The new Global FX Code retains controversial “last look” practice

The Bank for International Settlements has published its long-awaited second and final phase of the Global FX Code, which has been created to restore confidence in FX markets following recent public scandals about market manipulation.

The Code is structured around six guiding principles – ethics; governance; execution; information sharing; risk management and compliance; and confirmation and settlement and is designed to bring about a standardised approach to best-practices in the FX markets, to ensure best-execution and prevent price manipulation. The Code is a set of 55 principles that are not legally binding but they are expected to be formally adopted by all market participants, from central banks downwards.

One controversial practice that has been retained in the Code is the practice of “last look” on electronic trading platforms. 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 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 questions. Last year, the US Department of Justice fined an international bank $150m for using last look to decline client orders that might be less profitable for the bank, telling clients they had been declined because of ‘a technical issue’, and many saw this as its death knell.

As part of its 2015 Fair and Effective Markets Review the Bank of England had called for work to improve the controls and transparency around FX market practices saying that ‘the global code should also set out clearer standards on the use of last look, including whether it should remain an acceptable market practice’.

In the new Code the BIS has controversially retained the practice and freshly addressed the point under its Principle 17 – ‘Market Participants employing last look should be transparent regarding its use and provide appropriate disclosures to Clients.’

Under Principle 17 participants ‘must disclose, as a minimum, explanations regarding whether, and if so how, changes to price in either direction may impact the decision to accept or reject the trade, the expected or typical period of time for making that decision, and more broadly the purpose for using last look.’

The BIS stress that last look should only be used:

  • TFor 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 emphasises 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;

  • The Code warns 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.

Principle 17 concludes, saying that it is good practice for market participants to engage in a dialogue about the use of last look with clients on how their requests have been handled and how the information has been treated. The dialogue should also provide information that facilitates transparency around pricing and execution so that the client can assess whether the firm’s execution methodology continues to meet its needs over the long term.

Only time will tell whether this set of voluntary principles will stamp out abuse or whether tighter regulation or an outright ban may be needed; but any firm that signs up to the Code and then breaches Principle 17 will know that it is certain to feel the heavy hand of the regulator bearing down upon it.

Peter Manning