New model army

The foreign exchange industry is rediscovering the might of the c-words, also known as the codes of conduct. Following two years of intense regulatory and public scrutiny plus some hefty fines, the ongoing effort to tighten up standards of behaviour around the globe is in full steam.

Market participants are involved in a multitude of conversations about what should be done to ensure another scandal such as the WM/Reuters benchmark-rigging saga does not repeat itself. In May, the Bank for International Settlements (BIS) took charge of the global effort to agree on a set of common rules in FX, with a draft due in May 2016 and the final code a year later.

The BIS's efforts are being steered by its foreign exchange working group (FXWG), chaired by Guy Debelle, assistant governor of the Reserve Bank of Australia, who is being helped by the Market Participants Group (MPG), led by CLS chief executive David Puth. Work on the new code will build on that of the various regional FX committees and the ‘Global Preamble' agreed earlier this year.

"Two important aspects are: one, it's a single code for the whole industry; and, secondly, it's a global code. It's also intended to cover the whole gamut of the industry. This is not a code of conduct for the sell side. It is there for the sell side, the buy side, the platforms; its breadth is both across the globe and across the whole structure of the industry," says Debelle.

Debelle explains the aim of the new global code of conduct - to replace the half-dozen in place at various financial jurisdictions around the world - is to harmonise the existing codes, identify any gaps and plug them. Another aim is to clarify what is considered to be appropriate behaviour and provide guidance on what is believed to be good practice.

"We very much want the global code to be principle-based rather than too prescriptive in part, because the more prescriptive it becomes the easier it is to get around," explains Debelle, noting the attitude seems to have been if it's not expressly prohibited or expressly encouraged then it must be OK.

The ‘go-for'

When the FX market was still largely voice-driven, new staff on the trading desk, dubbed ‘go-fors', would shadow a trader, which in addition to learning the ropes of the trading floor would be instilled with the discipline of the market and the code of conduct.

"In one of my former roles, everyone in the dealing room was required to sign the ACI code of conduct, which was then given to HR. It wasn't law, but if a new trader wanted a job then they would have to sign the code," says David Clark, chairman of the Wholesale Markets Brokers' Association (WMBA).

"Back then nearly every foreign exchange trader was a member of the local ACI, and if you were a member of the local ACI you agreed to sign up to the ideals of the Model Code," adds David Woolcock, global head of sales and business development at Eurobase, and chair of the ACI Committee for Professionalism.

"Things have moved on since then. With the electronification of the market that process began to break down. University graduates started coming on to the trading floor without really doing some sort of formal training in foreign exchange. The process of education and training, particularly in market practices, disappeared," he continues.

Woolcock says evidence from the Libor cases shows the traders who were interviewed admitted to not knowing front-running was wrong - they were told to do it and so they did. "The Model Code clearly covers front-running. It covers confidentiality and collusion, but people just ignored it. From what I can see there was no process within the banks to satisfy the need for relevant education and training in market ethics and best practice," he says.

‘My word is my bond'

Issues regarding conduct in the largely self-regulated FX sector are certainly not new. At many of its milestones, especially structural and technological ones, concerns have been raised and addressed about what should constitute appropriate behaviour and proper conduct between members of the industry.

The work of the London Foreign Exchange Joint Standing Committee, created under the auspices of the Bank of England in 1973, is especially important in this regard as it formed the earliest efforts to create a code of conduct for FX.

"In 1973, the code of conduct took the form of an open letter to market participants from the chair of the FEC; the existing document being the ‘Stirling Letter'. The committee worked on redrafting this and the ‘O'Brien Letter' (named after the then chair of the FEC) was issued as a replacement in 1975 and amended in 1978," explains the summer 2004 quarterly bulletin of the Bank of England.

The open letters reminded market participants of the dealer's fundamental maxim, ‘My word is my bond', and addressed key issues such as confidentiality, who could trade with whom, as well as more practical issues such as the poaching of staff, unacceptable gifts, and the standardisation of trading language and its meaning.

From these efforts flowed the ACI's first code of conduct in 1975. "At that time, the 40 or so countries that were members of the ACI and didn't have a code of conduct or ethics adopted the ACI code, and for many it has been their code since," explains Clark.

"In 2000, the ACI decided to rebrand to the Model Code that would be more global in nature, so a huge rewrite was undertaken, which was then released and has subsequently been updated," says Woolcock.

While the Model Code of the ACI became globally accepted within the industry, Clark says the financial markets association failed to convince all of the major central banks to adopt it.

"Central bank FX committees around the world have gone down the route of their own codes for particular local reasons," explains Woolcock. Of the major central banks, only the European Central Bank and the Reserve Bank of Australia have adopted the ACI's Model Code.

Banks relied heavily on internal codes of conduct besides the central bank's codes.

"One could conclude, given the allegations flying around, that the [codes of conduct in place in the firms fined] weren't really fit for purpose. They didn't really cover real-life situations," adds Woolcock.

Harmonising and plugging gaps

The reliance on different codes without any associated enforcement or punitive measures has become untenable in the wake of the beating taken by the FX industry as a result of misconduct.

While it is unclear what enforcement powers will be attached to the new global code of conduct or how it will be policed by central banks around the globe, regulators and authorities are sending clear signals that self-regulation without teeth is something of the past.

In October 2014, the UK included FX benchmarks in rules that make any attempt to manipulate the fix a criminal offence. Furthermore, in June this year, the Fair and Effective Markets Review (FEMR) stated spot FX will be subject to new statutory and civil market abuse regimes, built on the global code of conduct being co-ordinated by the BIS.

The FX market has been tainted by a relatively small number of individuals, casting it into the spotlight as never before and creating challenges for both individuals and institutions.

"Unless we address the conduct issues that have surfaced over the past several years, we know we will face further challenges," said CLS's Puth, speaking at an ACI America event held in New York in October.

He said the global code would draw heavily on the work carried out by the ACI and the content of its Model Code.

Debelle says the success of the code is not going to be determined by the absence of poor behaviour, but rather the ability to detect it early. "We can't stop poor behaviour completely, but with training systems in place within firms this should hopefully reduce it," he says. "Identification of poor behaviour is important to the extent that we can provide clarity in terms of what is and what is not appropriate behaviour. It's more about early identification and stopping it before it gets too engrained or goes too far."

"We need to deliver something that is sufficiently strong and provides the right kind of incentives to adhere to the code," Puth said. "If we do something that is too high level, too light and misses the point, I think we will be sent back to our room to go give it another try and to do our homework. I am positive that in partnership with the FXWG, we will develop something that is sufficiently strong to shift market behaviour in the right direction."

He added: "We welcome the banks' input to the development of the code and they will certainly offer a valuable contribution. It will fall within the central banks' remit to develop a meaningful strategy to ensure adherence to the code. I expect this work will be released at the same time we put all the components of our work together."

With former bank trader Tom Hayes receiving a 14-year prison sentence for trying to rig the London interbank offered rate, Puth said the incentives to get common standards in place are higher than they have ever been.

"I think we all recognise the stakes for everyone in this room are extremely high," he concluded. "I believe we have a great opportunity and, more importantly, a great responsibility to get it right this time."

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