The $2tn-a-day spot foreign-exchange market could be put under regulatory control for the first time, under proposals being weighed by the EU markets watchdog.
The forex-rigging scandal five years ago, which saw $12bn in fines levied on global banks, was a good reason to bring spot FX within the EU’s Market Abuse Regime, or MAR, the European Securities and Markets Authority said on Thursday as it launched a consultation that will last until late November.
Esma is also weighing whether to widen the regime in the wake of the cum-ex scandal, described as the worst tax scam in German history. Esma is considering whether markets regulators across the bloc should have the ability to sanction financial institutions if they pose “a threat to the integrity of the financial markets as a whole” rather than just committing explicit market abuse.
“Including spot FX would have substantial consequences, especially in relation to monitoring of such markets,” said Jake Green, a partner at Ashurst, the law firm. “This would be a material regulatory development and also leads the way towards spot FX being treated as a regulated product in other areas.”
The task would be complex, and Esma itself also mounted several arguments against the proposition, with the diverse mix of participants and the number of transactions presenting hurdles. National regulators would have to build systems to receive and monitor data on all currency transactions and conduct market surveillance on insider dealing and market abuse. This would create “significant costs” for national regulators, “given the sheer number of orders and transactions generated in the spot FX market,” Esma said.
“Esma seems to be hedging its bets somewhat,” said Rob Moulton, a partner at law firm Latham & Watkins. “There will be considerable industry pressure not to expand market abuse rules into this area.”
While spot commodities are already caught by MAR, which came into effect in 2016, spot FX — the most basic end of the market — is not. In part that reflects a key complication: currencies cannot be traded in isolation — the Turkish lira is traded against the US dollar in London, for example — so it is unclear where regulatory responsibility would reside. Fines were levied on banks over the rigging probes because of lax controls rather than specific breaches of rules.
Historically there has been confusion as to how any regime would work for this market. Rather than having a centralised exchange, currency traders can agree deals on numerous trading venues or privately between themselves, depending on a number of factors such as the counterparty’s credit worthiness and the overall relationship between the two parties.
“It can be questioned who could be considered as the ‘issuer’ for spot FX contracts, which parameters should be taken into account to identify and publish ‘inside information’ or which should be the entities exempted from the requirements of MAR,” Esma said.
As a result, the regulator said it would tweak “some of the key concepts” of the rules to accommodate market structure quirks, if the asset class were brought into scope.
There are also industry concerns with what any rule change might mean to a voluntary code of conduct, set up in 2017 in the wake of the forex-rigging scandal, if Esma does move ahead.
The global code has proved popular with banks and brokers and Esma said that a “significant proportion of the market” has signed up. It has also received the backing of the European Central Bank and the US Federal Reserve, which insisted that principles would be more suitable for currencies markets than hard rules.
Esma said it could be better to wait for the results of a review of the code, due next year, before changing MAR.
James Kemp, managing director of the global FX division at industry body the GFMA, said: “Given how well established the global FX code now is, current discussions are around whether taking FX spot into MAR would be additive, duplicative or how it might happen in practice.”
In Thursday’s consultation, Esma also weighed whether markets regulators, which tend to concentrate on pure market abuse, should be able to fine banks and other financial institutions for tax scams such as the cum-ex scandal, whereby financial groups and their clients allegedly exploited a design flaw in the tax code to trick authorities into refunding dividend tax that had never actually been paid.
Two British former stockbrokers went on trial in Bonn last month accused of defrauding German taxpayers of €440m in lost tax, and face up to 10 years in jail.