EU authorities are mulling bringing spot foreign exchange trading under the market abuse regime, in what would be a major change for the world’s largest market. By Justin Pugsley.

What is happening?

In what could turn out to be a splendid example of ‘scope creep’, the European Securities and Markets Authority (ESMA) is asking in a consultation whether the largely unregulated spot foreign exchange (FX) market should come under the scope of Market Abuse Regulation (MAR) in the EU. This matters a great deal for what is the world’s largest market, and one that is heavily decentralised, totally global and where deals are largely done on a bilateral basis.

Reg rage anxiety

To make matters more complex, imposing MAR on spot FX would probably also impact non-EU jurisdictions, such as the US. Bringing this market under MAR’s scope would require a major overhaul of how spot currency transactions are monitored and reported on, and require lots of new IT plumbing. It would also massively increase the workload for regulators.

With so many transactions to sift through, detecting market manipulation would be a major challenge, given the market’s decentralised nature.

Why is it happening?

Under article 38 of MAR, the European Commission has to carry out periodic reviews of the regulation and present a report to the European Parliament and the European Council on how it is performing and advise if any changes need to be made. To assist it in this task, the European Commission asked ESMA to give its views and in turn the authority is asking market stakeholders for their feedback.

Of course, the consultation does not just cover FX, and mainly concentrates on a host of technical issues, from how to conduct market soundings through to definitions of inside information. However, the proposal for MAR to cover spot FX probably arises from the various market-rigging scandals that emerged after the 2007 to 2009 global financial crisis, involving the London Interbank Offered Rate and certain spot FX benchmarks.

What do bankers say?

Predictably, bankers are not pleased at the prospect of having to implement yet another piece of regulation. And given the nature of the spot FX market, this would be difficult. It would also disproportionately hit the UK, which hosts the world’s largest FX trading hub.

MAR is very much designed to complement the second Markets in Financial Instruments Directive (MiFID II), which focuses mainly on instruments traded on trading venues. Meanwhile, industry sources point out that there are already many measures to regulate behaviour in the spot FX market. For instance, there is the FX Global Code of Conduct; though voluntary, every major bank has signed up to it.

There is an indirect connection with MiFID II, which covers exchange-traded FX derivatives. And specifically to the UK, there is the Senior Managers and Certification Regime and the Financial Conduct Authority also specifies conduct expectations for UK-located FX market participants. 

In other words, the leeway for getting away with shenanigans in this market has become significantly narrower since the global financial crisis. Interested parties have until November 29 to send feedback, which will help inform ESMA’s report to the European Commission due in early 2020. It will be up to bankers to make a strong case, backed by evidence and data, to see off the MAR threat.

Will it provide the incentives?

In fairness to ESMA, it does not seem completely convinced that the spot FX market needs MAR, and it has clearly spelt out the challenges. This idea may have come from the European Commission. Besides, it is hard to see any urgent need to roll out MAR to the FX market as applying it would be challenging.

At the very least, the relatively new FX Global Code – which banks are taking seriously and is supported by all the major central banks – should be given more time to bed in, as it is tailored to the characteristics of the FX market. In 2020, the Global Foreign Exchange Committee will review the code’s performance and is proposing to do so every three years.

If it turns out that the code is doing its job, then why add yet more conduct rules to the spot FX market? Overall, it seems to be one of the less problem-prone markets. However, as some industry sources warn, the fact that the proposal is out there at all means EU policy-makers have been thinking about it and therefore there is a chance that there is some intention to pursue such a course of action.

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