The GFXC chair on the next steps for the FX global code

How did the head of reserve management at the Bank of Mexico become involved with the Global Foreign Exchange Committee and, ultimately, become its first chair from an emerging market?

In addition to being the reserve manager at the central bank for many years, I took over responsibilities for domestic operations, which encompasses the implementation of monetary and exchange rate policies, as well as acting as financial agent for the government. As I took on these additional responsibilities, I was appointed president of the local foreign exchange committee.

In that capacity, I participated in the Global Foreign Exchange Committee (GFXC) meetings. The Bank of Mexico has been actively involved since the creation of the GFXC and has striven to provide a strong voice for emerging markets. We have engaged in the most important discussions since the inception of the FX Global Code, not only by advocating for it, but also by contributing to its development in terms of ethics, governance, and risk management. Because of that, and due to our involvement with the Bank for International Settlements’ Markets Committee, which created the GFXC, there was a request for volunteers if they were interested in becoming the chair. I volunteered and participated in a selection process, which resulted in my appointment as chair of the GFXC, a role previously held by Andréa Maechler from the Swiss National Bank. It was then the turn for Banco de Mexico to chair the GFXC.

What progress has the introduction of the FX Global Code made in allowing market participants to trade FX confidently and effectively at competitive prices that reflect available information and in a manner that conforms to acceptable standards of behaviour using a resilient infrastructure?

To answer this, we need to think back to what happened after the global financial crisis, particularly in relation to the Libor and currency-fixing manipulation scandals. The Bank for International Settlements’ Markets Committee identified the need to promote good practice, which led to the creation of the GFXC. One of the cornerstones of the GFXC was the publication of the Foreign Exchange Global Code in 2017. Since then, more than 1,300 companies and institutions have adhered voluntarily to the code.

One very important aspect is that the code is not being pushed by a regulatory mandate. It’s something largely done by the industry, for the industry. That’s one of its most important achievements. The 55 principles were not written only by central banks; they were written by central banks together with buy-side and sell-side participants as well as the platform providers. The reason the code is so important is because it’s – so to speak– an agreement between all FX market participants. And it provides sound guidance and principles based on the entire process of FX transactions, including governance of institutions, ethics, execution, risk management, compliance and settlement. It is akin to a positive externality, in the sense that if one party adopts the code and others follow suit, many people start to promote good practice. Ultimately, there is a certain degree of peer pressure to adopt the code.

There have been tangible achievements in relation to the adoption of the code. For example, on ‘last look’ practices. This happens when the counterparty offering a price in a trade may have a ‘last look’ to determine if the trade is done or not. If that window is very wide or very open, it might create an opportunity for malpractice in terms of giving the price to the customer. Some platforms have significantly reduced that window since the inception and adoption of the code. Another important aspect of code adherence is that many platforms now only trade with those that adhere to the code.

How important is the code for central banks – both as users in the FX market that need to abide by the code and its implications, and as regulators of financial markets in many jurisdictions?

This is very important. And, as you mentioned, central banks ‘wear different hats.’ We have one hat as the financial authority but also one where we are active buy-side participants in the FX market.

One very important aspect is that the code is not being pushed by a regulatory mandate. It’s something largely done by the industry, for the industry

Gerardo García, Bank of Mexico

As a financial authority, it is crucial for central banks to foster well-functioning markets and promote good practice among market participants. That’s of the essence. And the FX market, the largest market in the world with $7.5 trillion transacted daily, needs to perform its functions well, providing good liquidity conditions and sound practice. I think that’s one of the most important aspects as a financial authority.

For our part, as buy-side reserve managers, for example, we require our counterparties to trade fairly and in a transparent way, and to disclose in what capacity they are trading with us – whether it be as a principal capacity or an agent, what practices are they going to use during the execution of the FX transaction, if they are going to use pre-hedging and their last-look pricing policies. We also want to know their practices when it comes to sharing data related to an FX transaction. It is also important that we, as central banks, signal that we have adhered to the code, as we want to set a standard.

Has the GFXC identified any specific geographic areas or segments of the market where the code needs to be adopted and implemented more rigorously? What can be done to address inconsistent implementation or non-adoption?

Let me start by segments: the sell side and the buy side.

The sell side has adhered significantly to the code. I think it’s in the best interest of liquidity providers, be they banks or platforms, to inform their customers that they comply with the code. It is an important signal that makes customers feel comfortable trading with these counterparties. That being said, the buy side has been somewhat slower in adopting the code. What they often say is that FX is not their primary activity and many of the principles are not necessarily related to their activities. We have done some work trying to convince them of the merits of adherence to the code and in getting transparency from their counterparties. In explaining the merits, we have come up with some new features for the GFXC website, one of which is a proportionality tool. By filling out a very short questionnaire, it shows to buy-side participants – indeed, to all participants – which principles of the code are of particular importance to them. This is the proportionality concept. We have also contributed to the ‘motivation for adherence working group’, which is trying constantly to reach out to all type of market participants. As of late, it has been focusing on the buy side – meaning investment funds, asset managers, hedge funds and corporates – to encourage adherence to the code and explaining all of the benefits they could get from it.

What were the key results of the 2023 code survey, aimed at measuring the effectiveness of the code?

Firstly, it showed there was more awareness of the code. That is important and exactly what we would like to learn. Around 330 institutions responded to the survey. Basically, they said that the code is still fit for purpose – it’s useful, it works and provides a benchmark against which to compare activities vis-à-vis best practice. Only about 30% of the institutions that participated suggested making some changes to the code and those changes are largely in the same areas that the GFXC is currently working on. One was to review the disclosure cover sheets. Another was to further clarify the position of the GFXC in terms of last look and pre-hedging practices. There was also a focus on developments in FX settlement. As you know, the North America settlement cycle for most securities transactions this year shifted away from T+2 to T+1. Is there any change needed in the code to account for this? The answer is ‘no’ with regards to T+1, but there are other aspects of settlement risk that need to be addressed.

Once an institution selects the settlement method, we want participants to consistently use that method and not change it from one day to next, as that could cause operational risks

Gerardo García, Bank of Mexico

What is being proposed to address some of those issues?

It is important to bear in mind the GFXC’s objective is to promote resilient and transparent FX markets, among many other characteristics. When considering resilient FX markets, you must think about managing risk, and one prevalent one is settlement risk. So, we are trying to further mitigate settlement risk by making some changes to our principles.

The GFXC is proposing having some sort of hierarchy of settlement risk methods. The first method is payment versus payment (PvP), which eliminates settlement risk by simultaneously having the payment of one currency that is bought and the one that is sold. If PvP is not a feasible option, then you could do netting. Automated netting would be preferable. And we are saying that gross bilateral settlement is probably not the optimal method. Once an institution selects the settlement method, we want participants to consistently use that method and not change it from one day to next, as that could cause operational risks. Once an institution has chosen the settlement method, it is also recommended that they  use a consistent set of settlement instructions.

Another change associated with settlement risk is not related to the code but to the BIS’s triennial survey – the most comprehensive survey on FX financial markets. But there’s an issue now with the assessment of how much settlement risk there is in the FX market. Previously, the focus was to look at the turnover of the currencies and how that related to settlement risk. But we have found out that turnover probably does not accurately reflect the real volume that is subject to settlement risk. So, we will change some of the questions and the way we gather the data for the survey to have a better assessment of how much settlement risk there is in the market. There are different views on this. In previous surveys, the BIS estimated that around 25–30% of the volume was subject to settlement risk; while other institutions, like CLS for example, say it is not that large and is more like 10%. This survey will help us to have a better assessment of real settlement risk in the market.

The other big area is transparency. We would like more transparency around how FX platforms use FX data. For instance, sometimes clients using electronic platforms do not know their data is being used, and maybe the data is not even anonymised or aggregated. We want more clarity on how electronic platforms and liquidity providers use such data. To be clear, we are not saying you cannot use the data. We are saying if you use it, you have to let your client know whether and how the data is being used. It is about being more transparent.

The other aspect of transparency relates to some specific operations or trades that happen when the customer has an agreement with an institution, which might be a prime broker, a custodian, a hedging provider, and that institution goes to trade in the FX market in a principal capacity.  What should they do, how should they conduct themselves and what information should be available to the client? One of the requirements set out by the Markets Committee for the three-year review is to get a better sense of the role of custodians and prime brokers. Custodians could assume a more important role as counterparties because of the shortened securities settlement cycles. We want to provide clarity on how they are expected to  behave with their clients. There will be three different areas in terms of how one relates to a counterparty: as a principal; as an agent; and as a special execution in which someone delegates the execution to an asset manager, custodian or prime broker and they trade on your behalf in the FX market as a principal. We want to provide clarity on how that relationship should be managed.

PvP FX settlement continues to be pushed by the GFXC as best practice – are there concerns that progress in PvP adoption and innovation is slowing? Is the aim of the review to accelerate this?

I don’t think there is evidence suggesting that PvP or innovation has slowed down. I think innovation probably is helping settlement cycles to get shorter – such as with T+1 securities settlement. This has an impact on the FX market, as there is a need to account now for this shorter settlement cycle and innovation might also help the settlement cycle of FX related to a security to be shorter and faster. There is no lack of innovation. Indeed, people now are even talking about atomic settlement, which I think is still far away. But we need to really study and analyse the implications. But if the settlement cycle gets shorter, even to the extent of atomic settlement, it will be because of innovation and new technology, as has been the case historically.

You mentioned the recommendations for amendments to enhance data transparency and how market participants use the code to ensure platforms are handling transaction data appropriately. Is there anything to add?

The only thing that I would like to say is that we are modifying the disclosure cover sheets precisely to make information readily available to clients on how they will transact with liquidity providers and electronic platforms and what they should expect from them. So, it’s a modification of the disclosure cover sheets.

Some say participants may selectively disclose information based on their interpretation of what constitutes ‘sufficient transparency’, leading to potential market information asymmetries and disadvantages for smaller players or less-informed participants. Do you believe the amendments will improve disclosure practices, particularly around complex order types and algorithms?

While we recognise that there could be some asymmetries, an expected interaction in the FX market would not only involve seeing a disclosure cover sheet and saying, ‘Okay, I’m done.’ If you have a question on the disclosure cover sheet, then you would expect counterparties to engage in a conversation in which they can clarify the way they are interacting with each other. There could be information asymmetries, but those asymmetries need to be mitigated  by the relevant parties.

Do you believe the proposed changes will resolve issues around complex order types and algorithms, or is that not a concern?

I think it will solve many types of orders and types of trading. This is not specific for spot orders or derivatives orders; it is for all types of orders. Code-compliant institutions should take the code into consideration for all of their transactions, even if they are complex.

Some participants caution that an overly rigid framework could hinder widespread adoption of the code. They argue that it might not provide sufficient flexibility to accommodate varying jurisdictional regulatory requirements and promote responsible innovation and efficiency. Is this a fair point, or is it a case that some in the industry would prefer a more principles-based approach because it gives them latitude to interpret the principles as they see best?

The code, from the outset, has been designed to have a principles-based approach, which is the most important concept – it is not regulation, it is not an obligation; it sets out to recommend best practice. And all the industry is involved. We know that there have been disagreements and, at some point in the future, there could be different opinions on how the code is drafted. Nonetheless, the code has reached consensus among 19 different jurisdictions, and, in those jurisdictions, there is a consensus among a very broad set of participants, buy-side, sell-side, platforms, authorities and so on. Saying that the code is too restrictive or prescriptive is not reasonable. The code remains principles-based.

My main message to those out there that believe the code is overly prescriptive is to be engaged. If they truly believe the code can be enhanced, they should reach out to the local FX committee or the GFXC. They had the opportunity to participate in the public consultation process, where all comments were carefully reviewed and considered. Very soon, the working groups that are investigating issues related to settlement risk, and the use of FX data will have a final proposal that will be discussed on December 5 and 6, for approval by the GFXC. This will allow the publication of the new version of the code by year-end.

On the flip side of this, others say definitions of principles can vary and they would like clearer definitions about what constitutes ‘fair and transparent’ or ‘ethical behaviour’ rather than leaving it open to interpretation. Will there be more clarity on some of those terms?

I think the terms ‘fair and transparent’ and ‘good behaviour’ are self-explanatory. As a participant in the FX market, I always expect the highest standard of conduct from my counterparties and I ask them to the same in return. If, for any reason, there is an institution that has a lower ethical standard or quality of behaviour in the FX market than I have, I always have the right to stop trading with them – and that’s precisely what I think has been going on in the market. People are adopting the code, embracing the principles of the code and, in that way, I think we already have a more resilient FX market. But I think we can even get it  to be more resilient.

The FX market has fragmented trading venues (bank platforms, electronic communication networks and interdealer brokers) and unequal access, with banks and hedge funds often get better pricing, liquidity and speed compared to smaller participants. It is also changing rapidly, particularly given the growing use of algorithms. How can the FX code keep up?

The code is a living document. I see what you say about fragmentation and the many diverse set of participants. I don’t think the trend will reverse. If anything, I think the trend will continue and the market will continue to be fragmented. We will have new participants, including more sophisticated ones, and we will still expect them to behave in line with the code. Can there be different pricing for different types of wholesale participants? Certainly, that’s something that might happen. But bear in mind that the FX market is very competitive. So, if you think that a counterparty is not giving you a fair price, you can go to another counterparty. Another important element here is that pricing issues, such as fees and commissions, are not part of the direct remit of the GFXC. The GFXC promotes transparency related to fees and mark-ups that are charged to clients, but does not make a judgement on them.

My main message to those out there that believe the code is overly prescriptive is to be engaged. If they truly believe the code can be enhanced, they should reach out to the local FX committee or the GFXC

Gerardo García, Bank of Mexico

Ultimately, the FX code is voluntary. The inherent danger with voluntary codes is that you get a lot of good actors that stick with the ground rules; but there are always those who don’t play fair that can end up causing problems for everyone else. Do you believe this problem can be tackled, or should the code be developed into formal regulation and enforceable penalties issued for non-compliance?

I don’t think the code will ever move to become a regulation. Regulation is for financial authorities in each specific jurisdiction to decide. If they believe that an institution has conduct itself in a way that has caused a market malfunction, malpractice or even fraud, they will have to  take appropriate action in their local jurisdictions. The code will remain principles-based; and making recommendations and strong arguments about why people should adopt the code. Regulation is for local authorities to enforce.

What are the next priorities for the GFXC?

The immediate priority is to publish the new version of the code by year end. After that, we would like institutions that have adhered to the code to confirm their commitment to the revised code through a signed statement of commitment. And there are  other matters that will become priorities for the GFXC, including, for example, conducting the triennial survey that I mentioned by the BIS in 2025. That survey will be very important, addressing settlement risk, in particular.

There will be some logistical changes within the GFXC, including the chair – it is most likely I will end my term and there will be a new chair in 2025. We will discuss if the code needs to be reviewed every three years, as has been the case hitherto. The code was created in 2017, it was reviewed in 2021, and it has been reviewed again in 2024. There is an expectation that the code will naturally reach some sort of an equilibrium, so it won’t have to be modified as much as in previous years. We are also engaging with many associations, including the International Swaps and Derivatives Association, to understand the nature of the changes to their Isda definitions. We will engage with them to see if we can help in any way. And we will keep promoting the code, particularly within buy-side participants, as I said.