the need for FMSB andthe critical role that it has been created toperform.”Andrew Bailey, CEO of the UK’sFinancial Conduct Authority adds, “Goodculture and trust go�hand in hand. Andtrust is fundamentally about the honestyand veracity of commitments and thereliability of future promises to yourcustomers, investors, creditors and thepublic authorities. By codifying agreedstandards that set out these commitmentsand are accepted by all its members,FMSB is building an essential foundationfor re-establishing public trust in marketsagain. I am a strong supporter of theirwork and am very pleased to see theprogress made in 2016/17.”

FMSB. Continued from p.9

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