By David Clark, chairman, the Wholesale Markets Brokers’ Association (WMBA)
The Fair and Effective Markets Review (FEMR), a joint initiative launched by the UK Government Treasury and the Bank of England aimed at rebuilding trust and restoring confidence in the wholesale fixed income, currency and commodity markets (FICC) is playing a key role in influencing the international debate on trading practices. It is the first time that a government treasury, regulator and central bank have worked together to address what went wrong through stronger conduct and behavioural standards. As the Review and the principles outlined within it gain traction to become a global blueprint, this article considers the reasons behind its success, and what considerations must be made by regulators around the world in adopting its principles to ensure they promote truly global standards and practices.
Why was FEMR so successful and how can its endorsement of codes of conduct be applied on a global basis?
Unlike various regulatory initiatives such as the Markets in Financial Instruments Directive (Mifid) and the Dodd-Frank Act, among others, FEMR’s success is due in large part to its ‘bottom-up’ approach whereby market participants have been working collectively not only to answer the UK authorities’ questions about what fair and effective markets should look like but come up with suggestions to ensure past failings and inappropriate behaviour are not repeated. The engagement of practitioners as part of the solution has been key to its success. The Market Practitioners Panel (MPP), comprising of senior industry leaders representing the buy-side and sell-side, market infrastructure providers and corporate users, enabled as many market participants from the broadest spectrum possible to provide input to the Review.
Another important change introduced by the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) alongside the FEMR was the extension of the existing Senior Managers Regime to encompass non-banks, including building societies, credit unions and investment firms to ensure that senior managers can be held accountable for any misconduct that falls within their areas of responsibilities. A new Certification Regime and Conduct Rules to hold individuals working at all levels in banking to appropriate standards of conduct were also implemented.
Lastly, it was widely acknowledged that abuses took place because of bad behaviour and governance but, interestingly, another feature of the review unearthed that standards of market practice were poorly understood, were short on detail or lacked a common approach. To use the FX market as an example, a number of practices including last look, internalisation and time stamping are currently being reviewed in further detail to ensure that practitioners do not intentionally or indeed unintentionally abuse these normal trading practices.
Why should FEMR become global and what progress has been made?
With London being the leading centre for global capital markets across the world, the general consensus is that what’s beneficial for London is beneficial for the rest of the world and, as such, it is believed that the international promotion of the Review is a prerequisite for its success and a contribution to the integrity of global traded markets. A strong argument for this bottom-up approach can be found in the FX market, which in March 2015 saw eight foreign exchange committees jointly publish a high-level set of conduct principles that should be expected of all participants. The document, Global Preamble: Codes of Best Market Practice and Shared Global Principles, aims to harmonise behavioural standards internationally.
Shortly afterwards, the Bank for International Settlements’ (BIS) Foreign Exchange Working Group (FXWG), was asked to strengthen the code of conduct standards and principles in the FX market. To support the FXWG, a Market Participants Group (MPG) was established, consisting of market participants from the sell-side and buy-side of the market as well as FX infrastructure providers. Together, the two groups will work with the various global foreign exchange committees to reach out to jurisdictions beyond those represented by the group.
What are the challenges?
As the risk of regulatory fragmentation increases, there is pressure on jurisdictions to deliver a supervisory system which recognises the values of adhering to a global code of conduct and implementing best practice guidelines. Undoubtedly those jurisdictions which have a longer standing history of understanding the principles of a code of conduct will have an advantage in adopting the principles of this Review. It has been acknowledged, however, that the more specific the guidelines, the taller the barriers to compliance will become. It is impossible to define every scenario that is or is not in breach of a set of guidelines, and so it is hoped that a globally agreed code of conduct can help market practitioners reach their own conclusions about what type of behaviour is appropriate and how to propagate it in their institutions.
It should be noted, however, that the success of a global code of conduct rests heavily on the ability to enforce better behaviour among practitioners without making major changes to the market structure that could have an adverse effect on liquidity and access. The move towards using a code of conduct as a supervisory tool also further supports the emphasis now being put on principles based regulation.
Furthermore, the proposed global code of conduct does pose the question about how the commodity and energy markets will be regulated as some jurisdictions do not classify commodities as a financial asset class and would not therefore apply the code in the way it is done so by FEMR, creating discrepancies which will affect the way these instruments are traded. Regulators therefore need to look at this issue in a wider context before a global code and principles based regulation can be applied to these instruments and adhered to on a global scale.
Great progress has been made in rolling out the recommendations of the Review on a global scale, particularly as regards the promotion of a single code of conduct but further work is needed. Regulatory authorities in the UK and beyond continue to consult with the market in this regard but there is a widely held view that little more can be done to enforce a set of principles upon the market and coerce participants to behave accordingly. Ultimately it is the responsibility of the latter to make it succeed.
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