The RBA’s assistant governor Guy Debelle together with Paul Fisher, Bank of England deputy head of the Prudential Regulation Authority, co-chaired an inquiry into the way benchmark rates are set for foreign exchange transactions.
It’s the latest battle field by regulators as they try to stop banks and other market participants from manipulating these important global fixes after the high profile Libor scandal and multi-billion dollar settlements which have resulted.
It questions the way client orders, both corporate and fund manager related, are handled by market makers in the lead up to important benchmark pricing like the globally important 4pm London “fix”.
This “fix” sets the price which fund managers and corporates will buy or sell large volumes of currencies to the market maker at a fixed, or set, price for the volume.
But Debelle and his cohort believe the fix is being manipulated by the market makers in their favour and through the Financial Services Board Foreign Exchange Benchmarks Group (FXBG) have made 15 recommendations to change the way prices for the fix are derived.
But while the AFR reports this morning that, “Dealers hedge by executing forex transactions in and around the calculation window and take pricing risks on behalf of clients before the final market price is known. This paves the way for dealers to “front run” clients, a possibility some prominent global asset managers were apparently blissfully unaware of,” this is not as straight forward as that assertion suggests.
Yes the market maker takes price risk on behalf of the client but that same price maker also takes a significant price risk him or herself given they promise to buy or sell large volumes of a specific currency pair, sometimes more than a billion dollars, at a fixed point price the client could not get if they managed the position themselves or rang in for a price at 4pm.
As far back as 1999 when wandering around London dealing rooms I marvelled at the way funds managers handed this risk away for someone else to manage. Surely the market maker needs to get paid for taking this risk?
For example if the price maker is a point out, just 0.0001, on his position on a $1 billion Aussie dollar position that is a hit to the bottom line of $100,000.
So while Debelle and his colleagues are right to ensure a fair market they should also be looking at what is a fair price for a fund manager or corporate client – who more often than not get paid to manage their own risk – to pay to transfer their risk to the market maker.
To this end the FXBG says that it is particularly inviting feedback on the following points:
- The width of the calculation window;
- The need for alternative benchmark calculations (such as a volume weighted or time weighted benchmark price calculated over longer time period);
- The centring and exact timing of the fixing window;
- Views on the development of a global/central utility for order-matching to facilitate fixing orders from market participants; and
- The establishment and enforcement of internal systems and controls to address potential conflicts of interest arising from managing customer order flow.
It’s not easy but its also not just a one way street.