Redefining conduct in FX Markets


A speech by Commissioner Cathie Armour at the ACI Redefining Conduct in FX Markets Seminar, Sydney, 14 August 2019


Good evening. Thank you for inviting me to speak.

Let me begin by acknowledging the Traditional Owners’ ongoing connection to and custodianship of the lands on which we meet today, and pay my respects to elders past, present and future.

I am very happy to speak at a seminar about “Redefining conduct in FX Markets.” This of course, is a very relevant topic for ASIC. Spot and other Foreign Exchange derivative contracts are regulated products in Australia, which differs from some other countries. And as a market and conduct regulator, ASIC has been very active in our surveillance and enforcement of conduct in the FX market. The work we have done covers both wholesale FX markets, as well as providers of FX products to retail consumers and investors.

Over the last year, ASIC has changed the way it supervises firms and I think that it is worth re-emphasizing the focus of this new approach at the outset today.

Enhanced supervision

Our new enhanced supervision aims to be more strategic, forward looking and pre-emptive. It is about promoting permanent cultural and behavioural changes in firms individually and across the financial services industry more broadly.

Our goal is to encourage firms to look beyond current known non-compliance and consider instead, the things that create a significant risk of future breaches. We will focus on cultural, organisational and management failings that may lead to conduct problems, breaches of the law and unfair outcomes. This involves understanding and testing the strategies, business models and risk management processes that are operating in the marketplace, as well as conducting benchmarking reviews across sectors of the financial industry. Combining this approach with the use of market analytics, means ASIC will be positioned to detect misconduct early and adjust our regulatory approaches in response to the complexity, innovations and continuous change in firms and markets.

We are applying this enhanced supervision approach to our surveillance and supervision of Fixed Income Currency and Commodities markets.

Let me illustrate this by reference to our work supervising conduct in the wholesale FX market in Australia.

Wholesale FX Market

Court Enforceable Undertakings

As you would be aware, ASIC accepted court enforceable undertakings (CEUs) in 2016 and 2017 from ANZ, CBA, NAB, Westpac and Macquarie in relation to their wholesale FX businesses. Our actions were based on each bank’s failure to ensure that their systems and their controls were adequate to address inappropriate conduct in their FX businesses.

ASIC is working with these banks, and the independent expert firms that have been appointed, to ensure that the banks comply with the CEU and implement the required organisational changes. This has, at times, been a rocky process. We want to see a strong commitment from these banks to improve their systems and controls, sooner rather than later. ASIC will report on some of these improvements in due course.

Recent Supervisory Reviews

Let me turn then to the FX Global Code. ASIC supports the objective of the FX Global Code, which sets good practice guidelines designed to promote the integrity and effective functioning of the global FX market. The Code is not regulation; your conduct remains subject to local laws. Nevertheless, the Code is an essential starting point for firms to follow to improve their practices. As incoming chair of the global committee responsible for maintaining and updating FX Global Code, I’m sure Guy Debelle will have more to say on this.

ASIC has conducted several recent on-site and targeted supervisory reviews where we have assessed wholesale FX market participants against their obligations under the Corporations Act, the ASIC Act, the FX Global Code and our own Report 525, which builds on the Code and promotes better standards of behaviour in spot FX markets.

Mark-up review

The first set of targeted reviews focused on FX Global Code Principle 14: that Mark Up applied to client transactions by market participants acting as Principal should be fair and reasonable.

Targeted surveillance was conducted across 11 banks, who are all FX Global Code signatories. The surveillance looked at the banks’ disclosure of mark-ups, and the mark-ups actually charged across both Forward & Spot FX trades. In March, we wrote to those banks with recommendations in the following areas:

  • first, disclosure of mark-ups charging policies to clients;
  • secondly, surveillance of mark-up charges by the banks;
  • thirdly, mark-up complaints and errors remediation policies; and
  • finally retention of records.

Onsite reviews

Separately, we have undertaken four onsite inspections of banks conducting wholesale FX businesses. This was part of ASIC’s new enhanced supervisory model which I mentioned earlier.

These onsite inspections focused particularly on FX Global Code Principle 9: market participants should handle client orders fairly and transparently; and Principle 11: market participants should only pre-hedge client orders fairly and with transparency.

The inspections were intensive, requiring significant information to be provided to ASIC, followed by a week of onsite activities. While onsite, our reviews included:

  • live time displays of FX sales order management systems;
  • live time displays of FX quoting & trading systems;
  • Presentations covering areas such as organisational structure, client interactions, and compliance functions;
  • An extensive surveillance capability review of trade surveillance alerts, E-Comms surveillance alerts and Audio surveillance alerts.

Across the four banks, there were differing levels of systems and controls in place, and differences in the level of compliance with the FX Global Code. We required a number of changes at those banks where we felt improvements were needed.

In these reviews, the Global FX Code was particularly useful in providing granular and testable requirements for the conduct of FX market participants. We also found some areas where we believe the Code can be strengthened, and we note with interest that a three-year review of the Code by the Global FX Committee is fast approaching.

We found that Principle 11 of the Code on pre-hedging activity appears to be interpreted with some ambiguity particularly, the statement that “Pre-Hedging of a single transaction should be considered within a portfolio of trading activity, which takes into account the overall exposure of the Market Participant.” Banks seem to adopt different approaches with regards to the pre-hedging of client stop loss orders. One option to strengthen the interpretation of this Principle might be additional guidance and worked illustrative examples of good and bad conduct.

Another area we looked at closely as part of these reviews was “Last Look.” Specifically, we examined the trade request rejections statistics, during the calendar year 2018, against all Australian clients, across all four banks. While in general, we found that client trade request rejections were reasonably low, we did notice Hedge Fund or HFT style clients received higher trade request rejection rates than real money clients. The use of Last Look, is an area we will continue to monitor.

Retail OTC derivatives market

Let me now move to focus my remarks on the Retail OTC derivatives sector.

The products offered by retail OTC derivatives issuers in Australia include FX products such as margin foreign exchange as well as binary options and other contracts for difference.

Last year we published results of a review that found high rates of client losses in retail OTC derivatives trades, with the percentage of unprofitable clients being up to 80% for binary options, 72% for CFD traders and 63% for margin FX traders.

We continue to respond to a high incidence of misconduct in the retail OTC derivatives sector and to see large sums of client losses. The complaints we and the Australian Financial Complaints Authority (AFCA) have received from clients has grown significantly over the past year.

In April 2019, we conducted our most extensive review yet of the licensed entities active in retail OTC derivatives. We found that the number of retail clients trading OTC derivatives has doubled in the past two years.

From the information collected, we observe that:

  • Over 60 CFD and binary options issuers are licensed in Australia.
  • Retail OTC derivatives is an active and growing market with an annual turnover of $21 trillion and over 1 million investors, 99 percent of which are retail clients.
  • Of the 675 million transactions in the 2018 calendar year, 426 million of these were in FX products – that’s over 60%. In our previous review, there were 165 million transactions in FX products. So there has been large growth in these FX products, and this growth has been much faster than the growth in the number of other CFD or binary option transactions over the same period.

Despite this high number of FX product transactions, margin FX represents around 32% in terms of net revenue, behind CFDs at 39%.

  • Over 80 percent of OTC retail derivatives clients reside offshore, including in high risk AML countries and countries which have restricted the sale of these products.
  • Licensed issuers hold over $2.9 billion on behalf of clients, an increase of 45% from the previous review.
  • Many margin FX issuers offer leverage of 400:1 and higher. Let me be clear, a leverage ratio of 400:1 provides $2 million exposure on a $5,000 investment. That’s staggering exposure.

We will continue to review the data we’ve gathered and will address the key themes and concerns that arise from the review. Where we see that products or practices in this sector have resulted in, or are likely to result in, significant consumer harm then we will address this harm using the full range of power available to us.

Regulators in many jurisdictions, such as in China, Europe, New Zealand, Israel, Japan and North America have restricted or prohibited the provision to retail investors of certain OTC derivatives. Recently we publicly warned Australian issuers that they may be dealing with offshore investors illegally and to cease any non-compliant activities. There may be consequences overseas for potential breaches of overseas law, but in any event, ASIC will consider whether breaching overseas law is consistent with obligations under Australian law to provide services efficiently, honestly and fairly.

Product Intervention Power

As part of my remarks today I was asked to discuss ASIC’s product intervention powers which we were recently granted by Parliament.

We have just recently closed the consultation period on our administration of this new power – the what, when, how and why of ASIC’s use of the power. We will review all feedback received before we finalise our regulatory guidance.

The product intervention power is an important addition to ASIC’s regulatory toolkit. ASIC can now step in and respond to significant consumer detriment in a targeted and timely way, rather than only after a breach of the law. But there are also important checks and balances – it is a temporary intervention power and we must consult before each and every use. Last month we consulted on our first proposed use of the power to address significant consumer detriment in the short term credit industry.

The product intervention power allows ASIC to take a range of temporary actions including banning a product or product feature, imposing sale restrictions, amending product information or choice architecture. The power can be used on a market-wide basis to address industry-wide problems or in relation to specified persons or products.

A product intervention power is not a new concept. Australia is joining regulators in other jurisdictions like the US, the UK, the EU, Hong Kong and Taiwan with product intervention powers.

Reports of Misconduct

Before I conclude, I want to leave you with a call to action about reporting market misconduct to ASIC.

In recent years, we’ve significantly enhanced our focus on Fixed Income, Commodity and Currency markets. We have hired people with significant industry experience, upskilled our existing teams, and improved our surveillance systems. We want these markets to operate fairly and efficiently and will actively assess reports of problems in the market.

Licensed entities of course, have an obligation to report their own breaches to ASIC. My message here is, make sure you are doing so. We have access to market data from trade reporting and our regulation of market operators – don’t wait to tell us about problems until we are knocking on your door.

But another important tool for us to identify misconduct in markets is through industry intel and Reports of Misconduct made by any market participants. We believe that the number of Reports made to ASIC lags significantly behind the number reported to peer regulators in other jurisdictions. It is in everyone’s interest that financial markets are fair and orderly, and bad actors are called out.

If you are a buy-side participant in the FX market, or indeed in the Interest Rates or Commodities market, and have seen unfair or potentially illegal dealing practices, I encourage you to report them to ASIC – either formally or informally.

Thank you for inviting me to speak today.

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