Looks like we are creeping toward full overhaul of spot FX in Europe

01/19/2021

2:46 pm UTC, Andrew Saks

Should we take heed of the alarmist nature of ESMA's view that the 'disturbance' of the FX market is a major reason for the FX Global Code to be brought in to crack down on spot FX? It is time to fight back against this draconian nonsense and to stand your ground.

As if there hasn't been enough bureaucracy, legal wrangling and wing-clipping over the past few years in major regions which are synonymous with FX brokerages.

It has become increasingly clear that the authorities in Europe, North America and Australasia, continents in which the vast majority of the world's retail FX brokerages are based and from which the majority of electronic OTC derivatives business is conducted, are continuing to demonstrate a very negative perspective, and drive ever toughening conditions onto the regulatory remit.

The advent of MiFID II in 2017 which led to its 2018 implementation may well now be long forgotten, so rapid is the development cycle in the electronic trading business, however it presented a considerable number of challenges to brokers, liquidity providers and vendors not only within the European Union, but also with those wishing to sell their products within the region.

We have witnessed Australia's crackdown on the CFD sector, which is one of Australia's largest retail electronic trading business sectors, succumb to over-reaching restrictions which have echoed Europe and the United Kingdom's draconian stance.

During interaction with Australian FX industry leaders over the past two years and certainly since the implementation of MiFID II in Europe, FinanceFeeds has been able to glean from opinion among senior executives that ASIC may potentially follow suit in terms of restructuring the means by which OTC trades are executed, reported and sold to retail customers, many of whom considered that leverage restrictions would be part of that remit.

Indeed, the speculation was correct and today ASIC has released a very detailed proposal in which the regulator demonstrates its clear intention to restrict the methods by which OTC CFDs are sold.

Currently, spot FX is not covered under the proposals, as ASIC has made its stance clear that, as far as regulatory research is concerned, its officials believe that a very high percentage of retail clients have been closed out of positions by their CFD provider automatically at low margin levels.

This differs tremendously from the MiFID II leverage and trade reporting stipulations in Europe, however the outcome is likely to be very similar in that leverage will be curtailed.

There is more than this on the horizon, however, this time the elephant in the room being the potential use of the FX Global Code (FXGC) to impose further strangulation on the FX industry.

In September 2020, the European Commission approached the FX industry with a proposal to extend the FX Global Code.

Despite strong opposition from market participants, the European Commission is continuing to look into regulating spot FX, taking its cue from the work of the Global Foreign Exchange Committee (GFXC). In its final recommendations to the EC on the Market Abuse Regulation (MAR) review report, published on September 23, the European Securities and Markets Authority said further analysis of spot FX regulation was warranted, but it should take into consideration the GFXC's review, which is very conservative to say the least.

As could be expected, a large majority of respondents expressed a preference against the extension of the scope, only a few respondents were in favour, and a third group of respondents recommended to evaluate the extension at a later point in time, once further experience with respect to the FX Global Code of Conduct ('the Code') has been gathered.

The arguments provided against the extension of MAR to spot FX contracts include a viewpoint that the breadth of the Spot FX market may lead to unintended consequences, including consequences to the "real economy", as well as that FX transactions are in many situations merely a consequence of another financial or business transactions (e.g. purchase of a good, payments, etc.).

Therefore, the disturbance of this market could potentially affect other areas of the economy and not only the banking and financial industry. Consequently, due to the wide breadth of the spot FX market and its global nature, the impact for market participants and the structure of EU FX market will be significant.

The constantly discussed fragmentation of a global market was also expressed as a reason not to go down this route, in that the inclusion of spot FX under MAR would break the global harmonization of the regulation of the FX global market with 56% of transactions carried out on a cross-border basis, incentivizing firms to relocate their spot FX trading activities to other non EU jurisdictions and creating the conditions for regulatory arbitrage.

The inclusion of Spot FX would likely extend the onerous licensing regime designed primarily for "true" financial service providers to a wider range of market participants active in the spot FX market, including the development of additional exemptions for certain transactions as well as extend the transaction reporting regime which requires the adjustment of the 65 fields currently required besides the need to collect personal data and the need to extend and adapt the identification system of financial instruments defined by the ISIN and provided by ANNA-DSB, would extend the pre- and post-trade transparency regime and the definition of the ToTV concept and extend the set of rules related to organizational and operational
requirements for the organization and operation of trading venues.

A moot point is that it would also include identification on how to provide best execution in such a global market, something which bureaucrats involved in the operation of MiFID II are considering scrapping, and which has caused tremendous arguments within the electronic trading industry.

A large number of A number of industry participants have warned about undertaking unilateral EU initiatives in this global market where the FX Global Code of Conduct is in the process of being adopted by most of the industry and currently under review.

However, it is worth noting that these respondents also acknowledged that the FX Global Code itself does not impose legal or regulatory obligations on market participants, nor substitutes regulation. The Code is intended to supplement any and all local laws and there is a relationship between spot FX and the FX derivatives with spot FX contracts as underlier.

Within the FX industry, a general consensus is that any regulatory oversight of spot FX contracts from a market abuse perspective should take place after the settlement phase, as occurs with the current EU oversight of FX derivatives. This request is due to the fast-paced nature and short tenor of the spot FX market.

ESMA undertook a fact-finding exercise to determine whether there were national pieces of legislation under which market abuse in spot FX markets could be enforced.

The outcome of that fact-finding exercise is that currently, only the national legislative framework of the United Kingdom enables the relevant authority to act against misconduct of authorized firms in their regulated activities and their 'ancillary activities' carried out 'in connection with' or 'held out for the purposes of' regulated activities, like can be the case for spot FX activities.

Other than that, the responses only indicate that in certain jurisdictions entities not registered under MiFID II willing to operate in the spot FX market have to register with the national bank for anti-money laundering purposes.

Unfortunately, there are compelling reasons that have been put forward by the European Commission for including Spot FX in the FX Global Code.

Australia, the country from within which the FX Global Code originates, has been a major study point for the European Commission when it comes to considering including Spot FX in the Global Code.

If the design of the market laws means essentially that the same provisions apply to spot FX as to other products, the differences in product and market become apparent in the practical application of the laws.

In this context, since 2014 ASIC has undertaken investigations into the conduct of certain Australian financial institutions in the spot FX market, both within Australia and overseas. Their focus has been on the institutions' compliance with their obligations under Australian law, particularly as AFS licensees.

In progressing their investigations, they worked with other regulatory agencies both domestically and internationally. Furthermore, they examined large amounts of material, including trading data, phone recordings, emails and chat messages, as well as policies and training and performance documents.

They conducted voluntary Interviews and compulsory examinations of numerous individuals, including spot FX traders, spot FX salespersons, and individuals with a supervisory role, up to senior management level, in Australia and overseas.

ESMA's position on all of this is that there might be a regulatory gap in the area of spot FX contracts, due to the absence of a regulatory coverage in the EU with respect of misconducts carried out in these markets, together with the fact that the FX Global Code, by its own nature, is not enforceable.

As if the spot FX industry needs even more of this nit-picking and bullying by government juggernauts that simply do not understand our industry properly and are clearly being lobbied by the large exchanges that cannot compete with spot FX brokerages and want all of the retail business back on exchange.

It is an absolute nonsense to go down this route in established markets such as Europe and Australia, whilst the entire world ignores the offshore unregulated business.

It has already become clear that some FX brokers with large retail client bases in regions not palatable to regulators have gone offshore, thus creating an adverse effect in that regulators are making it attractive for some brokers to close their regulated offices and go offshore and offer all kinds of trading terms and leverage and of course provide no recourse to customers if something goes awry.

This surely is the antithesis of regulation.

The European Union is a socialist juggernaut. Its anti-capital markets direction is odious and must be lobbied against.

In Britain, the spread betting and CFD companies attempted a lobby against the FCA when it attempted to clip the wings of the retail sector a few years ago. At that time, it was clear among FX industry professionals that this was an 'old school tie' brigade attempt by exchanges to bring regulatory havoc on the retail OTC derivatives industry.

What other reason could there be to have a go at companies that have been established for over 30, sometimes 40 years that have amassed a loyal client base with clean copybooks?

It is time to fight back against this utter bureaucracy and stand our ground.