Briefing: FX, the world’s largest and most liquid financial market

The foreign exchange (FX) industry is now emerging from a difficult period of scandal. Following the resulting increased scrutiny, which culminated in the creation of the FX Global Code, the global USD5 trillion-a-day market finds itself at a crossroads.

The Code’s efficacy is yet to be tested, but adoption continues and is strong. Why does any of this matter? Well for one, foreign exchange remains the world’s largest and most liquid market and plays a critical role in enabling international trade and investment.

Currencies provide a bell-weather for economic health, and short-term sentiment and speculation of course, but also a tool for hedging and the genuine flow of business and goods across borders.

Trust in its operation has to be restored, not just for investors but for the broader reputations of the institutions with FX operations.

A handful of banks, and non-bank trading firms – still mistakenly referred to as “the buy-side” – now dominate FX completely. This concentration was built over two decades and these global franchises have also been the first to adopt new technology and models, from prime brokerage to really maxing out on their API trading strategies.

A common muttering on FX street is that the banks have been distracted by regulation, paving the way for non-banks to steal clients from underneath the noses of the banks. Fair comment or sour grapes?

Meanwhile, in the post-trade space, there is a growing consensus for a shake-up of the current model, which is expensive and outdated. Demands for instant settlement continue to grow and more participants are backing DLT/blockchain-based platforms.

Many of the post-trade giants of today were established more than 20 years ago, as is their technology, so there is certainly scope for disruption. New entrants such as Cobalt are shaking up the post-trade FX landscape, while incumbents sensing their dominant position under threat, are eyeing the roll-out of DLT-based systems and – in some cases – investing in start-up systems.

 The move towards automation and straight-through processing began many years ago. Lower costs generally translate into lower barriers to entry, and we have already seen new entrant establish themselves as key market players. This will gather pace and will open the door to a new wave of market players to enter the FX market.

We would most certainly not bet against the blockchain, despite the inevitable kickback to the hype cycle. Cloud computing went through a hype cycle and subsequent trough of disillusionment before becoming a ubiquitous part of the IT landscape on what Gartner calls the slope of enlightenment.

The past is the key to the future of FX. The winners will continue to innovate using technology and will meet the challenges of adopting big data and analytics, distributed ledger technology, cloud computing, robotics and artificial intelligence (AI) head on.

Is the FX Global Code working?

In recent years, the FX market has been experiencing a period of turbulence. A series of scandals, following a string of misconduct issues, led to some market participants reassessing their existing relationships and trading processes.

To tackle the deficit of trust, the global foreign exchange (FX) market came together with policymakers to create the Global Foreign Exchange Committee (GFXC). This public-private partnership is tasked with overseeing and developing the FX Global Code, a set of guidelines which aim to improve transparency and ethics across the FX industry.

The FX Global Code debuted in May 2017. A little over a year later, the GFXC has carried out a thorough assessment of the progress so far and identified its priorities for the year ahead.

One of the main takeaways from the report was the sizeable levels of awareness and commitment theFX Global Code achieved in its first year. In a survey conducted in September 2017, 250 market participants said they would eventually sign the Statement of Commitment (SoC) to the Code. By May 201­­8, more than 326 had done so – an increase of 30%.

Along with the number of SoCs, 12 different public registers have been created to monitor and track sign-ups. Such numbers are indicative of how much the FX Global Code has embedded itself across the industry.

The Code has also achieved great penetration across the globe. It ranks high on the agenda of FX trade associations and at industry events around the world. Furthermore, in its first year, Mexico, South Africa, Scandinavia and Switzerland have either established FX committees to support the Code or are in the process of creating one. These local committees are critical to embedding a Code that is truly global and standardised.

Another success of the first year of the FX Global Code is the creation of training programs. These are created to aid FX traders that don’t have a process within their institution outlining how to follow the Code. One such program is the ACI FMA’s increasingly popular ELAC Portal, which provides step-by-step professional development for those looking to prove their adherence to the Code via tailored questions and real-life scenarios. This is a healthy sign that there is genuine demand in the FX community to follow the principles of the Code, and that it isn’t simply being forced upon industry professionals by the GFXC.

Of course, signing a SoC does not mean an institution has completely changed their practices to align with the Code. Rather, it indicates that they have reviewed their processes and intend to align with the principles laid out in the Code.

Looking the public registers, it appears the bulk of those that have adopted the Code’s principles are made up of sell-side institutions, central banks and FX market infrastructure providers. The buy-side and non-bank institutions are lagging behind, with only 11 of the top 25 asset managers and two corporates signing up to the Code.

According to the GFXC, the complexities of buy-side institutions and the lack of incentives for signing up are the reasons for the slow take up. The buy-side is much more diverse than the sell-side, and therefore has varying levels of resources.

At the same time, it is important to recognise that the Code has not been met with universal approval from all sections of the market. Issues such as last look have been contentious for some sections of the FX market.

Overall, it appears market participants believe the Code is robust in its current state, although evolution in line with market changes is inevitable. In this respect, a new working group has been set up to focus on integrating the Code into the ‘fabric of the FX market.’

To answer the question posed in the title of this blog, the Code is working and has achieved a lot of things it set out to do, securing significant awareness and commitment throughout the industry. However, there is a lot more that needs done – particularly around engaging the buy-side. It remains to be seen how the industry actually implements the principles laid out in the Code over the next year and the consequences, or lack thereof, for those that do not.