As we approach Halloween market abuse has come back to haunt the FX market. Our Advent Blog last year covered the ESMA Consultation Paper on the provisions of the Market Abuse Regulation (MAR) and highlighted the fact that spot FX is not covered by MAR. If spot FX was to be brought fully into MAR it would need to be reclassified as a “Financial Instrument” for MiFID II purposes. Alongside squeezing spot FX into the definition of insider trading under MAR, it would also raise the challenge of transaction reporting in capturing, reporting and analysing the data that would be required.
At the end of last month, ESMA published their final report which will now go to the European Commission from which legislative proposals to amend MAR will derive. Within the EU MAR has direct effect in national law. The report contains a host of responses to the consultation and I had the privilege to work on the ACI FMA response who cooperated with the GFXD (AFME) to establish common ground and ACI FMA and others publicly supported the GFXD response.
In the report the various responses were summarised and it was acknowledged that the breadth of the spot FX market could lead to unintended consequences if spot FX was shoehorned into existing regulation. It was also noted that these consequences could affect the “real economy” and due to the global nature of the FX market the impact for the structure of the EU FX market would be significant for the market itself as well as its participants. It was also acknowledged that the extension of MiFID II reporting requirements may not be cost effective and that analysis of the data would be extremely challenging and would give an incomplete market picture that would be of limited benefit to regulators.
Certain legal problems would also be encountered such as who would be the “issuer” in a spot FX transaction and what would, therefore, constitute inside information. Given that we already have a wider review of MiFID II/R underway it is suggested we should await the outcome of that review before considering changes to MAR. Furthermore MiFID II is designed for “true” financial service providers and if spot FX was to be included it would need to be extended to a much wider range of market participants who are active in spot FX. Most participants felt that it would be better to wait for the FX Global Code (FXGC) to bed down which is designed to cover all participants globally. Like MiFID II/R the FXGC is undergoing a review currently and the outcome of that review should be awaited before any changes to MAR including spot FX are considered. It is also noted that a lot of spot FX is conducted by non-authorised firms and the solution would need the MAR regulatory perimeter to be applied to the activity undertaken rather than the MiFID perimeter or the regulatory permissions held under regional supervision.
The report also identifies that the FXGC is voluntary and does not have legal weight in most jurisdictions. It also highlights some areas were the FXGC does not have precise coverage of certain aspects such as insider dealing but is more based on higher level principles such as the obligation of firms to operate in an ethical and professional manner to promote the fairness and efficiency of FX markets. In the world’s largest FX market, the UK FCA has officially recognised the GFXC and brought it in under both the general principles and the SMCR and so has sufficient sanctions available regarding Market Abuse in the spot FX market. The report also highlights the spot FX market in Australia which codifies market abuse in law through the Corporations Act 2001. This covers market manipulation and insider trading.
One has to hope that the EC will delay any changes to MAR until the reviews of the GFXC and MiFID II/R have been completed. The main areas that need clarification can then be looked at in the round namely, pre-trade hedging, insider dealing, front running and other forms of market abuse. To put this to bed may require the GFXC to include specific principles for these areas in the same way as its predecessor the ACI Model Code did. It is also to be hoped that more jurisdictions will formally recognise the FXGC and enshrine it into regulation. As I have been quoted as saying previously “the best way forward is stronger commitment to industry codes of conduct and a more robust approach from authorities to criminal wrongdoing. This is an industry that should remain self-regulating."
ESMA concludes in the report that there might be a regulatory gap with regard to misconducts in the spot FX market together with the fact that the FXGC, by its own nature, is not enforceable. Though it notes that the UK does enable the FCA to act against misconduct in spot FX. They further note that given the strong Central Bank involvement in the FXGC they “should be ensured in the definition of such regulatory regime for spot FX markets in the EU”. With possibly one eye on Brexit this section of the report concludes – “Last but not least, considering the global nature of this market, global coordination with the other main jurisdictions in developing such regulatory framework should be ensured.”
To my mind, financial regulation of the spot FX market itself is a difficult, if not impossible, undertaking unless it is global in nature and would need to apply to all market participants. This has been why we have had the Model Code, and similar internal codes, for many years and since replaced these with the FXGC. This does not mean we cannot have regulatory backing to the code as is the case with the UK and if this can be further backed up with criminal sanctions that apply to all individuals engaged in the market we can, hopefully, avoid detailed rules that have many undesirable and unintended consequences. As I have remarked before “principles that must be followed are much more effective in the long run than detailed rulebooks.”