FX Market participants beware of Market Abuse Regulation (MAR) in effect July 3rd 2016
Have you ever heard or read this? “FEMR highlights that MAR does not cover: (i) spot FX; and (ii) instruments which trade exclusively OTC” Wait for the May 2017 release of the BIS Global Code of Conduct for the Foreign exchange market, to implement further measurements on FX Spot trading.
“MAR will also affect financial instruments which are traded over-the-counter (OTC) and which can have an effect on the price or value of financial instruments subject to MAR.”
FX Spot and Forward trading, have a market share of 51% of the entire Foreign Exchange volume, resulting in USD 2’700 Bio of daily volume.
If something is not right here, I would suggest that it might very well have an impact on other financial instruments. Therefore, in my opinion, FX SPOT should be treated as a related part of MAR by the Buy and Sell Side. Controlls and procedures should be considered accordingly.
“FX Market – Is not regulated”. This is correct, but participants in the FX Market are regulated. If we look back to the “FX-Scandal” and the reasoning for the fines, it is rather clear that the FX Spot Market might not be regulated as such, but gets touched by various regulations, laws, business conducts and national codes. This becomes apparent when reading the reasoning for the fines:
- Swiss Financial Market Supervisory Authority-FINMA in the ruling against UBS: “The bank did not have adequate control instruments in place to identify violations of market conduct rules, manipulative conduct or breaches of the bank’s duty to act in the interest of its clients.”
- The United States Department of Justice against five Major Banks: “Today’s historic resolutions are the latest in our ongoing efforts to investigate and prosecute financial crimes, and they serve as a stark reminder that this Department of Justice intends to vigorously prosecute all those who tilt the economic system in their favor; who subvert our marketplaces; and who enrich themselves at the expense of American consumers,”.
Nothing about violations of any particular FX Market Regulations. Further investigations into “Competition Laws” are still conducted by the Swiss Competition Commission (WEKO) and the European Commission. (equivalent to DoJ’s Antitrust Division)
As a reminder, by making an FX trade, you are likely tied to laws, regulations, etc. of up to three Jurisdictions.e.g.,many EURUSD = Europe and USA & location of your institution.
Back to where we started. MAR – Market Abuse Regulation. Under the assumption that Benchmark manipulation and Front Running got already addressed, we want to focus on parts of MAR, that should get addressed by participants in the FX Market.
- Market manipulation – Attempted market abuse (trades and orders). Spoofing, Flashing, Layering, pump to dump much more.
- Market Surveillance –Depending on the frequency and volume of orders and transactions, should an automated system solution be considered necessary. Monitoring needs to be carried out on an ongoing basis and fully documented.
- Insider Trading –Inside information is information that, if it were made public, would be likely to have a significant effect on the price of financial instruments.
These are just very few highlights, which can get your FX Operation into the next gigantic “trouble zone,” should they be ignored. Further, CSMAR comes with a directive on Criminal Sanctions for Insider Dealing and Market Manipulation. This means: Individuals will go to jail (CSMAR) and Regulators may impose fines up to EUR 5 million on an individual (MAR).
Below you find a few fictive stories, highlighting how close these new regulations can be to your FX Operation.
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London – Big FX Bank, a large provider of FX Spot liquidity, has many Retail Aggregators connected to their API feed. Usual trade sizes from this segment are somewhere between USD 10K and 500K. One of these Retail Aggregators, SUPERFX in London, sometimes has large tickets in AUD/USD. Whenever those big tickets get traded, the market starts to move into the traded direction quite quickly. Most of the times 70 to 100 pips in a matter of an hour. Sometimes even more. Then, SUPERFX squares up the trade and the markets calm down and retraces. Exactly this pattern keeps repeating. Smart traders and quants at Big FXBank, realize this pattern and immediately square these larger tickets in the market and then position the book accordingly. ****JD, an execution trader at one of the largest Pension Fund in the universe, gets his print-out and discovers that he needs to buy a very, very large amount of AUD/USD and it is already 3 PM. He picks up his Apple S6, opens the App of SUPERFX and buys 15 Mio AUD/USD for his account. SUPERFX gives him 150:1 leverage, therefore the balance of USD 105’000 on his trading account was sufficient. He now calls his banks and starts buying clips of AUD/USD 300 Mio. The first clip, he bought already 25 pips higher than his SUPERFX trade. He continues one deal after the other. Now it is already 4.45PM, and he has the last clip of 300 left to do. First, he gets a coffee. On the way to the coffee machine, he opens his App again and sells 15 Mio AUD/USD. His account balance shows USD 225’000.00 now. Back with his coffee on his desk, he calls the last trade in and calculates the average for his huge order.
London – Big FXBank, a large provider of FX Spot liquidity, has many Retail Aggregators connected to their API feed. Usual trade sizes from this segment are somewhere between USD 10K to 500K. One of these Retail Aggregators, SUPERFX in London, seems to have large tickets to do, short before data releases in the UK and Canada. In the 15 minutes before these important data releases, SUPERFX is very active with an unusual amount of tickets and rather large tickets, ranging between 3 Mio and 5 Mio. Whenever this occurs, the data comes as a surprise to the market and in the direction that SUPERFX just traded minutes ago. Seconds and minutes after the release, SUPERFX takes profit on his trades and goes back to sending tickets in the regular size of USD 10K to 500K. Exactly this pattern keeps repeating. Smart traders and quants at Big FXBank, realize this pattern and immediately square these larger tickets in the market and then position the book accordingly. **** JD, a career criminal, somewhere in the Eastern part of Europe gets a phone call. Picks up and all he hears is a number. He hangs up, hits his speed dial, repeats the number in a hurry and hangs up the phone. In a matter of 2 minutes, he called ten different numbers, repeated the number and hung up.
JD, the head of all trading at Bank X in Frankfurt, calls for a meeting. He invites his heads of equity, futures, commodity and FI trading to a workshop with the Compliance Department. Topic: MAR (Market Abuse Regulation). CD, the head of Compliance prepared 15 powerpoint slides, highlighting the changes of the new regime and points out the changes made to some systems. He also hands out new rules of conduct, for equity, futures, commodity, FI traders, addressing MAR. ****UC, the trader at the FX Spot desk, just got given 10 Mio USD/CHF by a Corporate client. The market is very quiet, and EBS shows 0.9615/0.9618. UC inputs an iceberg order to sell 10 Mio USD/CHF at 0.96165, showing 2 Mio. Nothing happens. 15/16.5 no trading. UC hangs over the keypad and inputs a 15 bid for 50 Mio USD/CHF. Hits enter and a second later cancel. Does this a few times and every time he does it, he loses 2 Mio at 16.5. UC is pleased and proud of how we got paid out of his USD’s.