RegTech Intelligence 
JWG analysis.
Mark Carney recently declared the ‘age of irresponsibility’ within the fixed income, currency and commodities (FICC) markets to be over. Just over a year ago, the UK Government introduced the Fair and Effective Markets Review (FEMR) in response to the FX and LIBOR scandals. The large scale misconduct and collusion had damaged public trust and weakened the effectiveness of the fixed income, currency and commodities (FICC) markets. The review, conducted by the Bank of England, the Financial Conduct Authority (FCA) and HM Treasury, sets out its findings and recommendations on how to repair these markets.
Failures of the FICC markets
The exposure of further instances of misconduct has undermined the attempts to draw a line under the LIBOR and FX scandals and, as a result, public trust in FICC markets has continued to diminish. The review attributes the failures within FICC markets to a lack of firm governance, controls and acceptable standards of market practice, alongside a culture of immunity which has contributed to a process of ‘ethical drift’, resulting in huge fines, reputational damage, diversion of management resources and the reining in of productive risk taking.
Substantial progress has been made in addressing these deficiencies in recent years, and many RegTech readers will be aware of the major enforcement actions that have already been carried out – such as the Market Abuse and European Market Infrastructure Regulations (MAR and EMIR) and the new Markets in Financial Instruments Directive and Regulation (MiFID/R II) in Europe and the Dodd-Frank Act in the US.
In addition, changes specifically to improve the FICC markets are also under way. The design and regulation of key FICC benchmarks have been overhauled with the aim of addressing poor market structures. In an attempt to assign accountability, from 2016, senior managers of banks and insurers will be held directly responsible for failures within their remit. Finally, firms have already initiated conduct training and the renewal of control structures.
FEMR’s recommendations
Having taken into account all of the above reforms, the FEMR has identified some areas of concern. In particular, the review has highlighted a lack of an effective structure for agreeing and establishing common standards of practice, as well as gaps within the regulatory framework in the FICC markets.
To address these issues, the final report has put forward a set of 21 recommendations under six key principles. We have noted that many of these recommendations overlap with EU policy initiatives currently in development (the EU Benchmark Regulation, the Market Abuse Regulation and MiFID II).
Principle 1 – Raise standards, professionalism and accountability of individuals
The report recommends establishing of a set of consistent global trading practices in FICC markets. The review also discusses increasing accountability by extending UK criminal sanctions for market abuse for individuals and firms to cover a wider range of FICC-related instruments. Furthermore, FEMR have suggested increasing the maximum imprisonment sentence for market abuse from seven to ten years.
Principle 2 – Improve the quality, clarity and market-wide understanding of FICC trading practices
A key recommendation from the FEMR suggests establishing a FICC Market Standards Board (FMSB), made up of senior representatives from a cross-section of global and domestic firms and end-users.
Principle 3 – Strengthen regulation of FICC markets in the UK
In order to crack down on market abuse within spot FX markets, the review has recommended the creation of a new statutory civil and criminal regime. Note that, under the Senior Managers and Certification Regimes (which come into effect on 7 March 2016 for banks and other PRA regulated firms), individuals will be personally liable for any breach of a Conduct Rule. Further to this, the FEMR suggests increasing understanding of both firms and traders into how competition law applies to the FICC markets.
Principle 4 – Launch international action to raise standards in global FICC markets
Another key recommendation discusses the creation of a single global FX code, including principles for conduct, standards for venues and tools for promoting adherence. The review goes into great detail on how to improve the controls and transparency around FX market practices, including internalisation, last-look and time-stamping. Additionally, benchmark administrators should publish more consistent self-assessments against the IOSCO Principles and provide guidance for benchmark users.
Principle 5 – Promoting fairer FICC market structure while enhancing effectiveness
The report recommends improving transparency within the FICC markets but stresses that the benefits of diversity should not be limited. In addition, market-led reform through monitoring and taking action to prevent anti-competitive structures and behaviour should be encouraged.
Principle 6 – Forward-looking conduct risk identification and mitigation
FEMR has suggested the adoption of more forward looking supervision of FICC markets. Furthermore, enhancing the surveillance of trading patterns and behaviours by firms and authorities would allow conduct risks to be identified more quickly.
Key proposals from the FEMR
From the above recommendations, the most ground-breaking proposal is the creation of the FICC Markets Standards Board (FMSB). The functions of this new body would include:
- Reporting emerging risks and highlighting where market standards can be strengthened
- Reducing uncertainty of specific trading practices by setting guidelines, producing case studies and other materials
- Promoting adherence to standards by sharing good practices on control and governance structures
- Contributing to international convergence of standards.
The establishment of a new statutory market abuse regime for spot FX activity was also suggested and would consist of:
- Civil and criminal market abuse sanctions
- The establishment of a single global code of practice for spot FX activity.
Finally, the recommendations also suggested extending individual accountability with particular reference to:
- Extending the Senior Managers and Certification Regime to more FICC firms
- Broadening the criminal sanctions for market abuse.
Implementing the FEMR
The review continues in line with the general trend of recent regulations, focusing on individual accountability, and has made it clear that we can expect a greater degree of enforcement across the FICC markets.
In light of the ever-growing number of regulations and controls, it is possible that adding another body, the new FMSB, into the mix could over-complicate the regulatory framework. Following this, questions – such as what the legal and regulatory status of the FMSB’s guidance will be – have risen. It will also be interesting to see exactly how the new FMSB interacts with the FCA and ESMA. It is likely that a more holistic approach towards the regulation of FICC markets would have been better suited.
Where exactly these recommendations will lead to remains unknown. However, you won’t have to play the waiting game for too long as more will be revealed later this year in the Open Forum event at the Bank of England. A full implementation update will be provided to the Chancellor of the Exchequer and the Governor of the Bank of England by June 2016 and, of course, stay tuned for more RegTech coverage of all of these issues as we head into Q3.