Fintech Insights

FX Spot Trading Regulation Will Call for Special Surveillance

Magdalena Glowacka | Business solutions consultant, FIS

May 08, 2020

Even in the middle of a global health crisis, you need to keep a close watch on regulatory developments. And it’s still looking likely that the European Securities and Markets Authority (ESMA) will apply its market abuse regulations to the foreign exchange (FX) market.

But monitoring FX transactions is far from straightforward and could present major challenges for compliance operations. So, when it comes to surveillance, what’s so special about FX – and is there an equally unique solution?

An asset class with a difference

As the biggest financial market in the world, where trillions of dollars change hands every day, the FX market certainly operates differently from any other.

Unlike most asset classes, FX is always traded in pairs, as one currency is exchanged for another in almost every combination. With trades taking place 24/7, 365 days a year, prices change rapidly around the clock.

So, to guide their prices, FX market participants use reference rates that are captured over a precise minute in time. The most popular is the WMR 4:00 p.m. Spot Fix – an average spot rate for each currency pair, calculated five days a week between 3:59:30 and 4:00:30 p.m. London time.

Market abuse opportunities

With an enormous influence on millions of transactions a day, benchmarks like the WMR Spot Fix have proved ripe for manipulation. As well as rushing through orders in the one-minute window, traders have been found to share confidential information on deals that have driven prices up or down.

As a result, in 2014, regulators fined five major banks a total of $1.7 billion – the highest penalties ever imposed in the history of financial regulation. Then, in the comprehensive remediation program that followed, they aimed to address the root causes of the scandal and better control the banks’ activities.

This was just the first step on the road to regulating the wholesale FX market. In 2016, the Bank of International Settlement (BIS) began drawing up global code of conduct guidelines. And now, ESMA is considering bringing spot FX transactions into the scope of the Market Abuse Regulation (MAR) and MiFID II.

The FX surveillance challenge

In the volatile economic climate of 2020, it will be even easier to hide FX manipulation practices under the guise of unpredictable prices and less strictly monitored home-working environments. In the longer term, as we’ve seen, tighter regulations are surely on their way.

For an instrument that’s traded so heavily – around 30 times more than equities – you need market abuse surveillance technology that can handle not only high volumes but also the many idiosyncrasies of the FX market.

Notably, most surveillance solutions use market data to detect market abuse. But with so many FX trades happening over the counter, data-driven models don’t work for the world’s largest asset class as they do for others. Instead, for rigorous FX market abuse surveillance, you’ll depend on advanced algorithms and highly specific rules.

As a surveillance solution that works across all asset classes, FIS’ Protegent Market Abuse is designed to meet these requirements head-on. With the capacity to process millions of transactions a day, it applies robust rules to proactively identify FX compliance risks while both providing and using market data to detect and deter rouge trading in other financial markets.

Most critically, we’ve developed the solution’s rules framework to cover the BIS’ latest code of conduct guidelines for the FX market. That means it can closely monitor market-specific activities like pre-hedging and last-look quoting, which FX traders apply in their own unique ways.

Prepare for the inevitable – and keep up with the pack

Whatever the impact of the COVID-19 pandemic, don’t expect ESMA to back down from its regulatory plans for FX. It’s business as usual in the world of compliance – and the need for market surveillance remains critical.

As many financial institutions now recognize, FX monitoring will soon become part of that requirement: not a specialist, “good to have” capability but a mandated obligation. With a market abuse surveillance solution that can accommodate the unique nature of FX transactions, along with all other asset classes, you’ll stay one step ahead of the regulators and keep up with competitors, too.