Hardwiring best practice into spot FX trading venues

5 June 2017

The Bank of International Settlements’ (BIS) foreign exchange (FX) Global Code of Conduct is compelling market participants to take a hard look at established electronic spot FX platforms and ask if they are adopting best practices. 

It’s been a turbulent time for the foreign exchange market in recent years, with behavioural scandals, periods of patchy liquidity and so-called ‘flash-crashes’ shaking investor confidence. Attempts to repair the market’s reputation and prevent external bodies imposing additional regulation have led to the development of the BIS FX Global Code of Conduct.  

Launched on 25 May, the Code provides a single set of global principles to promote integrity and effectiveness across the USD5.1 trillion-a-day global FX market^[1]. 

The Code focuses on instilling a healthier environment, allowing for greater transparency, equality and fairness in day-to-day market practices. One of its most anticipated topics surrounds electronic trading, and the best practices and ethics to which platform providers should adhere. 

Electronic trading has grown exponentially as the industry has evolved over the past decade and new entrants have entered the market. According to a JP Morgan survey, 76% of FX trading volume is predicted to be executed through these channels this year^[2]. As electronic trading becomes increasingly dominant in FX, it is imperative that there are mechanisms in place to ensure platforms offer a framework that promotes best practices.

 

Tackling industry issues

The Code aims to reshape the FX market and instil the notion of truly ethical behaviour. This has not yet been wholly adopted by many existing platform providers, especially within the lucrative spot FX market which accounts for one third of daily currency trading – approximately USD1.7 trillion^[3].

 Adapting to the Code’s guidelines will involve a step change for some platform providers. For instance, the cost of trading and fee structures are amongst the most opaque areas of trading, with many venue operators coy about their pricing. Often, these fees are privately negotiated as part of a wider package and dependent on volumes traded, purchasing additional connectivity or market data packages. 

This means many platform providers, and the customers that benefit from favourable deals, are disincentivised from revealing this information. Those wishing to comply with the Code’s guidelines may have to change their strategy to provide a more transparent view of pricing. 

Similarly, the ability to buy faster market data to gain a competitive advantage is causing immense harm to the overall market. With many providers charging tens of thousands of pounds per month for market data products, purchasing low-latency data packages is only an option for those with the deepest pockets. An institution that is unable to buy the same data package is immediately at a disadvantage; this affects its ability to execute economically, leaving it open to being pipped by institutions that use their data and speed to engage in disruptive latency-based trading strategies. 

Such trading strategies are only successful if it is possible to determine the time taken to submit an order to execute a trade. Introducing a non-deterministic matching methodology, such as a randomised pause, counteracts this issue and only appeals to strategies that promote genuine trading behaviour, supporting the Code’s ethos. 

It is clear that under the Code, some institutions will also need to amend their post-trade practices. The lack of post-trade transparency is a prominent feature on many platforms, and allows firms that engage in nefarious trading strategies to thrive, as they benefit from anonymity.

 

Instilling a sustainable framework for the spot FX market

The Code outlines an effective framework that, amongst other things, promotes responsible and ethical trading behaviour. These key values now need to be hardwired into the spot FX market.

The six leading principles encapsulated by the Code – ethics, governance, execution, information sharing, risk management and compliance, and confirmation and settlement processes – all aim to place a renewed a focus on fairness, equality and transparency. These are the same values that were embraced by some of the world’s largest trading institutions when they came together to develop ParFX in 2013.

ParFX is underpinned by four key pillars: eradicating disruptive trading behaviour through a matching methodology that applies a meaningful randomised pause; a transparent post-trade environment where all counterparties – banks and non-banks – can be identified; distributing market data in parallel at no extra cost, which removes the ability to buy an advantage; and a flat and clear fee structure, which ensures all participants receive equal treatment and do not benefit from volume discounts or special deals.

Combined, these features nullify the speed advantages of low-latency systems, ensures market participants cannot predict the timing of orders or game the platform. In short, it encourages a fairer and more efficient trading environment.

The features that ParFX has put in place are largely due to its governance structure. The platform was created by a group of leading FX trading institutions, which continue to play an active role in our governance and strategy. This ensures the platform stays true to its guiding principles and operates in the best interests of the overall market. 

The benefits of our strategy are apparent; when analysing publicly-reported trading volumes reported by our peers, ParFX is one of the fastest growing platforms on the street. This success proves that participants are keen to embrace a market of genuine interest and liquidity where firms can operate in a fair, equal and transparent trading environment.                                                              

We welcome the unveiling of the final Code and hope others follow ParFX in adhering to its principles. It closely aligns with our core ethics and values, with guidelines that strengthen the integrity and effectiveness of the foreign exchange market. It is a great step towards not only instilling renewed confidence in the market, but also creating an ecology where participants work together to solve industry issues. 

Roger Rutherford is Chief Operating Officer at ParFX.

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Related ParFX Team Members: Roger Rutherford