The FCA confirms recognition of the revised FX Global Code and the Global Precious Metals Code with strong words on ‘last look’

In June 2017, we published a paper on the introduction of the Bank for International Settlement’s (‘BIS’) long-awaited final phase of the FX Global Code (‘FX Code’). 

 

FX Code of Conduct:

The Code had been developed to restore confidence and establish ‘best practice’in FX markets following public scandals about market manipulation. However, the Code still allowed the continuation of the controversial practice of ‘last look’.

 

Last look allows sell-side firms to decide whether the rate has changed from the rate that had been first quoted to its counterparty and decide whether to cancel or re-quote the order.

 

Last look originated in the early years of electronic trading to allow a window of time to check that a market maker’s price wasn’t based on stale pricing data and to check that there were available credit lines for the client. As electronic trading developed, last look became programmed into the systems and, one might say almost inevitably, it became the subject of profit-driven abuse with some firms cancelling trades purely because they became less profitable during the last look window which had led to suspicion and uncertainty on the part of buy-side clients when they experienced high rejection rates.

 

While regulators didn’t ban the practice they said they took a very dim view of firms that adopted a deliberate policy of blocking transparency and encouraging traders to give less than complete information when clients asked direct questionsand,  at the time, the BIS stressed that last look should only be used:

 

  • • For its original purpose of being a risk control mechanism, and;

  • • In order to verify validity and/or price. 

  • • It may also be used to check that the details contained in the request are appropriate from an operational perspective, and;

  • • That there is sufficient available credit to enter into the transaction. 

To be consistent with the principles of the Code and best market practice it emphasised that:

  • • Last look should not be used for purposes of information gathering, with no intention of accepting the client’s request to trade

  • • Use of any confidential information that arises at the start of the last look window should be consistent with the Code’s principles on Information Sharing and;

  • • That trading activity that uses information from the client’s trade request, including any related hedging activity, is likely to be inconsistent with good market practice as it may signal the client’s trading intent to other market participants and, in the event the request to trade is rejected, be a misuse of confidential information.

The FCA subsequently recognised the Global FX Code in 2018 as a code which set out ‘proper standards of market conduct’ and that by conducting themselves in line with the Code’s provisions, relevant individuals would be able to take comfort that they were meeting the required standards of market conduct to comply with the FCA’s Senior Managers and Certification Regime (‘SMCR’).

 

The Global Foreign Exchange Committee (‘GXFC’) has recently completed its triennial review of the Code updating eleven of its fifty-five principles of good practice in several key areas and retaining Principle 17 that allows the use of last look. 

In advance of this, the GXFC had earlier issued a guidance paper on last look to reinforce the principle, emphasising that last look should always be applied in a fair and predictable manner, and that the process is intended to be used for the price and validity checks only, and for no other purpose. The three main recommendations were to:

  • Ensure a fair and effective last look process;

  • Enhance ex-ante disclosures; and

  • Ensure information is available to regularly evaluate the handling of trade requests.

The Global Precious Metals Code (‘PM Code’) has also been updated by the London Bullion Markets Association (‘LBMA’) and the FCA, in confirming that both revisions have been formally recognised until the next three-year review, added a strong reminder about the use of last look to their confirmation.

After confirming with the GFXC and LBMA as part of the recognition process for the FX and PM Codes they warned that:

  • Regardless of the terminology used, last look practices that incorporate a delay that is additional to what is required to complete price and validity checks (some market participants refer to such deliberate delays as ‘additional hold time’) are not consistent with the Codes. For example, market participants should not prolong the duration of the last look window for the purpose of seeing if future prices move in their favour in relation to the client’s trade request.

  • pre-hedging practices where market participants do not communicate their practices to clients in a manner that allows the client to understand the potential impact on the execution of their order are not consistent with the Codes. This includes practices where market participants do not have appropriate controls to monitor potential conflicts of interest, and do not have controls in place to limit access to confidential information relating to anticipated orders.

More broadly, those who are signatories to the FX and PM Codes, will need to make clear and transparent disclosures to market users to explain how their orders will be handled. For example, a market participant applying last look price checks would need to explain if these are symmetric or asymmetric.

For the FX Code, anonymous trading platforms would need to disclose whether their users are signatories to the Code. These could be important indicators or even determinants of execution quality, and so of direct relevance to those seeking best execution outcomes.

It is clear that the FCA’s comments show that they will hold any breach of Principle 17 as a breach of Rule 5 of its Individual conduct rules (COCON 2.1)  that ‘you must observe proper standards of market conduct’ and therefore also breach the standards required to comply with the SMCR.

To date over 1,100 financial and non-financial institutions have signed up to the FX Global Code, which is increasingly seen as vital to the integrity and effective functioning of the foreign exchange market. FMCR can provide expert assistance in assisting firms who are contemplating signing up to the Code.

 
 
Peter Manning