What if I told you that the most important and most liquid market on this planet can be certainly one of the least understood? It is Daily spot sales of $2.1 trillion dwarfs bonds or stocks and all transactions are settled over-the-counter (OTC). The market also connects hundreds of participants in 52 different jurisdictions and facilitates a further $5 trillion in futures, swaps and options every day along with spot transactions.
I’m in fact talking in regards to the highly fragmented foreign exchange market.
Such a big and interconnected market should function in an open, liquid, fair, robust and transparent manner. Since the worldwide financial crisis (GFC), every day turnover within the foreign exchange market has roughly doubled. This has increased expectations of transparency and liquidity and necessitated increased supervision. Having followed the event of the foreign exchange market over the past 20 years, I remember it often making headlines for the mistaken reasons, as information imbalances between traders and customers led to abuse. “Suspicion of Forex Gouging Spreads” In February 2011, the clamor was: “Some of the largest investment firms in the United States were overcharged by banks for foreign exchange transactions, bank insiders and others claim, expanding the scope of alleged abuses in parts of the $4 trillion foreign exchange market.”
In response to such excesses, in May 2015 the G10 central bank governors launched a world initiative to introduce the FX Global Code (“the Code”). Over the subsequent few years, representatives from 16 central banks worked along with private market participants on each the buying and selling sides to create a comprehensive document. RBC Global Asset Management (RBC GAM) took part in certainly one of the working groups.
The final 70-plus page document, released in 2018, went beyond ethics and embodied industry best practices. The Code is predicated on six basic principles and describes what market participants expect of themselves and one another:
- Ethics: “Ethical and professional conduct to promote the fairness and integrity of the foreign exchange market.”
- Guide: “To have a solid and effective governance framework to ensure clear accountability and comprehensive supervision of their foreign exchange market activities and promote responsible engagement in the foreign exchange market.”
- Execution: “Exercise caution when negotiating and executing transactions.”
- Information exchange: “To be clear and accurate in their communications and to protect confidential information.”
- Risk management and compliance: “Promote and maintain a robust control and compliance environment to effectively identify, manage and report on the risks associated with their exposure to the foreign exchange market.”
- Confirmation and billing processes: “Introducing robust, efficient, transparent and risk-mitigating post-trade processes to promote the predictable, smooth and timely settlement of transactions in the foreign exchange market.”
The Code will not be a part of the regulatory framework in most jurisdictions, due to this fact compliance with the Code is voluntary and represents the participant’s commitment to good governance and good practices and to the promotion of fair, transparent, liquid and robust markets. The Code is meant to use to all participants within the wholesale foreign exchange market – each on the buying and selling sides, in addition to trading venues and other corporations providing brokerage and execution services. However, the Code allows for proportionate implementation as specific circumstances and differences in business activity require. This recognizes that the activities of traders are inherently different from those of asset managers, corporations or central banks and that not every principle applies to each participant. For example, as an asset manager, RBC GAM doesn’t create markets for clients or engage in proprietary trading on behalf of the firm, so most of the sell-side rules don’t apply to us. Determining the applicable principles is step one before a market participant can confirm compliance with the Code.
As a living document, the Code is maintained and updated to reflect market changes, which is a key objective of the Global Foreign Exchange Committee (GFXC). The GFXC website is a superb source of data and tools to facilitate adoption. The original 2018 version of the Code was updated in 2021, and with each triennial revision, participants are expected to reaffirm their commitment to the newest document.
In the 4 years because the Code was published, most sell-side foreign exchange market participants have joined the Code. However, acceptance on the client side was slow. Limited resources, the undeniable fact that foreign exchange only represents a small a part of their business, the voluntary nature of the code and the perception that it’s a “sell-side issue” are a few of the reasons for poor buy-side adoption to be named.
Having worked as a portfolio manager for greater than 20 years, I find this confusing. For greater than 25 years, we at RBC GAM have relied on our in-house foreign exchange desk for execution. Based on our experience, we consider that the Forex market as an ecosystem requires all participants to know, follow, implement and uphold the principles. We care about best execution in FX as much as we do in fixed income and equities: it’s a crucial a part of our governance framework.
How has adhering to the Code helped us?
- It has change into an education and training tool for brand spanking new members of our FX, trading support and operations teams and is a component of our onboarding materials.
- This has led to a review of our policies and an in-depth discussion on the applicability of the Code, which has strengthened our understanding of how the market works and its best practices.
- It has empowered our trading staff to demand best execution practices and requires all of our counterparties to sign the Code.
- This has enabled us to repeatedly improve our policies and procedures. With each update, ambiguities were eliminated.
- It has increased our confidence in our internal policies and procedures and demonstrated to customers the strength of our governance framework.
As corporations and asset managers seek to show their commitment to environmental, social and governance (ESG) values, they need to take the chance to conduct an intensive review of the governance framework that supports their FX business.
Our customers have also benefited from signing the code. It has integrated a world standard that contributes to the efficient and ethical functioning of an otherwise fragmented and decentralized foreign exchange market. Counterparties who’ve signed the Code can use it as a guide in unexpected circumstances or disputes, reminiscent of treating all customers fairly in settlement transactions on the occasion of Queen Elizabeth II’s funeral, an unexpected holiday. Initiatives have also sought to reward corporations that join the code with access to more money reserves. For example, global foreign exchange trading platform 360T announced that starting October 1, 2022, only code signatories or market makers offering fixed liquidity will have the option to set prices anonymously on its electronic communications network (ECN) 360TGTX.
As the forex market grows and evolves, more must be done to enhance its functioning and integrity. Progress requires that each one buy-side professionals commit to globally recognized best practices. And progress continues with the commitment to repeatedly improve them. We have tried to do that at RBC GAM and hope that other asset managers will see the advantages of signing the Code and adhering to its principles.
Reproduced with permission from RBC Global Asset Management Inc.
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