Conduct code comes to FX business

International regulators have implemented a voluntary Foreign Exchange Global Code of Conduct. This is a very big deal for this business, and I’ll explain why.

With more than 30 years in the currency market I have watched the daily volume go from $1 trillion a day to today’s average daily volume of $5.3 trillion a day. For years I lived and worked in what was called the Wild Wild West.

For most transactions there were very few rules in place. Traders did as they pleased and salespeople bragged about their customer business. There were no rules for proper spreads or appropriate behavior.

The goal was simple: Finish the day with a profit, go the bar, and brag about it. Most traders had an undergraduate college degree, some just a high school diploma. I knew only one person with a masters degree. Having a PhD was practically unheard of.

Winds of change coming to FX

The global financial crisis and the Dodd-Frank Act began to change this atmosphere, yet still much of the market to this day remains unregulated.

Buyers and sellers transact by phone, in chat rooms, or over electronic trading platforms run by banks or third-party vendors. There are no formal rules in place for trade prices and no rules about the information that can and cannot be shared.

Recently there were several significant fines placed on banks for sharing confidential information about client transactions and deal flow.

This information is often conveyed via Code names for key clients, like “Flipper” for a client that flipped his position often and “King” for a very large hedge fund. Most major clients of large financial institutions have Code names.

The Foreign Exchange Global Code of Conduct is meant to guide financial institutions towards an end to this behavior.

Origins of the Code

The Code was a project started by the Bank for International Settlements in 2015 and included a committee made up of numerous market participants and central bankers.

The Code was developed to be a living document that will be updated and maintained on an ongoing basis. It is a set of guidelines and principles established to make sure that currency transactions and the relationships between financial institutions and their clients be conducted in the most professional and proper manner.

The committee will regularly monitor ongoing changes in the industry and add to the set of guidelines and principles that it is already established. The Code was released in May 2017 and already has open items for discussion, review, and amendment.

What Code has to say

Six guiding principles make up the foreign exchange Global Code of Conduct. They include ethics; execution; governance; information sharing; risk management and compliance; trade confirmation and settlements.

The principles of the Code that I am going to focus on are ethics, execution, and information sharing.

• Ethics. To me ethics should be obvious, but clearly they aren’t to everyone.

Ethics in this case refers to behaving in a professional and honest manner when dealing with your clients or other banks. You should act fairly and conduct business with integrity, and always apply the proper judgment when dealing with ethical issues.

As an independent currency advisor, I can’t imagine how this is not obvious, but clearly it was not. The Code applies to all players in the business.

• Execution. Trade execution and the information you gain as a bank from your clients’ orders are key components of the FX market. It is vital for the client to make sure they receive the best possible price for their order and that the information remain confidential. The Code guides market participants that bragging rights is not part of the trade process.

The guideline is clear that a client and bank should set a clear understanding as to how orders will be executed. Whether or not the bank has discretion on the trade or must execute at a specific price should be made clear ahead of time.

Execution also refers to rules about when it is acceptable to trade in front of your client's order and when it is not. A bank must use discretion on this, as well as follow all ethical guidelines. You should only be trading in front of or behind the order when you feel it is in the best interest of the ultimate execution for the client.

For example, when a client gives you a large order to buy Swiss Francs at best price of the course of the day, you should buy them spaced out over the remaining trading hours in the day, and give the client an average price. You should not buy half the Swiss Francs immediately for yourself knowing that the size of the trade will move the market and allow for additional profits for the bank.

• Information sharing. I spent most of my career as a forward trader. There was very little client flow associated with that—most client flow was spot FX trades. For decades banks shared client information about trades with each other—very often with the clients’ names, and currencies traded and often amounts (usually larger than actual … it’s an ego thing).

In the early days of FX these conversations were over the phone or over a beer. More recently, they are over chat room conversations. The Code reminds us that all client information and client trade flow needs to remain confidential. A bank’s book of business should not be shared with another bank for any reason, especially not in order for both banks to profit on the business.

Why is the Code important to you?

The Code of Conduct was written expressly to protect investors that transact in the foreign exchange markets. It does not matter if you are an asset manager managing billions of dollars on an active basis, a mid-size regional bank that transacts foreign exchange periodically, or a corporate treasurer. The Code was established as a guideline for all participants.

Plain and simple, the FX provider is supposed to give a fair price on their currency trades on a regular basis. As an advisor, I help my clients with respect to that, since many of the clients I work with trade more complex, less-liquid instruments, but the Code was written to cover all foreign exchange business.

Application of the Code

It is not vital for the client to be an expert in the market. But it is vital that they know that the financial institution supporting their FX transactions has agreed to abide by the Code.

This is not a set of laws, but rather guiding principles. Even so, there is a standard document that is available for banks and clients to sign stating they will abide by the Code’s principles.

Any client of a large financial institution should request that their banks and brokers abide by the Code and sign the document. It was established with that sole purpose in mind.

I can’t express this with any greater sense of urgency. A regional bank, or mid-tier financial institution that transacts its foreign exchange business with a large money-center bank, must require their banking partners to sign this Code.

I am guiding all my clients to make that request of their banks in order to maintain a strong dealing relationship.

I am also advising my clients to add language to the foreign exchange policy documents that they are abiding by the Code of Conduct. Clients of regional banks and the regional banks themselves will benefit financially from this Code of Conduct.

As an intermediary bank that has clients and is a client to larger financial institutions, everyone will benefit financially. The amount of money saved may be significant, and no doubt as a banker you will sleep more comfortably at night knowing you are being treated fairly.

Read the Foreign Exchange Global Code of Conduct