FX Market Supervision And Surveillance


By Rupert Walker, Managing Editor, GlobalTrading

The FX market should continue the dialogue that led to its Code of Conduct, identify ways to share data and examine initiatives that promote efficiency.


  • FX Global Code is principles-based rather than rules-based, contrary to the trend across other financial services
  • Prosecutors struggle to win cases against malpractice in the FX markets and often have to rely on inadequate legislation
  • The regional centres of FX trading are shifting
  • Electronic non-bank market makers are proliferating and trading is becoming more relationship-based
  • Private initiatives enhancing transparency and fairness might establish normal practices that be formalised in regulation
  • Regulation can be selective rather than wholesale
  • It is important to maintain a constant dialogue within the industry and promote the issue of regulation as a discussion topic in the media

The world’s financial markets are continuing to adjust to a vast array of new regulations and tighter levels of scrutiny imposed in the wake of the global financial crisis almost a decade ago and amid its disclosures of abusive activities. Legislation, especially in the US and Europe, aims to improve transparency and risk control, reduce market distortions and extreme volatility, and eliminate malpractice and fraud.

Meanwhile, the global FX market has largely avoided rule-based regulatory oversight. However, following several scandals, in May 2017 the Bank for International Settlements (BIS) issued a new code of conduct for foreign-exchange trading.

The 78-page code, developed by a partnership of central banks and market participants from 16 jurisdictions around the world, complemented a version that was released a year earlier. It is not designed to replace local laws, but the 55 principles were compiled through consultation with all the major stakeholders. Central banks have made it clear they expect fairness, discretion and high ethical standards. (1)

In addition to a general exhortation to ethical behaviour and good governance, the standards incorporate principles and processes for trade execution, information sharing, risk management and compliance, and confirmation and settlement.

The Code is expected to apply to all FX market participants, including sell-side and buy-side entities, non-bank liquidity providers, operators of e-trading platforms as well as other entities providing brokerage, execution, and settlement services.

However, its principles are guidelines; they are not legal obligations and there are no explicit punitive consequences for breaching them. Instead, they are “intended to serve as a supplement to any and all local laws, rules, and regulation by identifying global good practices and processes.” (2)

Guy Debelle, deputy governor of the Reserve Bank of Australia, explained at the launch of the Code of the Code on 25 May, that it is principles-based rather than rules-based, because “the more prescriptive the Code is, the easier it is to get around. Rules are easier to arbitrage than principles…If it’s principles-based and less prescriptive then market participants will have to think about whether their actions are consistent with the principles of the Code.” (3)

Arguably however, this embrace of self-regulation and reliance on peer-pressure to encourage good practice is inconsistent with the trend for the strict, detailed regulation and legally accountable measures being imposed on other sectors of the financial industry.

For instance, the Markets in Financial Instruments Directive (MiFID) II, which will be introduced across the European investment services industry in January 2018, is unambiguously rule-based. Moreover, the MiFID II regulations will cover the trade execution of most FX instruments, with the notable exception of spot transactions.

In this context, and against a background of historical and topical malpractice among FX market practitioners, it is debatable whether or not a principles-based code is sufficient, desirable or even feasible.

There is no single regulator of the global FX market. Instead regulation is dispersed among national central banks, and activities at the institutional level are also closely monitored and supervised by government bodies.

Prosecutors have often found it difficult to pursue criminal cases against banks or individual employees for market malpractice.

But, there have been notable successes. An international investigation into currency misdeeds saw seven banks, including Citigroup, Barclays and JPMorgan Chase agree to pay about $10 billion in fines for sharing confidential information about clients. The UK Serious Fraud Office closed down its own investigation into currency rigging in 2016, so the US has been the sole authority to bring individual charges. Three former HSBC employees are awaiting federal trial in Manhattan and, separately, a former London-based currency trader at HSBC is on trial in New York for his alleged role a front-running scheme. (4)

However, it is uncertain if the Code and current regulation will be enough to deter and identify future malpractice.

Furthermore, the nature of the FX market is changing rapidly with the adoption of new technologies and a proliferation of bank and non-bank electronic trading platforms. In addition, reduced risk appetite is affecting trading behaviour, and there is also a shift towards booking FX trades in regional centres such as Hong Kong and Singapore.

In order to assess how the global FX markets could be more tightly and uniformly regulated, an understanding of its current structure and composition and trends in liquidity provision and trading patterns is essential.

The industry should continue the comprehensive dialogue that led to the creation of its May 2017 Code, identify ways to share data and information on both a formal and informal basis, and critically examine private sector initiatives that promote greater market transparency and efficiency.

The BIS Quarterly Review, December 2016, contains a detailed analysis of the composition of the global FX market, and the latest developments. (5)

FX Market Activity
For the first time in 15 years, FX trading volumes contracted between two consecutive BIS Triennial Surveys. Global FX turnover fell to $5.1 trillion per day in April 2016, from $5.4 trillion in April 2013. In particular, spot trading fell to $1.7 trillion per day in April 2016, from $2.0 trillion in 2013. In contrast, trading in most FX derivatives, particularly FX swaps, continued to grow.

The decline in global trade and gross capital flows in past few years partly explains why FX spot activity has fallen. Different monetary policies in major currency areas and the rise of long-term investors in FX markets have also played a significant role.

The volume of trading for hedging and liquidity management rather than for taking currency risk (by leveraged traders and “fast money”) has risen, so spot and FX swaps, have moved in opposite directions. The decline in prime brokerage has been associated with a fall in trading by hedge funds and principal trading firms, with spot market volumes contracting as a consequence.

In addition, while declining in the aggregate, hedge fund and principal trading firm (PTF) activity has been shifting towards Asian financial centres, partly reflecting greater liquidity of Asian currencies and hence inducing co-location to their main trading venues. For instance, FX trading by hedge funds and PTFs in London and New York dropped by 50% and 10%, respectively, but rose by 88% in Hong Kong SAR, more than doubled in Singapore and tripled in Tokyo. Combined, Asian financial centres now account for 4% of trading by hedge funds and PTFs, compared with 1% in 2013.

FX Market Participants
The structure of FX markets may be moving from anonymous trading towards a more relationship-based form of activity. The number of dealer banks willing to warehouse risks has fallen, while non-bank electronic market-makers have gained greater prominence as liquidity providers. Yet, the resilience of voice trading suggests that market participants at times prefer to avoid primary electronic venues due to concerns about price impact and information leakage.

  • Dealer banks have been adjusting their business models to their reduced capacity to warehouse risk and tighter limits on proprietary trading. A few top-tier banks have consolidated their position as liquidity providers, attracting further customer flows, including from other banks. They have also have maintained their position as large flow internalisers ( the process whereby dealers seek to match staggered offsetting client flows on their own books instead of immediately hedging them in the interdealer market) and price-makers. The largest dealer banks include JP Morgan Chase, Citigroup, UBS and Deutsche Bank. By contrast, many other banks are increasingly acting as agents or conduits, sourcing liquidity from the largest dealers and passing it on to their clients. Dealer banks appear to be focused on retaining a relationship-driven market structure, where bilateral over-the-counter (OTC) transactions dominate. Bilateral trading takes place primarily via proprietary single-bank trading platforms operated by the FX dealing banks, or electronic price streams via application programming interface (API) connectivity. Single bank platforms include Citi Velocity, JPMorgan’s Morgan Markets, UBS Neo and Deutsche Bank’s Autobahn.
  • Electronic non-bank market participants have gained prominence as market-makers and liquidity providers due to new technologies. While previously focused on high frequency trading (HFT) strategies, they are becoming some of the largest liquidity providers on primary trading venues and have been making inroads in direct etrading with customers. Non-bank electronic market-makers includes XTX Markets, Virtu Financial, Citadel Securities, GTS and Jump Trading. Their trades are prime-brokered by a dealer bank. They are active on multilateral trading platforms, where they provide prices to banks’ e-trading desks, retail aggregators, hedge funds and institutional clients. Typical daily volume for each firm is estimated to be about $10 billion with the highest concentration in spot trading.
  • Multilateral trading venues, such as EBS and Reuters Matching have suffered a fall in trading volumes due to the emergence of relationship-driven electronic platforms and also because they rely on centralised limit order books (CLOBs) as their primary trading protocol. They have responded by providing alternatives facilities to allow direct e-trading. For example, Thomson Reuters bought FXall, a multibank trading platform based on the request-for-quote (RFQ) trading protocol. Nevertheless, traditional multilateral (or inter-dealer) electronic trading venues continue to be vital to the FX market: they play a major role in price discovery, and they offer crucial backstop when FX market conditions worsen by allowing dealers to hedge their inventory risk anonymously.
  • Multi-dealer electronic communication networks (ECNs), allow customers to trade directly with a range of dealers, using a suite of trading protocols, such as price streams from individual dealers or requests for quotes, and direct (or bilateral) trading between a dealer and a counterparty.
  • High Frequency Trader activity has levelled off as a result of tighter FX market access from the decline in prime brokerage as well as from various measures, such as “speed bumps” to curb HFT activity which were put in place by major FX trading venues beginning in mid-2013.
  • Institutional investors and corporate treasuries have increased their participation, notably for hedging purposes.

FX Market Regulation
The dichotomy between a principles-based and rules-based regime for the global FX markets has been discussed and examined by many experts, and the conclusion was that former is likely to be more effective. Arguably, however, implicit in the message of the FX Global Code is a warning that if market practice comes up short of its recommendations and standards, then the heavy hand of regulation will be administered. The consequences on industry participants would be costly, time-consuming and add a considerable administrative burden.

However, regulation does not need to be wholesale. An alternative is to apply global regulation to particular areas that are susceptible to manipulation and malpractice due to ambiguity (for instance “last look”) or where transparency can be achieved. Private initiatives have an important role too, especially if they meet the demands of customers.

An example, is a consolidated tape. In September 2017, FastMatch, part of Euronext, announced the launch of a consolidated FX Tape for the spot market. It will publish real-time post-trade information collected from market participants in aggregated and delayed fashion to minimize market impact. The idea is that it will serve as a central reference point for spot FX transacted prices helping market participants evaluate best execution performance, and improve post-trade transparency. (6)

Other initiatives are likely to be launched too, and for similar commercial reasons. If they are adopted by market participants at a critical mass, then they are likely to be normalised and hence easier to formalise in regulation.

Therefore, if there is momentum towards regulation of the FX markets, it is important for the discussion to identify the scope of that regulation: whether it should be all-encompassing or selective.

National regulators and market participants should maintain a constant dialogue about the advantages and disadvantages of global regulation, and where and how it can best be applied. The new Code is all-embracing, and it should be possible to identify some of the 55 principles that can be formalised as rules. The implementation of MiFID II across the European investment services industry and its compatibility with other regional jurisdictions can help point to future difficulties as well as opportunities.

The dialogue can be maintained through existing industry bodies such as FIX Trading Community (FICC Committees and Working Groups) globally and any new initiatives that have the purpose of exploring and examining best practice regulation. They should:

  • Help coordinate the agenda by identifying key issues, working with all stake holders
  • Support submission of whitepapers and consultative documents about FX markets regulation in general and specific problem areas of the markets
  • Help coordinate and plan ‘best practice’ implementation strategies
  • Promote discussion of the issues in industry media outlets

This paper is intended to form part of a continuing discussion within the FX industry about market regulation, supervision and surveillance.


  1. Financial Times, 25 May 2017
  2. FX Global Code, May 2017
  3. Guy Debelle, FX Code Press Conference, London, 25 May 2017
  4. Bloomberg, 25 September 2017
  5. “Downsized FX markets: cause and implications”, Michael Moore, Andreas Schrimpf and Vladyslav Sushko, BIS
  6. Mondovisione, 25 September 2017

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