3 Forex Trends to Address in 2018
2017 was an eventful year for the foreign exchange (Forex) markets. The $5.1 trillion-dollar industry experienced high-volume trading activity as global economic policy and market forces, interest rate hikes and national elections impacted currency volatility.
For traders, it created growth that made 2017 a profitable year. For their institutions, it came with an increase in Forex surveillance and more indictments for fraud and scrutiny around pricing practices called “look backs.” In 2017 alone, banks as large as Deutsche Bank and Wells Fargo incurred settlement fees of over $2.5 billion and $100 million respectively to resolve charges of FX market rigging.
Major FX Developments in 2017:
May: FX Global Code of Conduct is issued by the Bank for International Settlements
June: FX “Cartel” surrenders; agrees to market rigging charges
September: DB AB pays $190 million to settle FX rigging; CS decides not to settle
October: Mark Johnson, HSBC head trader, convicted of fraud by the US DOJ
November: Stuart Scott, HSBC head trader, requested by the DOJ to be extradited; Wells Fargo fraud allegations in retail and customer Forex transactions are revealed, the bank is further restricted by the US Fed
Forex is an attractive business for banks as it is the most liquid market and remains among the most profitable, based on the market size and volume of trading done but it comes with challenges. The current environment of ongoing indictments and perceived fraud is reducing market confidence and driving participants to new platforms and trading environments that provide price transparency and improved customer experience. Foreign exchange is ripe for disruption and sits in a pivotal place in its future growth. There will always be a need for the exchange of currencies however, the “business as usual” approach is no longer viable.
The role of the “Look Back” took on added significance last year when it became apparent how misunderstood it was within the Forex industry and by those who follow it. This method ensures that the house is protected and that margins are maintained for the trades by allowing traders to revise the agreed upon price if the market moves against them. The tactic became more visible when Mark Johnson, head trader from HSBC, went to trial last fall in the U.S. and was convicted of fraud.
Its widespread use was further elevated when the Bank for International Settlement (BIS) issued the FX Global Code of Conduct. The industry is only now under pressure to remove the practice and adopt the Code. The tactic also came under attack in and around the investigations into alleged Wells Fargo’s fraudulent practices, and continued to be a theme throughout the summer and late fall. The conviction of Mark Johnson and subsequent investigations into Deutsche Bank and Credit Suisse and their “look back” practices will likely impact its ongoing use in 2018.
As the market attracts more corporate customers and regional banks, as well as non-bank financial institutions, the nature of price transparency will also change in 2018. In particular, the non-bank financial institutions are investing in new technology solutions that are incorporating AI and NLP to enhance the speed and transparency access to multiple liquidity providers. As new FX platforms have brought greater visibility into the cost associated with each trade, these solutions highlight the for change.
The traditional market makers has been caught in the crosshairs of this push for greater transparency. The large market making broker dealers are looking more like “toll collectors” than providers of access, price and speed. This perception will continue to erode their market position and the migration towards non-bank market makers and other LPs will increase throughout 2018.
Technology and “Algos”
The Forex marketplace has seen an acceleration in the move to electronic and algorithmic trading, like the rest of the fixed income markets. Electronic trading increases speed and accuracy and supports pricing arrangements. Today’s platforms allow for full price transparency and show all embedded costs. Real-time transparency impacts the FX marketplace in a positive way and ensures greater confidence in its structure – an overdue and welcome enhancement. As the marketplace moves to become more transparent, faster and “flatter,” technology’s benefits will continue to reveal themselves. Banks will see that technology not only provides a flexible trading infrastructure, but it also ensures that small players have similar access to pricing as the large players, creating greater competition for all.
2018 and Beyond
This year, market participants will see broader implementation of the FX Global Conduct and with it, a growing need for a cultural audit as described by the FX Global Code of Conduct, for all major market-making banks. The old ways of opacity and front running will become more and more difficult to maintain. As additional technology companies enter the surveillance business, unstructured data analysis will be make it easier to root out wrong-doing. The firms that were investigated and paid fines to major regulators can’t afford to maintain the status quo. To instill greater confidence by the regulators, market makers and the new entrants will need to provide greater price transparency to show how trades are quoted and executed. MiFID II hasn’t yet incorporated Forex in its scope, but when it does, the players will need to act quickly to maintain their market position while adhering to these rules. The US and European regulators also have their eyes on the foreign exchange market and while the current administration has diluted some of the major regulatory bodies and rules, Forex continues to be scrutinized because of its market practices.
Given the importance of transparency, firms will need a short-and long-term plan to:
- Develop a “culture” audit and adopt a “code of conduct” that is communicated in the organization
- Analyze their technology and whether it provides adequate transparency
- End the “look back” tactic before global regulators impose more restrictive practices
In a vibrant and liquid market where disruption is a constant, the regulatory landscape yet to be fully defined and innovation across technology providers pushes the market to commit to a new path forward. Those that don’t will put themselves at risk. Worse yet, they will also diminish the integrity of the FX market.
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