how fair and effective are the fixed income, foreign

FAIR AND EFFECTIVEMARKETS REVIEW

How fair and effective are the fi xed income, foreign exchange and commodities markets?Consultation documentOctober 2014

Contents

Executive summary 3

1 Introduction 6

1.1 Why the FICC markets matter 6

1.2 Misconduct 7

1.3 Objectives of the Review 8

1.4 Principles guiding the Review’s work 8

Box 1 Common themes in recent FICC misconduct cases 9

1.5 The consultation process 10

2 Key characteristics of the FICC markets 11

2.1 Common features 11

2.2 Specific FICC markets 11

Box 2 The recent evolution of the FICC market making model 13

2.3 Regulation 14

3 What does ‘fair and effective’ mean for the FICC markets? 16

3.1 Fairness and effectiveness for whom? 16

3.2 Defining ‘effective’ 16

3.3 Defining ‘fair’ 17

Box 3 The meaning of caveat emptor 17

3.4 Can there be trade-offs between fairness and effectiveness? 18

4 Evaluating the fairness and effectiveness of FICC markets 19

4.1 The Review’s analytical framework 19

4.2 A high-level summary of Sections 5.1 to 5.6 19

Box 4 The importance of market liquidity in the context of the Review 21

5 Specific issues in FICC markets 23

5.1 Market microstructure 23

Box 5 Barrier and digital options 26

5.2 Competition and market discipline 28

Box 6 Conflicts of interest and information flows 30

5.3 Benchmarks 32

5.4 Standards of market practice 35

Box 7 Reported uncertainties over FICC market practices 36

Box 8 FCA Principles for Businesses 38

Box 9 Codes of Conduct 39

Box 10 The Takeover Panel 40

Box 11 Methods for ensuring compliance with codes 41

5.5 Responsibilities, governance and incentives 43

5.6 Surveillance and penalties 46

6 Questions for feedback 50

Glossary and acronyms 54

Appendix: Further detail on the operation and regulation of FICC markets 58

A Foreign exchange 58

B Fixed income rates 60

C Fixed income credit 61

D Commodities 62

E Market conduct regulation of UK FICC markets 63

Fair and Effective Markets Review October 2014 3

The purpose of this consultation document is to seekrespondents’ views on the fairness and effectiveness of theFixed Income, Currency and Commodities (FICC) markets, andon ways in which, where necessary, that fairness andeffectiveness might be improved.

FICC markets underpin almost every major financialtransaction in the global economy. They help determine theborrowing costs of households, companies and governments,set countries’ exchange rates, influence the cost of food andraw materials, and enable companies to manage financial risksassociated with investment, production and trade. They arevast in size, and support employment for many around theworld, not least in the United Kingdom, where a substantialshare of these markets is based. Further details of thesemarkets, and their economic significance, are set out inSections 1 and 2, and in the Appendix.

Public trust in the FICC markets has nevertheless beenseriously damaged by a series of high-profile abuses involving,among other things, the attempted manipulation ofbenchmarks, alleged misuse of confidential information, themisleading of clients about the nature of assets sold to them,and collusion. Such actions fundamentally undermine theprimary function of markets to provide price signals to thebroader economy and allocate resources effectively — andthey materially increase uncertainty, at a time whentechnological and regulatory developments are driving othersubstantial changes in FICC market structures.

Much has already been done to respond to these abuses, bylegislators, regulators and market participants, and there hasbeen a series of major enforcement actions against firms andindividuals. But with further investigations and private legalchallenges still under way, the purpose of the Fair andEffective Markets Review is to assess whether that change hasyet gone far enough to reinforce confidence — and, where ithas not, to ask what further steps may be needed, by firms andindividuals (who bear the primary responsibility for ensuringappropriate behaviour) or by the authorities.

The Review will publish its independent recommendations inJune 2015. In forming its views, it is seeking input from manydifferent sources, including its own Market Practitioner Panel,academics, international authorities, a wide range of end-usersof FICC markets, market infrastructure providers, and thegeneral public.

This consultation is organised around four key themes:

First, Section 3 sets out the Review’s perspective on what‘fair and effective’ means for FICC markets. FICC marketparticipants are predominantly sophisticated firms — but theoutcomes in those markets have ramifications far beyondthose firms alone, potentially affecting everyone in theeconomy. With that in mind, the Review proposes to define‘effective’ FICC markets as those which: enable marketparticipants to trade at competitive prices; and allow theultimate end-users to undertake investment, funding, risktransfer and other transactions in a predictable fashion,underpinned by robust infrastructure. The Review proposes todefine ‘fair’ markets as those which: have clear andconsistently applied standards of market practice;demonstrate sufficient transparency and open access (eitherdirectly or through an open, competitive and well-regulatedsystem of intermediation); allow market participants tocompete on the basis of merit; and provide confidence thatparticipants will behave with integrity.

Second, the Review is seeking respondents’ views on areaswhere the fairness and effectiveness of FICC markets maycurrently be deficient. In its initial conversations, the Reviewhas heard a wide range of different perspectives on theunderlying factors that may have caused, or facilitated, recentabuses. Some of the drivers put forward relate to structuralfeatures of FICC markets. These include: the greater ease ofmanipulation in markets for bespoke products that are rarelytraded; conflicts of interests; limited transparency; poorbenchmark design; market concentration; and a reduction inthe effectiveness of market discipline. Others bear moredirectly on conduct, and include: poor or misunderstoodstandards of market practice; weak cultures of accountability,poor controls and inappropriate remuneration structureswithin firms; poor personal ethics; the limited regulatoryperimeter; poor benchmark governance and transparency;and limited surveillance or penalties for wrongdoing fromfirms or regulators in the pre-crisis period. The Review alsoheard concerns from market participants about the potentialresilience of liquidity in post-crisis FICC markets.

The Review is keen to know where respondents believe themost important deficiencies lie, to help inform theidentification of potential solutions. To give structure to thatassessment, the Review uses the framework set out in Table Ashown at the end of this summary. This framework focuses onthe six potential sources of vulnerability that are considered

Executive summary

4 Fair and Effective Markets Review October 2014

most critical. Three of these are structural: marketmicrostructure; competition and market discipline; andbenchmarks. And three relate to conduct: standards ofmarket practice; responsibilities, governance and incentives;and surveillance and penalties. Section 4 describes thisframework in more detail, and provides a high leveloverview of the remaining sections of the document.

Third, the Review is seeking views on the extent to which theregulatory, organisational and technological changes thathave taken place since the financial crisis are likely toaddress perceived deficiencies in fairness and effectiveness.Where they do, the Review has no desire to duplicate existingefforts. Relevant regulatory initiatives include: post-crisisreform to prudential and conduct regulation in theEuropean Union, United States and elsewhere; reforms in thedesign and regulation of benchmarks; prospective revisions toglobal foreign exchange codes; and a more proactiveapproach by conduct regulators to supervision andenforcement. Industry-led and technological changes includethe new Banking Standards Review Council, widespread effortsto improve firms’ internal controls systems, and the increasingmigration of FICC business to more transparent tradingplatforms. These issues are considered in further depth inSections 5.1 to 5.6.

Finally, the Review is seeking views on further steps thatmight be needed to help boost fairness and effectiveness inparticular FICC markets. Using the same six-part framework,Sections 5.1 to 5.6 identify a wide variety of possible steps:

• To improve market structures, the Review is seekingrespondents’ views on actions including: industry-ledstandardisation of more FICC assets; initiatives led by the

market or public authorities to improve transparency, forexample, through greater use of electronic platforms;enhancements to market-driven competition; industry-ledimprovements to benchmark design; and steps toencourage greater compliance of benchmarks withinternational standards.

• To improve conduct, the Review is seeking respondents’views on actions including: developing a global code (orcodes) of conduct for FICC markets, written by the marketin terms that market participants understand; bringingtrading in certain FICC markets more fully into the scope ofregulation; further steps to strengthen the translation offirm-level standards into more effective control andincentive structures; stronger tools for ensuring that firms’hiring and promotion decisions take due account of conduct;greater use of electronic surveillance tools by firms; andstronger penalties for staff breaching internal guidelines.

Throughout, the Review is conscious that the FICC markets areglobal in scope, and shaped by forces far wider than those inthe United Kingdom alone. In each case, the Review will needto evaluate the extent to which change is: (a) for the industry(which has the capacity to act globally) to implement; (b) forthe UK authorities; or (c) for wider discussion withinternational authorities.

The full list of questions on which the Review is seekingviews is given in Section 6. Responses are sought byFriday 30 January 2015 and should be sent by email [email protected]. Further details on theconsultation process are given in Section 1.5.


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1 Introduction


1.1 Why the FICC markets matter

1 The Fixed Income, Currency and Commodities (FICC)markets lie at the heart of every aspect of the global economy.They are huge in size, and highly diverse. To take just threeexamples, turnover in foreign exchange markets is someUS$5 trillion a day;(1) the global stock of corporate, financialand government bonds is nearly US$100 trillion (Chart 1);and FICC ‘over-the-counter’ (OTC) derivatives amount toaround US$700 trillion in notional terms, or US$18 trillion(2) inmarket value (Chart 2). So it is vital that they work well, andin the best interests of everybody.

2 The challenge is global: FICC instruments are tradedcontinuously in financial centres around the world. But theUnited Kingdom has a particular concern for ensuring theFICC markets are fair and effective, because substantial sharesof these markets are based here. The United Kingdom is thevenue for 70% of trading in international bonds, nearly 50% oftrading in OTC interest rate derivatives and 40% of foreignexchange trading. London is a leading centre for trading inenergy, gold, silver and other precious metals — and majorderivatives exchanges located in the United Kingdom accountfor around a sixth of total global commodities trading. Muchof this business is done by foreign banks based in theUnited Kingdom, which employ around 160,000 people inLondon alone.(3) On one estimate, revenues from FICCbusiness booked in London accounted for perhaps two thirdsof the US$45 billion European total in 2013 (Chart 3),(4) andmade a major contribution towards the United Kingdom’s netforeign earnings from trade in financial services as a whole ofmore than US$70 billion in 2013, over twice that of any othercountry.(5)

(1) BIS Triennial Survey.(2) BIS semiannual survey of OTC derivatives.(3) ‘Key facts about the UK as an international financial centre’, CityUK, June 2014.(4) Oliver Wyman.(5) CityUK, June 2014, op. cit.

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Financial companies’ bondsGovernment bondsEquity

US$ trillions

05 06 07 08 09 10 11 12 13

Source: McKinsey. Values are at end-year, constant 2013 exchange rates, based on a sample of183 countries.

Chart 1 Global financial assets

June2000

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Foreign exchange contracts

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Source: BIS semiannual survey of OTC derivatives.

Chart 2 Gross market value of OTC FICC derivativecontracts

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US$117US$63

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Equities

Investment banking division eg corporate finance

FICC

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Source: Oliver Wyman.

Chart 3 The size and composition of investment bankingrevenues (US$ billions, 2013)


1.2 Misconduct

3 In recent years, major FICC markets have been hit by aseries of actual or alleged acts of misconduct. In fixed income,employees in firms around the world attempted to manipulateLibor, Euribor and other similar measures of short-termborrowing costs in order to benefit themselves or some otherpart of their firm’s business. In the United States andelsewhere, firms structured the mortgages or other assetsused to back securitised assets, or misrepresented the natureof those underlying assets, in ways inconsistent with theinterests of end-investors. Regulators identified systematicattempts to mis-value and otherwise engage in marketmisconduct in relation to large scale positions in credit defaultswaps. And in commodities markets, traders were found tohave sought to manipulate physical or derivative prices,including gold, oil, lead, platinum, palladium and coffee. Box 1on page 9 draws out some common underlying themes fromthese recent cases.

4 In the past, it was sometimes argued that misconduct inFICC and other wholesale markets had limited relevance tothe wider economy because it primarily affected only therelative financial positions of sophisticated firms, which wereseen as being capable of looking after their own interests. Asdiscussed in Section 3, recent events have highlightedlimitations to that view. First, the many linkages betweenFICC markets and the wider economy mean that successfulmanipulation of FICC markets can have large negativeexternalities on a broad swathe of end-users who relyindirectly on those markets. Second, there may be conflicts ofinterest between professional intermediaries and their specificend-investors. And, third, less sophisticated investors may onoccasion seek to access FICC markets directly.

5 The policy response to recent FICC market misconduct hasbeen two-fold. First, the number of large-scale enforcementactions against specific abuses has increased significantly(Chart 4). Authorities in the United States, the UnitedKingdom and the wider European Union have so far leviedfines of some £4 billion for the manipulation of Libor, Euriborand similar indices, and there have been further substantialfines for misconduct relating to securitisations and other FICCinstruments. Taken together with fines and provisions forconduct issues in other markets and banking activities,(1) thatis large enough to require significant recapitalisation andbusiness restructuring by many of the firms involved.Investigations of further cases and criminal actions, in foreignexchange and other markets, remain ongoing.

6 Second, there has been concerted action to reform thedesign and regulation of key FICC benchmarks, themanipulation of which featured in many recent cases. TheUnited Kingdom introduced a new regulatory regime for Liborin 2013 — and the first act of the Fair and Effective Markets

Review was to recommend that this regime be extended toinclude a further set of seven major UK-based benchmarksdrawn from across the FICC markets.(2) Consultation on, andimplementation of, these recommendations is now beingtaken forward by HM Treasury. Further steps to strengthenglobal benchmark standards are also under way, through theFinancial Stability Board (FSB) reports on interest rate andforeign exchange benchmarks,(3) the InternationalOrganization of Securities Commissions (IOSCO) assessmentprocess,(4) and the proposed EU benchmarks Regulation.

7 The continued accumulation of misconduct casesnevertheless suggests that the causes of these abuses liedeeper than deficiencies in benchmarks alone. Recognition ofthat fact has further undermined public confidence in FICCmarkets. Attempts to mislead clients or manipulate prices,sometimes through collusion, prevent markets fromperforming their primary function, and foster distrust of thoseinvolved by wider society. That distrust in turn further impairsthe effective operation of FICC markets, creating uncertaintyamong intermediaries, investors and other end-users, divertingmanagement resources and increasing the compensationrequired for taking risk. Those challenges come at a timewhen FICC markets are also undergoing substantial change forother reasons, including a reduction in leverage by someliquidity providers and a series of other changes in trading andclearing arrangements, driven by reduced risk tolerance andnew regulatory requirements designed to tackle the causes ofthe financial crisis. Reflecting those factors, global FICCrevenues fell by 40% between 2009 and 2013 (Chart 5).

(1) Estimated to be £160 billion between 2009 and 2013 by the Conduct Costs Project atthe CCP Research Foundation.

(2) The Review’s detailed recommendations are available atwww.bankofengland.co.uk/markets/Documents/femraug2014.pdf.

(3) See www.financialstabilityboard.org/publications/r_140722.pdf andwww.financialstabilityboard.org/publications/r_140930.pdf.

(4) See www.iosco.org/library/pubdocs/pdf/IOSCOPD415.pdf.

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Number of fines

Source: Conduct Costs Project at the CCP Research Foundation, fines imposed on a sample often banks by authorities in the United States, the United Kingdom and the wider EuropeanUnion.

Chart 4 FICC related fines


1.3 Objectives of the Review

8 Against that backdrop, the formation of the Fair andEffective Markets Review was announced on 12 June 2014 bythe Chancellor of the Exchequer and the Governor of theBank of England. Chaired by Nemat (Minouche) Shafik(Deputy Governor for Markets and Banking, Bank of England)and co-chaired by Charles Roxburgh (Director General,Financial Services, HM Treasury) and Martin Wheatley(Chief Executive Officer, Financial Conduct Authority), the aimof the Review is to identify ways to reinforce confidence in thefairness and effectiveness of wholesale financial marketactivity conducted in the United Kingdom, and to influencethe international debate on trading practices.(1) The threechairs are supported by a secretariat drawn from the Bank ofEngland, HM Treasury and Financial Conduct Authority and ledby Andrew Hauser, the Bank of England’s Director for MarketsStrategy.

9 In view of the continued accumulation of misconduct cases,the main aim of the Review is to take a much broader look atthe fairness and effectiveness of the FICC markets: identifyingareas of potential deficiency, evaluating the extent to whichthose deficiencies will be addressed by reforms currently underway, and proposing ways to fill any remaining gaps. To informthat work, the Review will draw on the insights of FICC marketparticipants, infrastructure providers and end-users,academics, commentators, international authorities, and thegeneral public. An important role will be played by anindependent Market Practitioner Panel, made up of seniorrepresentatives of internationally-active sell-side and buy-sidefirms, market infrastructure providers, major corporate usersof financial markets and independent members, and chairedby Elizabeth Corley, CEO of Allianz Global Investors. Allexecutive decisions will however be the responsibility of theReview’s leadership team. The Review will make its finalrecommendations in June 2015.

10 The Review is aware that many changes are already underway at a regulatory, market and firm level in response to thefinancial crisis. Where these are likely to improve fairness andeffectiveness in FICC markets, the Review will say so, and willnot seek to duplicate them. Relevant regulatory changesinclude: MiFID 2 and the Market Abuse Regulation (MAR); theG20 provisions for trading, reporting, clearing and marginingderivatives, as implemented in EMIR (and MiFID 2) in Europeand the Dodd-Frank provisions in the United States; theBasel III capital and leverage provisions, as implemented ininternational and national law; and the Banking Reform Actand Senior Managers and Certification Regime in theUnited Kingdom. International foreign exchange committeesare developing a global set of high-level principles onFX trading. And the FCA has launched a new, more pro-active,approach to wholesale market supervision,(2) has continued its‘credible deterrence’ enforcement strategy, and recentlyconsulted on areas of the wholesale markets that mightbenefit from further investigation from a competitionperspective.(3) Market structure changes in FICC, manyinfluenced by regulatory reform, include: greater pricetransparency; a move towards greater use of standardisedexchange-traded and cleared derivatives; the development ofa range of single and multi-dealer electronic platforms; andmore offerings of agency-only services. And there have been anumber of initiatives aimed at improving culture andbehaviour at a firm and individual level, including theUK Parliamentary Commission on Banking Standards, theBanking Standards Review Council,(4) and widespread effortsby individual firms to strengthen internal controls.

1.4 Principles guiding the Review’s work

11 The Review’s work will be guided by three importantprinciples.

12 First, the Review believes that markets are the best sourceof dynamism, prosperity and progress. FICC market function,structure, scope and participation are all evolving rapidly —and interventions should where possible anticipate, and berobust to, those changes. For that reason, it is likely that keyparts of the Review’s final recommendations will consist offirm and market-led initiatives to boost fairness andeffectiveness. In considering ways to shape market structures,the Review will seek to harness market forces, incentives andcompetition. And in considering ways to improve culture andvalues within firms and markets as a whole — a primarydeterminant of individual behaviour — the Review recognisesthat overriding responsibility rests with the leadership offinancial firms themselves. The Review is therefore

(1) The full terms of reference for the Review are available atwww.bankofengland.co.uk/publications/Documents/news/2014/tor120614.pdf.

(2) See www.fca.org.uk/news/evolving-the-fca-approach-to-markets-regulation.(3) See www.fca.org.uk/news/wholesale-sector-competition-review.(4) See www.bankingstandardsreview.org.uk.

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EquitiesInvestment banking division eg corporate financeFICC US$ billions

Source: Oliver Wyman.

Chart 5 Investment banking revenues


Box 1Common themes in recent FICC misconductcases

The Review has analysed all of the published enforcementcases of market abuse and misconduct in UK FICC markets inrecent years, as well as a range of significant internationalcases. Such behaviour is not a new phenomenon. But thebreadth, scale and impact of recent cases involving themanipulation of Libor and other major benchmarks is greaterthan in the past. This box draws out some of the commonthemes associated with those recent cases.

1 Benchmark and other price manipulationBenchmark manipulation: benchmark manipulation has beenthe highest profile of all recent cases of market abuse inFICC markets. The attempted manipulation of Libor, Euriborand other interbank rates has affected every major financialcentre, including London, Singapore, Frankfurt and Tokyo, andresulted in total fines on institutions of some £4 billion, byUS, UK and European regulators. In addition, the FCA recentlyfined one firm £26 million for manipulation of the LondonGold Fix, and another firm £70 million for attempting tomanipulate the BBA Repo Rate benchmark in order toinfluence the fees payable to the Bank of England for liquiditysupport. These cases highlighted the susceptibility of somehistoric fixing processes to manipulation, but they alsoinvolved other forms of misconduct. For example, some casesinvolved inappropriate influence being exerted on Libor settersby their bank’s derivatives traders, who had incentives toattempt to move the fixing in order to profit from contractsreferencing the benchmark.

Manipulation of other market prices: there have been anumber of cases where traders have either placed orders orexecuted transactions in order to push a market to an artificialposition. Such cases often occur in more thinly-tradedmarkets, where traders take advantage of low liquidity tomove a reference level (for example, the closing price) in orderto benefit from another transaction that depends on thatlevel. The low levels of liquidity in certain FICC markets makethem potential targets for these kinds of abuse. Cases likethese are less common in more liquid markets, such as thosefor government debt. But they are not unheard of, particularlyin less regularly-traded securities. A recent enforcementaction by the FCA involved a fine of nearly £700,000 on anindividual for attempted manipulation of the price of such abond in the gilts market.

2 Misuse of informationFront-running and abuse of confidential information:front-running, the practice whereby an individual is trading inpossession of private information with the purpose of takingadvantage of the anticipated price effect of a future order, has

been the subject of a large number of abuse cases in equitiesmarkets. One major investigation by the FCA, whichconcluded in 2013, resulted in a trader being jailed for twoyears for front-running the orders of his own firm. Morerecently, there have been a number of allegations that similarpractices may also have occurred in FICC markets. Moregeneral abuse of confidential client information has also beenat the heart of a number of abuse cases in fixed-incomemarkets, where bond traders have used privileged informationabout new bond issues or corporate re-financing to benefittheir own positions.

Misleading clients: a related but different form of abuse hasbeen the provision of false or misleading information about aproduct by brokers to their clients. One example is the sale ofa product (designed by a broker for one client) to anotherclient, without the broker disclosing how and why the productwas created. However, courts have on occasion rejectedclaims from plaintiffs alleging that a broker-dealer hadresponsibilities towards them, judging they were sufficientlysophisticated to have understood the deal on offer from thebroker.

3 CollusionAn important feature of some recent cases has beenattempted collusion to manipulate market prices. In the Liborand Euribor cases, for example, the European Commissionlevied fines of €1.7 billion against two groups of firms forcolluding. Although most benchmarks had some defenceagainst attempted manipulation by individual firms, few hadexplicit anti-collusion measures — highlighting an importantdesign weakness. A more general lesson of this case is thatwhere a relatively small number of players in a market havethe ability to set a fixing or a reference price from which theyall stand to gain, there is a risk that those players may attemptto collude. The potential implications of this for FICC marketswith elevated concentration levels are discussed in Section 5.2.

4 Artificial restriction of physical supply to drive uppricesAttempts to restrict supply in a market are typical in cases ofabuse in the commodities markets. For example, firms thatcontrol the supply of a commodity in their physical businessmay be able to manipulate that supply in order to profit fromtransactions undertaken by their trading arm. The best-knowncase of this kind involved Enron in 2000–01, where the energyfirm deliberately withheld power supplies in California. Theultimate expression of abuse of this kind is the ‘cornering’ of aparticular market, where an entity acquires such a dominantportion in an individual asset class that it can force thoseseeking that asset to buy from it at inflated prices. Majorattempts to corner the copper and silver markets in the 1980sresulted in the introduction of new rules for the relevantexchanges.


particularly interested in exploring ways in which theauthorities can help to catalyse credible and effectivemarket-led processes, for example, by helping to enhancemarket discipline and innovation, or co-ordinating industryefforts to improve standards, culture and incentives. TheReview’s Market Practitioner Panel will play an important rolein the Review’s work, including by helping to launch and takeforward those parts of the Review’s final recommendationsrequiring active market ownership.

13 However, given the seriousness of recent misconduct,recommendations for targeted interventions by theauthorities must also be a potential part of the Review’stoolkit. The Review’s terms of reference make it clear thatsuch recommendations should have due regard to the impacton the efficiency, competitiveness and growth-generatingpotential of the financial services sector, and on the cost ofregulatory resources. Interventions by the authorities tocreate or influence market structures, for example, have thepotential to bring about profound change, so would requireparticularly careful analysis.

14 The second principle stems from a recognition that theFICC markets are global in scope, and shaped by forces farwider than those in the United Kingdom alone. For thatreason, the Review is conscious that many of itsrecommendations are likely to require global discussion —whether with industry bodies, or with EU and otherinternational authorities (including standard setters, such asthe FSB and IOSCO, and central banks). In the latter case, theReview’s primary role will be to raise issues and proposeoptions for consideration by the wider internationalcommunity. That will require extensive prior outreach tointernational partners — a process that is already under way,and will intensify during the consultation period. Whereappropriate, the Review will also make recommendations forregulatory reforms at a domestic level, subject to theconstraints of the current EU legislative framework.

15 The third principle stems from a recognition that there isno such thing as a single ‘FICC market’. As described inSection 2 and the Appendix, fixed income, currency andcommodities markets differ markedly in their operation,structures and regulation. Within each market, there are alsofurther sub-segments, each with their own characteristics.The Review will take account of those differences in its

analysis, drawing clear distinctions between markets wherechange is not required, and those where further action may beneeded to improve fairness and effectiveness.

1.5 The consultation process

16 Given the broad scope of the Review’s terms of reference,the range of possible issues for consideration by respondents iswide. Nevertheless, for the Review to have lasting impact itsfinal recommendations will need to focus on a small numberof the highest priority actions. To give focus to theconsultation process, without imposing pre-set notions ofwhat those priorities should be, the main body of thisdocument is organised around the six key potential sources ofvulnerability identified in Table A on page 5, and elaboratedon in turn in Sections 5.1 to 5.6. In some of these sections,specific policy options are discussed. In others, the questionsare somewhat broader in scope. The Review is seeking candid,robust and constructive responses across the full range oftopics, including respondents’ sense of where the relativepriorities lie. The full list of consultation questions is drawntogether in Section 6.

17 The Review intends to make all responses to thisconsultation available for public inspection, unless therespondent requests otherwise. Information provided inresponse to this consultation, including personal information,may be subject to publication or release to other parties or todisclosure, in accordance with access to information regimesunder the Freedom of Information Act 2000 or the DataProtection Act 1998, or otherwise as required by law or indischarge of statutory functions. Respondents should indicateif they regard all, or some of, the information they provide asconfidential. If a request for disclosure of this information isreceived, respondents’ indications will be taken into account,but no assurance can be given that confidentiality can bemaintained in all circumstances. An automatic confidentialitydisclaimer generated by a respondent’s IT system on emailswill not, of itself, be treated as constituting notice that suchrespondent regards any information supplied as confidential.

Consultation responses are sought by Friday 30 January 2015 or earlier, and should be sent byemail to [email protected].


2 Key characteristics of the FICCmarkets 1 This section gives a factual account of the operation andregulation of four main areas of FICC — fixed income(subdivided into interest rate and credit markets), foreignexchange and commodity markets — to set the scene for thesubstantive analysis of fairness and effectiveness in theremainder of this document. Further detail on these marketsand their regulation is given in the Appendix.

2.1 Common features

2 Although individual FICC markets differ in many respects,most share three key features, which have importantimplications for the rest of this consultation:

• First, FICC markets tend to be dominated by largeprofessional counterparties, often acting on behalf ofend-users or investors. The professional nature of themarket means that most direct participants can be assumedto be highly knowledgeable about the products they trade,and capable of making educated investment decisions. Theimplications of those decisions however affect a much widerset of end-users, investors and the broader public — an issuereturned to in Section 3.

• Second, a relatively large proportion of FICC assets arebespoke, designed to fit the particular funding or hedgingneeds and maturity profiles of borrowers or investors. By nomeans all FICC assets are of this type: developed economycurrencies and government bonds for example typicallytrade in highly liquid, standardised forms. But, takentogether, FICC assets are unusually heterogeneous(Table B provides examples of FICC assets by market).

• Third, trading in most FICC markets has tended to rely to agreater or lesser extent on intermediaries known as marketmakers, which means that more trading has occurred on a‘principal-to-principal’ basis than, for example, in equitymarkets. The key features of the market maker model, andthe pressures for change that have arisen since the financialcrisis, are discussed in Box 2 on pages 13–14.

2.2 Specific FICC markets

3 The foreign exchange (FX) market has a wide range ofpurposes, including: facilitating businesses’ import or exportof goods and services; corporate and financial hedging orinvestment; and central banks’ implementation ofmacroeconomic policy. Markets in developed countries’

currencies in particular are the most liquid of all FICC markets,with very tight bid-offer spreads. In 2013 the global averagedaily reported FX turnover was US$5.3 trillion per day — morethan half of which was in the form of swaps, forwards andderivatives. Although FX turnover is globally dispersed,London is home to 40%(1) of overall turnover.

4 Foreign exchange markets remain predominantlyphysically settled OTC markets. The need for flexibility onsettlement and tenor for the majority of FX products is citedas remaining a significant barrier to the further developmentof organised exchanges and associated clearing. Neverthelessthe OTC dealers’ business models have become increasinglyelectronic, and many end-users now access the marketthrough the ‘single dealer’ and ‘multi dealer’ platforms thatthese firms offer. However, price variations acrosscounterparties remain, in part because credit spreads andclient-servicing costs are embedded in the prices shown tocustomers. An important recent trend in spot FX markets hasbeen the growth of ‘internalisation’, where banks match offclient orders internally without having to go to theinter-dealer market to hedge their risk. Market participantshave indicated that dealers with large enough market sharenow internalise up to 90% of their client orders in majorcurrency pairs. The increased use of technology andinternalisation by the large dealers has coincided with greaterconcentration in the market. As at April 2014, six firmsaccounted for 61% of overall FX turnover in the UK-basedinterdealer market; the equivalent figures for business withother banks, other financial firms and non-financial firms lay inthe range 64–81%.(2)

5 The fixed income rates market is essential for the economicfunctioning of most countries, by providing financing forgovernments and government related agencies. Takentogether the stock of G7 government debt amounts to overUS$30 trillion.(3) As government debt securities are oftenviewed as having little or no credit risk, they provide a yieldcurve against which other assets can be valued, and serve anumber of other important secondary purposes, includingproviding collateral against short-term loans in the repomarket. The size of the European repo and reverse repomarket in June 2014 was €5.8 trillion.(4) Derivatives also playan important role in the fixed income rates market, principally

(1) BIS Triennial Survey 2013.(2) Bank of England FXJSC Turnover Survey, April 2014.(3) BIS Triennial Survey 2013.(4) ICMA European repo market survey, June 2014.


to switch fixed for floating rate risk between counterparties.The majority of the interest rate derivative market is OTC,reflecting end-users’ needs for specific hedging products. In2013 the total outstanding notional of OTC interest ratederivatives was US$577 trillion,(1) with almost 50% of themarket located in London. A smaller, but still significant,proportion of the interest rate derivatives market consists ofstandardised contracts that trade on exchanges. The totalnotional amount of exchange-traded interest rate derivativeswas US$66 trillion.

6 The secondary market for government bonds continues tooperate on an OTC basis in many countries. In theUnited Kingdom, for example, designated Gilt-edged MarketMakers (GEMMs) are responsible for providing liquidity.Ongoing concentration of the market around benchmarkissues and larger issuance volumes has resulted in greaterliquidity in the secondary market, and average daily turnoverwas £29 billion in 2012–13.(2) An increasing amount ofOTC trading is now facilitated through electronic platforms.

7 The fixed income credit market provides banks andnon-financial companies with access to short-term andlong-term funding. Short-term fixed income credit marketsinclude the issuance of certificates of deposit by banks, andcommercial paper by banks and non-banks with relatively highcredit ratings. The related market for short-term unsecuredinter-bank loans has declined in recent years as concernsabout counterparty credit risk have led to greater reliance onsecured lending. However, the unsecured lending marketcontinues to have wider significance for the fixed incomemarkets as the basis for Libor, the benchmark to which mostinterest rate swaps and many other derivatives refer. Theaverage daily turnover in the sterling unsecured and securedmoney markets as at May 2014 was £45 billion and £90 billionrespectively.(3)

8 Bonds provide long-term finance to financial institutionsand other companies in both developed and emergingmarkets. In most cases, corporate bonds are issued via a‘syndication’, where a group of banks or investment firmsunderwrite a bond issue and act as advisers on the timing,

price and allocation to investors. In addition, securitisations —that is, the transformation of portfolios of credit assets intoinvestment products in the form of asset-backed securities(ABS) — have helped to broaden credit markets. However, thesize of the European securitisation market has declined inrecent years, with US$239 billion of new issuance in 2013.(4)

Credit default swaps (CDS) are also an important part of thecredit markets, and serve a range of purposes includingallowing banks with large credit exposures to mitigate that riskwithout having to cut credit lines or liquidate bond or loanpositions. The size of notional outstanding in the CDS markethas, however, also declined considerably in recent years, fromUS$51 trillion in June 2007 to US$24 trillion(5) by June 2013.

9 A striking feature of the fixed income credit market is itsheterogeneity. Whereas a company will typically only issue asingle class of equity shares, it will often have multipleoutstanding debt securities of different sizes and maturities,some with optional features. In turn, issuance of new debtmay be accompanied by sales of other financial instrumentssuch as derivatives, as borrowers switch the proceeds intocurrency and interest rate profiles more suited to theirultimate funding needs. Secondary market liquidity in mostbond issues (and the associated derivatives) can be limited,and bond investors therefore rely on market makers to providequotes rather than trading through an exchange. Although avariety of electronic platforms show live pricing for corporatebonds, they mostly reflect indicative bids and offers that needto be confirmed with the dealers supplying them beforeexecution can take place. Attempts to develop alternativetrading platforms to provide a central pool of liquidity have sofar failed to achieve critical mass.

10 The commodity markets determine the prices of food andraw materials that are relied upon by producers andconsumers across the globe. The four main sectors of thecommodities markets are energy, agriculture, precious metals,

Table B Examples of FICC asset classes by market

Fixed Income (rates) Fixed Income (credit) Currency Commodities

Cash • Repo • Certificates of deposit • Spot • Physical• Government bonds/SSA • Commercial paper• US mortgage-backed agency debt • Securitisations/asset-backed• Covered bonds securities (CLO, CDO, MBS)• Corporate bonds

Derivatives • Short-term interest rate futures • Single-name CDS • FX forwards • Exchange-tradedand options • CDS Index • FX swaps futures and options

• Bond futures and options • Synthetic CDO • FX options • OTC swaps and forwards• Interest rate swaps (incl. basis swaps) • Credit index futures • Non-deliverable forwards• Cross-currency swaps • FX futures• Interest rate swaptions

(1) BIS Triennial Survey 2013.(2) UK DMO Data.(3) Bank of England MMLG Sterling Money Market Survey 2014 H1.(4) SIFMA and AFME.(5) BIS Triennial Survey 2013.


Box 2The recent evolution of the FICC marketmaking model

In recent decades, many FICC markets have been built arounda ‘market making’ system in which market participants tradebilaterally with an intermediary on an ‘over the counter’ (OTC)basis, rather than multilaterally with each other on anorganised exchange. In cash markets, the market maker buildsup inventories of assets on its own balance sheet when thereare net sales from the market, and runs them down whenthere are net purchases, providing investors with continuoustwo-way prices in return for compensation via a bid/offerspread. In derivatives markets, the market maker performs asimilar function, but warehouses risk positions rather thanasset inventories.

This structure has a number of important advantages. Itallows market participants to trade smoothly in and out ofpositions, if necessary in large size, without excessive pricevolatility, even where the underlying positions may berelatively illiquid or heterogeneous — as they can be incorporate bonds and many other FICC markets — and in arelatively wide range of market conditions. It also givescounterparties certainty over their credit exposure in marketssuch as foreign exchange where there can be extendedexposures related to settlement or other risks. However, tothe extent that the model relies on bilateral price discoveryand execution (historically often by phone), market-widetransparency of pricing may be limited both pre andpost-trade, and pricing may differ across market segments,including so-called ‘dealer to dealer’ and ‘dealer to client’markets.

Standing ready to meet customer demand at committedprices exposes market makers to potentially sizeable losses, ifthey deal with counterparties who have an informationaladvantage, or face sharply moving markets. They thereforeneed to specialise in gathering information about theirmarkets in order to predict the likely path of demand andsupply, and adjust their risk positions accordingly. That meansthat market making has natural increasing returns to scale, inthe sense that a market maker that sees more trades in aparticular market is likely to be able to make more efficientprices. In the pre-crisis period, many firms on the sell-sidesought to enhance these efficiencies in the use of informationand returns to scale further by engaging in horizontalintegration between market making and other FICCbusinesses, including proprietary trading and market making instructured products and derivatives. This increasinglyintegrated approach gave a number of firms substantial scaleand breadth of product offering, increasing the rates ofconcentration in some FICC markets and providing scope for

complex price differentiation between different ‘bundles’ ofproducts and different counterparties.

The market making model, whether combined with horizontalintegration or not, provides a number of key benefits.Investors in gilt and foreign exchange markets, for example,have benefited from near-continuous liquidity at very tightprices in a wide range of market conditions. That deepliquidity has in turn allowed issuers to borrow at very fine andpredictable terms. At the same time, it requires marketmaking firms to have effective controls in place to managetwo key risks. First, the need to take principal risk givesmarket makers an interest in future price movements that canbenefit, but may sometimes also conflict with, the interests oftheir clients. That may be particularly true where a marketmaker accounts for a large share of a particular market, or ispart of a horizontally integrated firm. Second, the informationthat market makers gather about market trends and customerdemand as part of their role is important for them to providecustomers with the best possible service, and avoid significantlosses. But, in the wrong hands, it may also be used tomanipulate thin markets, undertake transactions or otherwisework against customer interests.

None of these risks are new: well-managed market makershave long had controls in place to prevent the abuse ofconflicts of interest, confidential information or market power;and investors have long known to handle information aboutfuture orders carefully. Nor are they unique to market makers:inter-dealer brokers will often have confidential informationabout order flow, even though they cannot take principalpositions. Customers may also have informational advantagesor pricing power, particularly where they are large relative tothe overall market — as has increasingly been the casepost-crisis. The role these factors may or may not have playedin recent cases of market misconduct is discussed in Sections 4and 5.

The traditional market making model is however nowchanging rapidly, reflecting a combination of technologicaland regulatory drivers. First, market makers have becomemore reluctant to commit capital to warehousing risk. Thatreflects a combination of reduced risk tolerance since thefinancial crisis, and the impact of regulation designed toimprove the resilience of the financial system by increasingcapitalisation and reducing the implicit government subsidy.This reduction in market making capacity has further increasedconcentration in some FICC markets. Second, regulation isrequiring more types of FICC business that previously wouldhave traded via market makers to move onto an exchange orother regulated venue (for example, the more liquid types ofderivative). And, third, market makers have been embracingmore electronic forms of trading, including ‘request-for-quote’platforms (which automate processes previously carried out

by phone), and single-dealer or multi-dealer platforms(SDP/MDP), which allow customers to place orders within anautomated system. As discussed further in Section 5.1, such‘electronification’ can bring significant increases intransparency. But it may not always do so: ‘internalisation’for example, widely used in FX spot markets, allows customersto trade across the books of a single firm, with no pricetransparency to the wider market. And exchange-likeplatforms are only well suited to relatively standardisedproducts with a regular flow of buyers and sellers.

These recent developments highlight some of the challengesin improving fairness and effectiveness in FICC markets. Theshift from voice-based market making may increasetransparency and access for more standardised assets, withoutharming liquidity in normal market conditions. But there maybe a more explicit trade-off between the two for morebespoke assets or in unsettled market conditions. For thesereasons, market makers are likely to play a continued, albeitpotentially more specialised role in many FICC markets.


and industrial metals. Each sector has a huge array ofderivatives contracts, with each contract having very specificrequirements concerning the precise nature of the underlyingcommodity, for example the grade or delivery location anddelivery date of a particular commodity. For example,deliverable crude oil streams include UK Brent Blend, US WestTexas Intermediate, Norwegian Oseberg Blend, ColombianCusiana and Nigerian Bonny Light. For a number of keycommodities, there are liquid exchange-traded derivativesmarkets. However, many commodity derivatives are tradedOTC, including the entire London precious metals markets andlarge sections of the energy derivatives market.

11 The commodity derivatives markets are linked tounderlying physical markets which are typically global inscope. Most trading in the physical market is done on anOTC basis and, in many cases, there are few published dataon such transactions. As a consequence, market participantswho also have physical businesses often have an informationadvantage over those who only participate in the derivativemarkets. A recent trend across many commodity marketshas been the transfer of market share in commodities tradingfrom the major investment banks to vertically integratedcommodity firms, combining both a physical business and atrading arm.

2.3 Regulation

12 Historically most FICC markets were not covered bymarket conduct regulation, reflecting the perception thatprofessional counterparties could take care of themselves.Most provisions governing market conduct in theUnited Kingdom related to markets organised as exchanges,and therefore focused predominantly on the equity markets,together with a few exchange-traded FICC instruments such as interest rate futures. By contrast, OTC FICC marketswere covered by a range of codes — some of which continueto play a role (notably in the United Kingdom the Non-Investment Products or ‘NIPs’ Code,(1) which coversforeign exchange and certain physically settled commodityderivative markets).

13 Over time, regulation has replaced codes in some areas ofthe FICC markets. The four main parts of the regulatoryframework governing market conduct in the United Kingdomare: the FCA Principles for Businesses; the EU’s Markets inFinancial Instruments Directive (MiFID); the EU’s MarketAbuse Directive (MAD); and the EU’s Regulation on WholesaleEnergy Markets Integrity and Transparency (REMIT). TheFCA’s Principles for Businesses apply to all authorisedindividuals and firms, and are a fundamental part of theregulatory framework which all firms must adhere to, evenwhere detailed rules do not apply.

14 MiFID requires the authorisation of investment firms andsets out rules determining how such firms must behave whendealing with clients, calibrating requirements according to thenature of the client and the activities that firms undertake.For participants in wholesale markets, there are two classes ofclient: professionals and eligible counterparties (ECPs). Whilea range of protections exist for business done withprofessional clients, transactions with ECPs are mostly exemptfrom the obligations. MiFID also sets out rules governing theoperation of exchanges and other trading venues. MAD andREMIT set out rules on market misconduct covering insiderdealing and market manipulation. These rules aresupplemented in the United Kingdom by the FCA’s Code ofMarket Conduct and separate criminal offences forinsider dealing and market manipulation (under the CriminalJustice Act 1993 and Financial Services Act 2012, respectively).

15 Earlier this year, both MAD and MiFID were replaced bynew pieces of European legislation which will apply from July2016 and January 2017, respectively. The revised Markets inFinancial Instruments Directive and new Markets in FinancialInstruments Regulation, known as MiFID 2, will widenregulatory coverage of the FICC markets. MiFID will nowcover shares, fixed income securities and derivatives, allcommodity derivatives traded on authorised venues, and mostcurrency derivatives.(2) However, spot FX and, depending on

(1) www.bankofengland.co.uk/markets/Documents/forex/fxjsc/nipscode1111.pdf.(2) A full list of financial instruments covered by MiFID can be found in Appendix I

Section C of the Directive: http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014L0065&from=EN.

http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014L0065&from=EN

http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014L0065&from=EN

www.bankofengland.co.uk/markets/Documents/forex/fxjsc/nipscode1111.pdf


context and purpose, some forward contracts in foreignexchange and physical commodities, are not specificallycovered. Pre and post-trade transparency requirements will beextended to cover firms and venues in all bond and derivativemarkets, and the creation of a new regulated venue, the‘Organised Trading Facility’, will mean that much FICCbusiness that was traditionally classified as over the counterwill now be subject to the rules covering venues. Whereappropriate, standardised and liquid OTC derivatives will alsobe required to be traded on regulated venues, as part of theEU’s implementation of the G20 derivatives commitments.(1)

16 The changes to MiFID will therefore not only extendregulatory cover, but also have a profound impact on thestructure of many areas of the FICC markets. The G20commitments will see large sections of the derivatives marketmoved onto organised venues for the first time, and the newtransparency measures are expected to have a significantimpact on the functioning of secondary bond markets. Thenew Market Abuse Regulation (MAR) will also greatly extendthe coverage of market abuse provisions in FICC markets,including a broader range of financial instruments traded onvenues other than regulated exchanges and also covering spotcommodity markets (where trading in spot affects a financialcontract). Taken together, these measures will mean there isgreater regulatory cover of most FICC markets. The issue ofthe regulatory perimeter is considered further in Section 5.4.4.

17 Recent developments in prudential regulation are alsocited by market participants as having a major impact on theFICC markets. The third Basel Accord (Basel III), which isimplemented in Europe via the Capital Requirements Directive(CRD IV), contains a number of measures including: higher

trading book capital requirements to ensure adequatecapitalisation of positions that cannot be exited quickly; anon risk-based leverage ratio, requiring banks to assess capitalas a percentage of total exposure; and measures to ensurethat firms have sufficient liquidity coverage in times of stress.These new provisions will only apply to banks and other creditinstitutions (not to firms such as hedge funds and inter-dealerbrokers), and some are not due to be fully implementedinternationally for several years. Taken together thesemeasures are designed to ensure greater prudential stabilityof financial firms, including those playing a key role in theFICC markets. The implications for liquidity in FICC marketsare discussed in Box 4 in Section 4.

18 There are a number of other recent regulatory initiativeswhich, while not dealing directly with conduct issues, alsohave an important bearing on the fairness and theeffectiveness of FICC markets. The Dodd-Frank Act willimplement the G20 derivatives commitments in theUnited States, and the European Market InfrastructureRegulation (EMIR) will implement most elements of thecommitments in the EU (except for the trading commitment,which is covered by MiFID 2). Reforms to the structure ofbanking, such as the UK Banking Reform Act and theVolcker Rule in the United States, may indirectly affectliquidity in the FICC markets. Finally, the EU’s AlternativeInvestment Fund Managers Directive (AIFMD) has led to alarger number of participants in FICC markets being subject toregulatory oversight. These other regulations are consideredin more detail in the Appendix.

(1) See Group of Twenty (2009), ‘The G20 Pittsburgh Summit Leaders’ Statement,’item 13 under ‘Strengthening the International Financial Regulatory System.’www.g20.org/sites/default/files/g20_resources/library/Pittsburgh_Declaration.pdf.

www.g20.org/sites/default/files/g20_resources/library/Pittsburgh_Declaration.pdf


3 What does ‘fair and effective’ meanfor the FICC markets?1 Table C summarises the Review’s provisional view of thehigh-level characteristics it would expect to see in fair andeffective FICC markets. These have been derived from a rangeof sources, including academic and practical studies in finance,economics, law and competition policy, and have been thesubject of initial discussions with a range of marketparticipants, policymakers and academics. The rest of thissection elaborates on the reasoning behind the proposeddefinition.

3.1 Fairness and effectiveness for whom?

2 A central question for the Review is how to craft a set ofcharacteristics appropriate for FICC markets which — asdiscussed in Section 2 — are largely populated by professionalmarket participants. Such firms have historically been thoughtof as being capable of taking care of their own interests whenengaged in mutual trade, without regulatory interference togovern conduct: a principle sometimes loosely described as‘caveat emptor’ (or ‘buyer beware’). The true meaning of thatterm has never involved the complete absence of standards, asdiscussed in Box 3 on page 17. But avoiding the imposition ofhighly prescriptive conduct rules has long been thought of ashelping FICC and other wholesale markets to operateeffectively — particularly important for markets relied upon bya wide range of other markets, companies and policymakersfor efficient price discovery and liquidity.

3 In recent years, and particularly since the financial crisis,conduct regulators have been re-evaluating this balance, forthree main reasons. First, there has been a growingrecognition that some market practices that may have beenconsidered acceptable between market intermediaries maynevertheless impose negative externalities on the ultimateend-users of those markets as a whole, underminingconfidence in the integrity of those markets more generally.

Second, conflicts of interest may mean that outcomes that arein the interests of professional intermediaries are not always inthe interests of their individual clients or counterparties. And,third, on occasion, less sophisticated investors may seek toaccess FICC markets directly. For these reasons, there hasbeen increased supervisory and regulatory interest, asdiscussed in Sections 1 and 2 and the Appendix. At the sametime, the importance of not overburdening the effectiveoperation of wholesale markets has remained a keyconsideration. For example, while MiFID requires investmentfirms to act ‘honestly, fairly and professionally’ andcommunicate in ways which are ‘fair, clear and not misleading’in their dealings with ‘retail’ or ‘professional’ clients andMiFID 2 will extend that general requirement to the mostknowledgeable and sophisticated ‘eligible counterparty’category, more detailed conduct rules only apply totransactions with ‘retail’ or ‘professional clients’. The conceptsof fairness and effectiveness proposed here are consistent withmaintaining that balance, but the Review would welcomeviews of respondents on this issue.

3.2 Defining ‘effective’

4 The Review believes that effective FICC markets are onesthat successfully achieve the underlying objectives of financialmarkets. This has two key components.

5 The first characteristic of effective FICC markets is that theyshould operate in ways that allow end-users, borrowers andend-investors to undertake transactions, including risktransfer and the channelling of savings to investment in apredictable way, in support of the broader non-financialeconomy. This definition requires markets to be underpinnedby robust infrastructure, and implies as an outcome that theyare sufficiently liquid and resilient to support the needs ofend-users, and not prone to sudden closure. It does nothowever imply that more is always better when it comes toliquidity. Excessive liquidity provision caused, for example, bythe underpricing of liquidity and credit risk — such as that seenin the build-up to the financial crisis — may harm, rather thanserve, the interests of the ultimate users of markets (see Box 4on page 21).

6 The second characteristic of effective FICC markets is thatmarket participants should be able to trade at competitiveprices, set through a price discovery process reflecting thecurrent and expected balance of supply and demand. This

Table C Proposed characteristics of ‘fair and effective’ FICCmarkets

‘Effective’ Enabling investment, funding and risk transfer; underpinned by robust infrastructure

Competitive prices

‘Fair’ Clear standards of market practice

Transparency

Open access

Competition on the basis of merit

Integrity


implies that allocations of assets should result fromcompetitive behaviour, free from collusion, unwarrantedbarriers to entry or other restraints on trade, and that pricesshould be observable to relevant parties. This definition of an‘effective’ market is preferred to the concept of an ‘efficient’market more commonly used in the economics and financeliterature, since that concept has not described marketoutcomes well in recent years, and has a number of potentiallyextreme policy implications (for example, that ‘anything goes’in terms of getting information to market).(1)

3.3 Defining ‘fair’

7 The first proposed characteristic of fair markets(2) is thatmarket outcomes should result from clear and consistentlyapplied standards of market practice. That implies thereshould be good collective knowledge among marketparticipants of the relevant codes, rules and other means ofencapsulating acceptable market practices; and confidencethat market participants will apply those standardsconsistently and rigorously. It does not imply that rules, codesand market practices are necessarily uniform across allmarkets, participants and jurisdictions. Nor does it imply theyneed necessarily be highly prescriptive in nature.

8 The second proposed characteristic is that there should besufficient transparency, giving participants common access tothe information necessary to allow them to verify that rulesand practices are applied consistently. So, for example, thereshould at a minimum be enough post-trade transparency toallow a firm paying for best execution to verify that its brokerachieved it, or a beneficial owner to verify that an agent lender

has lent securities only to allowed borrowers. This definitionallows for the possibility that there may be instances in whichincreases in transparency, beyond some point, may reduce theeffectiveness of a market — an issue that for example lies atthe heart of the calibration of the MiFID 2 provisions on preand post-trade transparency. The Review is not seeking tore-open that debate — but would welcome respondents’ viewson the broader role of transparency in FICC markets (see alsoSection 5.1).

9 The third characteristic is that there should be open accessto FICC markets for all, either directly or through an open,competitive and well-regulated system of intermediation.This criterion implies that access to a market should be onterms that are reasonable and transparent, do not conferunfair advantage on large or otherwise incumbent firms, andallow at a minimum effective intermediated access for all. TheReview nevertheless recognises that evaluating such terms canbe far from straightforward in practice.

10 The fourth characteristic of fair markets proposed by theReview is that fairness should be consistent with competitionon the basis of merit, reflecting equality of opportunity ratherthan equality of outcome. This concept, similar to that used incompetition policy, means that market participants who

Box 3The meaning of caveat emptor

Discussions of FICC and other wholesale markets often referto the concept of caveat emptor. Some argue that it isimportant to preserve this principle in order to avoidover-regulation. Given its importance to the debate, it isimportant to elucidate its meaning.

In the general law of sale, caveat emptor expresses the basicprinciple that a buyer of property purchases it at his or herown risk, and that — unless expressly agreed otherwise — theseller makes no representation, gives no warranty, and is underno obligation to volunteer information, about the propertysold. In financial markets, the phrase is often used asshorthand for the more general proposition that marketparticipants contracting with each other should be held to thebargains that they agree, and that the public interest is bestserved by allowing them to contract freely with each otherwithout regulatory restriction or overlay.

However, caveat emptor has never meant ‘anything goes’. Ithas always been subject to the general law on fraud andmisrepresentation, which has long been relatively strict,embodying the principle that (in the words of a Victorianjudge, Lord Macnaghten in Gluckstein vs Barnes [1900] AC 240)‘sometimes half a truth is no better than a downrightfalsehood’. And over the years the practical application of thecaveat emptor principle has been further qualified by judicialand statutory intervention (for example on implied terms), bydisclosure and other provisions of consumer law, and, in thecontext of investment transactions, by statutory andregulatory rules. For example, caveat emptor does not trumpthe regulatory obligation on a firm to act ‘honestly, fairly andprofessionally’. Market manipulation cannot therefore be saidto be consistent with caveat emptor, even where it takes placebetween two counterparties of broadly equal bargainingpower and sophistication.

(1) The Efficient Markets Hypothesis asserts that markets fully, accurately, andinstantaneously incorporate all available information into market prices — including,in some strong forms of the definition, hidden or insider information.

(2) The suggested characteristics of fair FICC markets draw among other things on theliterature on ‘organisational justice’ (see, for instance, Greenberg, J (1987), ‘Ataxonomy of organizational justice theories’, The Academy of Management Review,Vol. 12, No. 1, January, pages 9–22). That suggests that outcomes are typicallyperceived to be fair in the presence of procedural, informational, interpersonal anddistributional justice.


innovate successfully, leading to superior capabilities orprocesses, should be able to earn a return on that investmentin the form of superior prices and allocations, provided thoseoutcomes are merit-based. In the Review’s opinion, such aconcept is necessary in order to ensure there are incentives formarket participants to innovate and invest. Such a criterion ishowever challenging to assess in practice. For example, firmsmay seek to exploit an initially beneficial technology toestablish a lasting incumbency position, preventing fair marketentry by others, and creating systematic losers out ofend-users.

11 Finally, and importantly in light of the misconduct ofrecent years, fair markets should be markets in whichparticipants behave with integrity. Among other things, thatmeans participants should be confident that they will not besubject to fraud, deception, misrepresentation, manipulationor coercion. In particular, where one party acts for another,that other party’s essential interests should be reasonablyprotected. By implication, attempts to manipulate markets ormeasures such as Libor and Euribor are wholly inconsistentwith fair markets.

3.4 Can there be trade-offs between fairnessand effectiveness?

12 It is sometimes argued that there may be trade-offsbetween fairness and effectiveness. The characteristicsproposed in this section have been designed to minimise thatrisk. For markets characterised by low levels of fairness,increases in fairness should also increase effectiveness. Forexample, combatting serious market abuse, including insiderdealing, will improve effectiveness by increasing market

participation by those previously unwilling to tolerate the riskof large indiscriminate losses or abuse. At higher levels offairness, the Review recognises that some market participantssee this relationship as more finely balanced. It is oftenargued, for example, that regulators seeking to impose everhigher levels of market transparency may at some pointtrigger market fragmentation as those seeking to trade in largesize seek alternative trading arrangements, or cease tradingaltogether. These issues are discussed in more depth inSection 5.1. However, the concepts of transparency, opennessand merit-based competition used in the definition of fairnessproposed in this section have been designed with the objectiveof avoiding this risk.

Consultation question

Q1: The Review would welcome respondents’ views on thedefinition of ‘fair and effective’ FICC markets proposed inSection 3. Does it strike the right balance betweensafeguarding the interests of end-users withoutunnecessarily impeding the effectiveness of FICC markets?Are the concepts of transparency, openness and equality ofopportunity appropriately specified? And how does thedefinition compare with those used in other markets,jurisdictions, organisations or legislation?


4 Evaluating the fairness andeffectiveness of FICC markets4.1 The Review’s analytical framework

1 Section 2 sets out the key features of the major FICCmarkets, and Section 3 gives a working definition of thecharacteristics the Review would expect to see in fair andeffective markets. This section draws the two together, andoutlines a framework for evaluating the fairness andeffectiveness of the major FICC markets. Between now andJune 2015, the Review proposes to develop this framework,and use it to identify: (a) where FICC markets are susceptibleto abuse, which practices are potentially detrimental to clientsand whether current market structures exacerbate conductproblems; (b) the extent to which these issues have been, orwill be, addressed by regulatory and other changes alreadyunder way; and (c) the areas where further action is needed.

2 The scope of this assessment is potentially enormous. Togive its preliminary work focus, while avoiding potentialblindspots, the Review has drawn on a wide range of inputs,including published enforcement cases from the FCA andother international regulators, an extensive round ofdiscussions with end-users and participants in FICC markets(including those on the Market Practitioner Panel and itsExpert Groups), regulators and other stakeholders; anassessment of economic and legal academic research includingdiscussions with a number of academic experts; and data andother desk-based analysis.

3 This process has helped the Review to refine its view of thekey questions and the broad shape of possible policyresponses. But in the time so far available, the Review has notsought to reach definitive answers. Indeed, it is clear thatthere are many alternative perspectives on the key issues,including the sources of misconduct, the extent to whichindividual FICC markets are already fair and effective (or willbecome so once the current set of reforms is complete), andthe efficacy of alternative proposals for improving fairness andeffectiveness. A key aim of this consultation is therefore toseek respondents’ views on how to weight these alternativeperspectives, in order to inform the Review’s finalrecommendations in June 2015.

4 To give structure and focus to this process, the Review hasdeveloped the framework shown in Table A in the ExecutiveSummary. The table divides the sources of potentialvulnerability in FICC markets into six categories. Three ofthese are structural: market microstructure; competition and

market discipline; and benchmarks; and three relate toconduct: standards of market practice; responsibilities,governance and incentives; and surveillance and penalties.(1)

These categories are designed to capture the full range ofhypotheses about the extent and nature of cross-cuttingvulnerabilities. As stressed in Sections 1 and 2, however, it isrecognised that the assessment may vary across different FICCmarkets.

5 The Review will also use the framework in Table A toevaluate ways in which the fairness and effectiveness of FICCmarkets might potentially be improved. The table highlightsthe fact that, for each of the areas in which fairness andeffectiveness might potentially need to be improved, thiscould happen through action either by markets, by firms, byindividuals or by regulators. This ordering reflects theprinciples set out in Section 1.4, in particular the desire toexplore ways in which the authorities can help to catalysemarket-led initiatives to improve fairness and effectiveness.Given the seriousness of recent misconduct, however,recommendations for regulatory interventions may also berequired — and that is reflected in the final column in thetable. Since the Review is consulting on the appropriate wayforward, this document does not present a completed versionof this table — but the table has been used as an organisingframework for the Review’s diagnostic work.

6 Sections 5.1 to 5.6 explore the potential vulnerabilities andsolutions under each of the six headings in more detail. Therest of this section provides a high level summary of thatmaterial.

4.2 A high-level summary of Sections 5.1to 5.6

7 Section 5.1 considers issues related to marketmicrostructure. As discussed in Section 2, markets forbespoke FICC products — such as many types of corporatebonds, credit products, OTC interest rate derivatives andinterbank unsecured lending — tend to be relatively thin andlack widespread transparency. Instruments traded in marketsof this type are intrinsically harder to value, and hence theirprices may be more vulnerable to manipulation. Regulatory

(1) The three conduct categories broadly follow the approach recommended bySue Jaffer, Nicholas Morris and David Vines in Chapter 16 of Jaffer, S, Morris, N andVines, D (2014), Capital Failure: rebuilding trust in financial services, Oxford.


and technological change is already leading to greaterstandardisation and transparency across many FICC markets.The question posed in Section 5.1 is whether respondentsthink that process should go further, through industry-ledstandardisation, removing barriers to entry for new tradingplatforms or utilities, or further transparency enhancements topractices (such as new issue allocation) and structure, ledeither by industry or through regulation. The contrary view isthat the process already under way is sufficient, and thatimposing standardisation or transparency standards in excessof that required by issuers and end-users may harm, ratherthan enhance, market functioning and risk transfer.

8 Section 5.2 considers issues related to competition andmarket discipline. Concentration in some FICC markets isrelatively high on both the sell and the buy-side, and in somecases firms have also engaged in horizontal or verticalintegration — raising potential conflicts of interest andconcerns about information asymmetries. A number of recentmisconduct cases have involved attempted collusion, exerciseof market power or inadequate management or control ofconflicts. The ability of FICC market participants to exercisemarket discipline against those engaging in misconduct mayalso have diminished somewhat in recent years, weakening akey bulwark against abuse.

9 At the same time, the market maker system that hastypically characterised FICC markets has delivered importantbenefits, including tight pricing and deep and near-continuousliquidity in a wide range of market conditions. As Box 2 inSection 2 discusses, that model is now changing, as increasedrisk aversion and regulatory reforms designed to return thecost of liquidity and capital to more sustainable levels favourmore agency-based trading models in some FICC markets.The potential diminution of liquidity in certain FICC marketshas been raised as a concern about market effectiveness bymany investors and end-users in early conversations with theReview (see Box 4 on page 21). This is therefore a finelybalanced issue for the Review to explore. Section 5.2 asksrespondents for their views on the effectiveness ofcompetition and market discipline in FICC markets, on thescope for enhancing market-driven competition, and on thepotential role for official sector competition policy.

10 Section 5.3 considers issues related to FICC benchmarks.Recent abuse cases revealed widespread issues with the designand oversight of benchmarks in FICC and other markets.Substantial reform has already occurred, and furtherregulatory change is under way. Section 5.3 asks forrespondents’ views on whether those steps are sufficient.Further steps may include: reducing or diversifying benchmarkuse; improving benchmark construction; and ensuring morecomprehensive compliance of benchmarks with the IOSCOstandards.

11 Section 5.4 considers standards of market practice.Recent enforcement cases in FICC markets reflect clearbreaches of standards of market conduct and integrity, as setout for example in the FCA’s Principles for Businesses. Inaddition, fundamental standards in relation to fraud, insiderdealing and market manipulation are set out in law. On oneview, those standards provide a sufficient guide toexpectations of market practice, given the impossibility ofproviding detail for every scenario or circumstance. In suchcircumstances, the main priority should be to ensure that allFICC market participants understand the implications of thoseprovisions, and abide by them.

12 An alternative view, expressed to the Review by somemarket participants, is that there is a need in the future tosupplement these standards with more specific market-wideguidance or rules on acceptable market practice, closingperceived gaps caused by the combination of an unevenregulatory perimeter across FICC markets and dated voluntarymarket codes lacking formal enforcement powers. Theregulatory perimeter is being extended through theintroduction of MiFID 2 and MAR in Europe, and codescovering foreign exchange markets are being updated. Marketparticipants have nevertheless identified a range of marketpractices to the Review where they believe further guidancewould be helpful.

13 Section 5.4 seeks respondents’ views on these issues. Iffurther guidance were judged to be desirable, practical designquestions for comment include: whether to couch suchguidance in a market code owned by the industry, or whetherto give it regulatory force; whether it is desirable for suchcodes to be broad or precise in nature; how to recognise thedifferences between FICC markets; how to phrase them interms that could be of practical use in a trading context; howto ensure they remain up to date; how to avoid conflict withother existing codes and regulations; how to ensure theyapply to all relevant market participants; and how to ensurecompliance. The Review is mindful of the need to avoidconflict between market-wide guidance and regulatoryrequirements, and the vulnerability of overly detailed guidanceor rules to ‘gaming’ behaviour. A final issue raised in thissection is whether there is a case for extending the scope ofregulation to extra institutions or markets.

14 Section 5.5 considers responsibilities, governance andincentive structures within firms. Those who place particularweight on this as a key vulnerability argue that, in the run-upto the crisis, some firms active in FICC markets had allowedthe culture on their trading floors to get out of control. Onthis view, poor ‘tone from the top’ was coupled withwidely ignored firm-level codes of conduct, weak and siloedmanagement, and desk heads with incentives focused heavilyon their own short-term revenue performance. In such


structures, focus on maintaining a firm’s reputation —normally a bulwark against misconduct — was weak, withtraders feeling greater loyalty to their desk or friends andpeers in the market than to their firm.

15 Since the crisis, the major financial firms have signalledtheir determination to move away from this model, and haveembarked on a wide range of initiatives. Practitionersnevertheless recognise the challenges of translating thesegood intentions into lasting change. Section 5.5 seeksrespondents’ views on the key priorities for firms in thatrespect, including: improved performance measures forindividuals and firms; adjustments to remuneration;safeguards against inappropriate staff moves; the importanceof high standards of conduct in decisions on promotion andadvancement; ways to strengthen the role of boards in thegovernance of FICC activities; and ways to strengthen theso-called first line of defence. Section 5.5 also seeks views onhow the Review’s recommendations should interact withthose of the Banking Standards Review Council, and on thescope for strengthening firm-level practices throughregulatory backstops, including the prospect of extendingthese regulatory provisions across the FICC industry.

16 Section 5.6 considers surveillance against, and penaltiesfor, those found to be engaging in misconduct. It highlightsthat looking out for misconduct, and ensuring identified caseshave consequences, are shared responsibilities between firmsand regulators. Pre-crisis, many firms’ systems for monitoringFICC traders were underdeveloped, and procedures for dealingwith internal misconduct were sometimes inadequate,particularly where higher-paid staff were involved.Approaches to these issues have since improved, but theReview is keen to identify examples of best practice, and waysin which the authorities can work with the industry to catalysefurther progress. Questions raised in Section 5.6 include: thescope for stronger firm-level whistleblowing regimes; the rolefor electronic surveillance tools; penalties for staff breachinginternal guidelines (and ways to publicise such cases); and theextent to which firms can punish poor behaviour by otherfirms by shifting business and reporting such behaviour to theauthorities.

17 Conduct regulators have also increased the resourcesdevoted to FICC and other wholesale markets in recent years,having been perceived by some as being more focused onretail and more directly regulated wholesale markets such as

Box 4The importance of market liquidity in thecontext of the Review

A recurrent theme throughout this consultation document,and in the Review’s initial round of conversations with marketparticipants, is the role of market liquidity. In a broad sense,market liquidity typically refers to the ease with whichinvestors are able to transact in reasonable quantities of aninstrument without discontinuity of price formation. Theexistence of markets that are sufficiently liquid and not proneto sudden closure matters for both issuers (who want to beable to borrow when they want, at competitive terms) andinvestors (who want to be able to move smoothly in and outof positions).

Market participants report that liquidity in some FICC marketsis noticeably lower than it was before the financial crisis.Market makers are less willing or able to take on risk,increasingly focusing on activities requiring less capital andbalance sheet capacity and shifting to a more order-driven orbrokerage model, meaning that the execution of large tradestends to take longer. Some market makers have alsowithdrawn from key markets, increasing concentration levels.These trends are not universal across FICC markets — whiledealer inventories in corporate bond markets have fallen bynearly three-quarters since early 2008, liquidity in spotFX markets, for example, remains high. But the general trendappears to reflect a combination of reduced risk tolerance

since the financial crisis, together with the impact ofregulation designed to improve the resilience of the financialsystem by increasing the capitalisation of financial institutionsand reducing the implicit subsidy to the banking system (seethe Appendix).

It is not clear that these changes will necessarily reduceliquidity in the FICC market over the long run. Many marketparticipants recognise that liquidity was oversupplied beforethe crisis, reflecting the underpricing of risk and the subsidyprovided to major banks by implicit government guarantees.That led to a sharp deleveraging when the pricing of riskreturned to more normal levels. One of the goals of recentprudential regulation has been to reduce the probability ofsuch cycles in future, increasing the resilience of the system,reducing subsidies and hence ensuring liquidity is provided at amore sustainable level. For that reason, respondents shouldtake the international post-crisis prudential reform package asa given when replying to this consultation.

It is nevertheless recognised that the increased cost of marketmaking could have potential implications for the structure ofFICC markets, and hence may interact with some aspects ofthis Review. The traditional role of the buy-side in policingpoor market conduct by sell-side firms, for example, may beweakened when there are limited alternatives for them tochoose. The Bank of England’s Financial Policy Committee isconsidering the resilience of market liquidity as part of itsmedium-term priority on supporting diverse and resilientmarket-based finance.


equities in the pre-crisis period. In particular, as Section 5.6discusses, the FCA now has a more forward-lookingsupervisory approach, and has continued its credibledeterrence approach to enforcement activities. But FICCmarket supervision poses a number of specific challenges,given the markets’ global scope, less widely available data onpricing, and the relatively complex regulatory coverage.Respondents are asked whether the level of supervisoryresources dedicated to FICC market supervision is appropriateand whether there are further steps that might be taken tostrengthen the impact of enforcement action further.


Q2: Of the six themes identified in Table A on page 5which do you consider to be the most important factorscontributing to the recent series of FICC market abuses? Inwhich other areas do you believe the fairness andeffectiveness of FICC markets globally may be deficient?Do these answers vary across jurisdictions, or specificmarkets within FICC? Are there any other important areasof vulnerability that are not identified in the table?


5 Specific issues in FICC markets

1 Section 4 describes the six key areas where vulnerabilitiesarising from structural features and conduct issues potentiallyarise in FICC markets, using the framework shown in Table Aon page 5. Sections 5.1 to 5.3 consider the three structuralthemes in that table. Section 5.1 asks whether there are waysto improve market microstructure and price discoverymechanisms; Section 5.2 considers competition and marketdiscipline issues; and Section 5.3 explores issues related to thedesign of benchmarks.

5.1 Market microstructure

5.1.1 Overview2 Box 2 in Section 2 discusses how the OTC market makingstructure in FICC markets developed as a means of bridgingbetween a diverse set of heterogeneous assets and thedemand for continuous two-way liquidity from investors.That model has brought many benefits in terms of tightpricing and deep, continuous liquidity. But price discovery hastended to be somewhat less transparent, and thespecialisation in information gathering and increasing returnsto scale inherent in market making may increasevulnerabilities.

3 Improvements in market structures that facilitate pricediscovery and improve price transparency are therefore key toensuring fair and effective markets. Regulatory andtechnological changes have already started to impact thesemarkets. MiFID 2 will extend rules on pre and post-tradetransparency to many areas of the FICC markets for the firsttime. The introduction of the new ‘organised trading facility’(OTF) will mean that much FICC business that wastraditionally classified as OTC will now be subject to the rulescovering venues. In addition, the G20 derivativescommitments will result in large volumes of standardisedOTC derivatives moving on to organised venues.

4 There have also been a number of initiatives to enhancetransparency and standardisation in securitisation markets.For example, the Bank of England and the European CentralBank have introduced loan-level information requirements aspart of their collateral eligibility criteria in recent years. Aspart of a joint Discussion Paper, they also welcomed ongoingwork by the European Securities and Markets Authority(ESMA) to seek further improvements in disclosure oftransaction documentation and performance information, andsuggested there may be scope for additional standardisationof prospectuses and investor reports.(1)

5 This section asks about the extent to which othermarket-led or regulatory initiatives could support furtherchanges in that direction, while avoiding a reduction ineffectiveness or access to markets.

5.1.2 Fixed income6 Recent years have seen an increase in more transparentforms of electronic trading in fixed income markets, throughthe increased use of single or multiple-dealer platforms.Other initiatives have sought to improve the matching processso that less intermediation by banks is required. For example,in some markets there are designated time periods when aparticular bond can be traded at a price set to reflect thebalance of supply and demand. Some providers have alsosought to introduce exchange-like trading for corporate bondsvia a central limit order book model. However, the use oftechnology in many FICC markets remains relativelyunderdeveloped (Figure 1). Many end-users therefore stillaccess the market via an OTC market maker, with the marketssegregated into separate interdealer and dealer-to-clientplatforms.

7 As set out in Box 2, one of the main drivers of theOTC market maker model is the heterogeneity of fixed incomeproducts. While there will always be a need for a range ofbespoke structured products, there may be scope for greaterstandardisation of more frequently-traded instruments. Thishas already occurred, to some extent, in government bondmarkets, futures contracts, and with credit default swaps(CDS) which were standardised to have fixed coupons andmaturities in April 2009.

8 Some market participants argue that standardisingcorporate bond issuance would help reduce the problemsassociated with variable secondary market liquidity, byconcentrating market activity in a smaller number of bondswith similar features, improving price transparency forinvestors, reducing the scope for market manipulation andpossibly also resulting in cheaper funding for issuers.However, issuers place a high value on being able to choosespecific maturity and coupon structures to match theirunderlying cash flows, and this presents difficulties for movingto a more standardised model. Indeed private placements areoften sought for that very purpose. The Review is interested

(1) The case for a better functioning securitisation market in the European Union, availableat www.bankofengland.co.uk/publications/Documents/news/2014/paper300514.pdf.

to know more about whether greater standardisation ofcorporate bonds could occur in the issuance process, how thismight be achieved, and the extent to which it would affect theability of end-users to meet their funding needs (or fully hedgetheir exposures).

9 The new issue process for syndicated bonds has also beenraised with the Review by many market participants as being‘unfair’, especially to smaller investors. A lack of transparencyaround the allocation process has been a particular area ofconcern, with some alleging that some investors receivegreater allocations because they are either favoured clients ofthe arranging bank or a large market participant. There is alsoa perception that when smaller investors receive a full orhigher than normal allocation it is because the bond is notfaring well with large investors and expected to performpoorly after issuance.

10 However, these concerns must be balanced against anissuer’s objectives. Those may include: ensuring an issue isfully allocated; developing a stable investor base willing tohold its bonds for a significant period of time; and optimisingthe prospect of bonds performing well in secondary trading(so that the price does not immediately fall, generating lossesfor investors), minimising the risk that the bonds areimmediately sold (or ‘flipped’). These aims may be mosteffectively achieved through careful allocation and by ensuringlarge commitments from the biggest investors. ICMAmaintains market-wide guidelines(1) on syndicate bestpractices for the new issue process for sovereign and corporateissuance in Europe, including allocation procedures, and isengaged in dialogue to explain the new issue process toinvestors.


Figure 1 Electronic market development by asset class

Current state

Both

ele

ctro

nic

and

voic

e

Products

Cash equities(b)

Futures (eg US Treasury)

CDS – index

FX – spot

US Treasuries(c)

European government bonds

Precious metals

FX – forwards

Agencies

Covered bonds

FX – options

Short-term interest rate trading

FX – swaps

Repos

Standardised interest rate swaps (IRS)

Investment grade – cash

CDS – single name

High yield – cash

Bespoke IRS

Structured rates/credit

‘e’ penetration(a), per cent

0 10 20 30 40 50 60 70 80 90 100

‘Fullyelectronic’

Significantlyelectronic

Becomingelectronic

Largelyvoice

2012 2015 McKinsey projection

Source: McKinsey.

(a) Includes multidealer RFQ.(b) Included for comparison.(c) ‘On the run’ securities in dealer-to-client market.

(1) See ‘Pre-Sounding, Bookbuilding and Allocations’, in Appendix B of Section 6 in theICMA Primary Market Handbook.


11 The Review would like to hear from respondents aboutadditional measures that could enhance transparency in thenew issue process. These might include publication of finalallocations, or the use (or integration of) some of the featuresof an auction process to determine the clearing price andallocations.

5.1.3 Foreign exchange12 Section 2 and the Appendix set out the major structuralchanges seen in global FX markets in recent years, includingconsiderable investment in electronic trading, and increased‘internalisation’. In early conversations with the Review, manyof the largest end-users of FX markets have emphasised thebenefits stemming from the availability of multiple prices thatcan be sourced from different single and multiple-dealerplatforms. Electronic communication and confirmations werealso cited as being helpful in providing an audit trail todemonstrate best execution, and the Review heard argumentsthat internalisation resulted in better execution for clientsbecause it allows them to trade at bid-offer spreads that arenarrower than those available in the external market.However, the structure of such platforms reducestransparency to the broader market and concentratesinformation on flows in the hands of several large banks. Ithas also been argued that there are risks associated with toomuch internalisation if the external market withers away: intimes of stress when client flows are likely to be in the samedirection, banks may not be able to offload their residual riskeffectively.

13 Banks have also developed ‘last look’ practices which givemarket makers the chance to accept or reject a tradeimmediately prior to acceptance, in order to protectthemselves against market moves or automated tradingstrategies that might exploit the market maker’s inability torefresh quotes quickly. But some market participants haveargued that such practices may also incentivise market makersto delay a decision for longer periods in order to observemarket moves and reject unprofitable trades or even engage infront-running of orders. The Review would be interested tohear views on the risks associated with internalisation and‘last look’ practices and whether there are any barrierspreventing a shift to a more transparent FX market structure.

14 Another structural feature of FX markets is that somemarket participants are incentivised to transact at abenchmark price (the ‘fix’) in order to match benchmarkindices in other markets, or to value portfolios or otherwiseestablish transparency in execution. Customers often submitorders earlier in the day that are to be traded at the fix,creating the opportunity and incentive for dealers to try toinfluence the exchange rate to generate a profit. Even ifdealers act with integrity, attempts to hedge can look likefront-running.

15 The FSB established a Foreign Exchange Benchmark Groupto consider ways in which the market infrastructureunderpinning the calculation of FX fixing prices could beimproved. Among its fifteen recommendations, it welcomed anumber of market initiatives recently proposed to addressthese issues.(1) Most of these solutions have the form ofmaximising the netting opportunities of fixing orders and thenexecuting those orders in a way that clearly delineates theseparation between dealers acting as principal and dealersacting as agent. Some firms have already started to segregatefix orders from other types of trading to eliminate potentialconflicts of interest. The Review is interested to hear aboutpotential barriers preventing the FX market moving further inthis direction.

16 Finally, the Review has heard potential concerns about theimpact of trading in so-called ‘barrier’ and ‘digital’ options inforeign exchange and other markets, and would welcomerespondents’ thoughts on the seriousness of this issue. Box 5on page 26 discusses this in more depth.

5.1.4 Commodities17 Section 2 and the Appendix note that, for many majorcommodities, price formation is driven by exchange-tradedderivatives markets, where pricing is fairly transparent. Pricesin the underlying physical markets are linked to derivativesprices by robust arbitrage relationships. However, somecommodity derivatives, such as those for energy and preciousmetals, are mostly traded OTC via interdealer brokers, withassociated reduced transparency. Market participants stressthat bespoke OTC hedging is a necessity in physical marketsfor many end-users. But since many contracts in physicallysettled forward markets are of a fairly standardised type it isnot clear why these OTC markets should not benefit fromgreater transparency.

18 Market participants who have physical businesses oftenhave an information advantage over those who onlyparticipate in derivatives markets. The Review notes thattechnology has improved transparency in some physicalmarkets: firms willing to invest in technology and informationservices can build up more complete views of the supply anddemand dynamics in some (though not all) markets.However, the Review would like to know respondents’ viewson further measures that could be taken to enhancetransparency in the OTC commodity derivatives markets.

5.1.5 Regulatory measures19 So far, this section has discussed how well-designedmarket microstructure can reduce the scope for marketmanipulation and other misconduct, and how variousmarket-led initiatives might address potential weaknesses inthe fairness and effectiveness of FICC markets. However, in

(1) www.financialstabilityboard.org/publications/r_140930.pdf.


Box 5Barrier and digital options

1 A theme in enforcement actions against marketmanipulation has been the involvement of so-called ‘barrier’and ‘digital’ options.

2 Barrier options are types of options that are either activatedor cancelled if a pre-determined level of the underlying marketprice is reached. Digital (or binary) options pay out either afixed amount or nothing, depending on whether theunderlying price reaches a particular level at a specific point intime.

3 These options are typically used by market participants toexpress a view that more closely matches their beliefs aboutfuture price movements, or to hedge specific economic andfinancial risks. They can also be used to reduce costs — barrieroptions tend to be cheaper than alternative ‘plain vanilla’options because they provide more limited protection. Theyare used by a variety of participants, including non-financialcompanies managing risk, speculative investors and retailinvestors (eg via the purchase of structured notes). They arealso the building blocks for a wide range of other complexfinancial contracts, including ‘knock-ins’, ‘knock-outs’,‘one-touch binaries’ and ‘range accruals’.

4 Unlike simpler options, barrier and digital options havediscontinuous pay-off profiles. This means that the value ofthe derivative increases or decreases when the price of theunderlying asset reaches a certain level (Figure A). When theprice is near this level, the buyer and the seller of the optionstand to gain or lose substantial amounts depending on smallmovements in the price. In some cases, the resulting exposurecan far exceed the normal trading size in the underlyingmarket. This creates at least the incentive for both buyers andsellers to place large orders in the underlying asset in anattempt to move the market and thereby prevent (or cause)the occurrence of the barrier event. This practice is known as‘defending’ (or ‘triggering’) a barrier option.

5 Such trading, where it occurs, may temporarily force themarket to an artificial level, harming other users of thatmarket. For that reason, it is banned for barrier options undermarket abuse rules where the underlying is a listed security.Some market participants nevertheless suggest that it can stilloccur in these markets, perhaps reflecting the sheer size of theincentive. Market abuse rules do not cover some othermarkets, including those for foreign exchange — though theFCA’s Principles for Businesses may still apply. Whethertraders can in fact influence the underlying price will dependon the depth and liquidity of the market in question, and theshare of the market they control.

6 Market participants typically distinguish ’defending’ anoption from trading in the underlying market to cover theoption’s ‘delta’ risk. ‘Delta hedging’ involves a trader takingoffsetting positions in the underlying market to manage therisk as it develops, but without seeking to move that market toa different level. The motivation is therefore quite different —though in some cases the difference may be hard for a thirdparty to detect by looking at trading patterns alone.


Q3: Do trading practices involving barrier or digital optionspose risks to the fairness and effectiveness of one or moreFICC markets? How hard is it to distinguish betweenhedging and ‘defending’ such options in practice? Shouldfurther measures be taken to deal with the risks posed bybarrier options, whether through market-wide disclosure ofsignificant barrier positions, an extension of regulation orsome other route?

Pay-out at maturity

0

Discontinuity in digital option pay-out

Digital call option

Standard call option

Strike price Price at maturity

Figure A Digital and standard call options


some areas there may be fundamental barriers to changing orimproving the design of current structures. In such situations,transparency and other regulatory requirements may benecessary to ensure the fairness and effectiveness of markets.As set out in Section 2 and the Appendix, there are a numberof ongoing international regulatory initiatives that aim topromote the transparency of market microstructure. Takingthese initiatives as a given, the Review would like to knowwhether respondents feel any further regulatory measures areneeded to address structural weaknesses that exist in thedesign of current market microstructure.

Consultation questions

Q4: Does the market microstructure of specificFICC markets — including trading structures, transparency,asset heterogeneity or market access — enhance ordiminish fairness and effectiveness? Where there aredeficiencies, will recent or in-train regulatory ortechnological changes improve the situation, or are furthersteps needed? How do these answers vary acrossjurisdictions, or specific markets within FICC?

In fixed income:Q5: Is greater use of electronic trading venues for a widerrange of market participants possible or desirable? Arethere barriers preventing a shift to a more transparentmarket structure?

Q6: Is standardisation of corporate bond issuance possibleor desirable? Should standardisation be contemplatedacross a broader range of fixed income products? Howcould that be brought about?

Q7: Should the new issue process for bonds be made moretransparent through the use of auction mechanisms,publication of allocations or some other route?

In foreign exchange:Q8: Are there risks associated with internalisation and lastlook practices? Are there barriers preventing increased preand post-trade transparency in foreign exchange markets?

Q9: Are there barriers impeding the development of morecomprehensive netting and execution facilities fortransacting foreign exchange fix orders?

In commodities:Q10: Are there any material barriers preventing greatertransparency in OTC commodity derivatives markets? If so,what could be done to remove them?

Regulatory measures:Q11: Are there any areas of FICC markets where regulatorymeasures or internationally co-ordinated regulatory actionare necessary to address fundamental structural problemsthat exist?


5.2 Competition and market discipline

5.2.1 Overview1 Being able to trade at competitive prices, and engage inmerit-based competition, are two of the key characteristics offair and effective markets proposed in Section 3. Among otherthings, that implies that allocations of assets result fromcompetitive behaviour, and there is no collusion,anti-competitive barriers to entry or other restraints on trade.Furthermore, market discipline has historically been thoughtof as one of the central bulwarks against market misconduct,in the sense that professional counterparties who feel theirinterests have been harmed are likely to move their businesselsewhere. An important question for the Review is thereforewhether competition in each of the key FICC markets issufficiently effective to achieve competitive outcomes, andwhether market participants are able to exercise marketdiscipline against counterparties that engage in unfair marketpractices.

2 Assessing competitive conditions in FICC markets isnevertheless a complex matter. As described in Section 2 andthe Appendix, the fixed income, foreign exchange andcommodities markets differ markedly in their composition,operation and geographical reach. And the structure of thesemarkets is evolving substantially. In its preliminarydiscussions, the Review has heard a range of views frommarket participants on this issue. On the one hand, severalcontacts have argued that some FICC markets are intenselycompetitive, demonstrated by the extremely thin marginsearned on some products, the level of innovation, and thewide range of instruments available. Others, however,highlighted relatively high barriers to entry and degrees ofconcentration and horizontal or vertical integration in somemarkets, a perceived diminution in the effectiveness of marketdiscipline, and the prevalence of attempted collusion in anumber of recent misconduct cases.

3 There are several ways in which changes to competitiveconditions may come about. Market forces, includingso-called ‘disruptive innovations’(1) and new market entrants,can be powerful agents for change. And the authorities have anumber of regulatory and legislative tools that can impact oncompetitive conditions if necessary. The FCA has a statutoryobjective to promote effective competition, and fromApril 2015 will have competition powers which will operateconcurrently with those of the Competition and MarketsAuthority (CMA).(2) The FCA recently consulted oncompetition in UK wholesale markets.(3) Competition law hasalso featured in a number of recent enforcement cases aroundthe world.

4 Regulation can, however, also act as a barrier to entry thatcan prevent new entrants from entering the industry.A number of regulatory changes are under way in response tothe financial crisis that have or could have an effect on

competition and market structure, including MiFID 2,Dodd-Frank, and the capital and leverage provisions ofBasel III. Respondents should take this post-crisis reformpackage as a given. The Review would nevertheless beinterested to hear views on whether there are any otherregulatory interventions that could be helpful in promotingcompetition and market discipline in FICC markets, or whetherthere are any alternatives to additional regulation that canachieve the same level of protection for end-users.

5.2.2 Promoting effective competition throughmarket forces5 The review is interested in understanding the currentrelationship between the level of competition in FICC marketsand the fairness and effectiveness of those markets. There aretwo aspects to that question: first, whether the currentcompetitive structure may in certain circumstances facilitatepotential misconduct; and, second, whether it helps toprevent it through enabling effective market discipline. Theseare considered in turn.

Could the current competitive structure facilitatepotential misconduct?6 Box 2 in Section 2 describes the key features of the marketmaker model that characterises many FICC markets. Animportant question for the Review is the extent to which thisbusiness model may also have created vulnerabilities whichare open to abuse. On one view, the combination of mixedprincipal and agent responsibilities, specialisation in richinformation gathering, and extensive horizontal integrationcreated multiple conflicts of interest and scope for marketmanipulation or misuse of information. Similar vulnerabilitiesmay also arise in cases of vertical integration, which isprevalent in some commodities markets. It is noteworthy thata number of misconduct cases featured some combination ofimproper influence being exerted across different functionswithin a firm (for example by derivatives traders over thosemaking Libor submissions), inappropriate use or disclosure ofmarket-sensitive information, and attempted collusion.Concentration in some FICC markets has continued toincrease, reflecting amongst other things the failure of anumber of key intermediaries during the financial crisis and aperception in some quarters of increased barriers to entry,created not least by the cost of regulation.

(1) The term ‘disruptive innovation’ was introduced by Clayton Christensen (Professor ofBusiness Administration, Harvard Business School). It describes a process by which aproduct or service takes root initially in simple applications at the bottom of a marketand then moves up market, eventually displacing those offered by establishedcompetitors.

(2) Specifically, the FCA is to be given: (1) Enforcement powers under the Competition Act 1998 (CA98) to addressrestrictive practices engaged in by companies operating in the United Kingdom thatdistort, restrict or prevent competition — for example ordering that offendingagreements or conduct be stopped. Businesses that break the law can be fined up to10% of their worldwide turnover.(2) Power under the Enterprise Act 2002 to carry out market studies and makereferences to the CMA.

(3) Wholesale sector competition review — call for inputs, available atwww.fca.org.uk/your-fca/documents/market-studies/wholesale-sector-competition-review--call-for-inputs.


7 On another view, however, outcomes in many FICC marketsappear consistent with strong competitive conditions. Forexample, government bond and foreign exchange marketscontinue to provide near-continuous liquidity at very tightprices in a wide range of market conditions. And vulnerabilityto conflicts of interest, abuse of confidential information orcollusion can at least in principle be avoided through robustinternal controls, even in highly-integrated sell-side firms. Forexample, some firms have begun to separate trading functionsphysically, as discussed in Box 6 on pages 30–31. Thoseadvocating this view also point out that the structure of someFICC markets is now changing rapidly, as higher costs ofliquidity and capital make the pre-crisis business modelsubstantially less economic, and regulatory and technologicalchange increasingly point towards an agency-only,exchange-based trading model, at least for more standardisedFICC assets. On this view, the bigger challenge to the fairnessand effectiveness of FICC markets is the potential loss of theeconomic and market-wide benefits of the continuoustwo-way pricing and liquidity that an OTC market makingmodel can provide.

8 To the extent that respondents believe competition isineffective in any of the FICC markets, the Review would beinterested to hear what market-led initiatives, or structuraland technological changes, might best remedy this situation.Examples might include:

• Technological developments and disruptive innovations thatcan foster more effective competition between existingincumbents or facilitate the entry of new firms to themarket — for example, through lower cost access to moresophisticated analytical toolkits, or the growth of agencybroker firms in the corporate bond market since the crisis,who have taken business from the traditional marketmakers. A comparable example outside of the FICC marketsis the recent growth in peer-to-peer lending as analternative to the established banks.

• The cessation of practices that make it difficult for lessestablished players to compete, for example tying orbundling of services.

• The growth of electronic trading platforms (as discussed inSection 5.1) that have, in some cases, resulted in investorsbeing able to view a broader range of prices from multipledealers, and thus increase competitive pressures.

9 The Review would also be interested to hear respondents’views on whether there are any lessons that can be drawnfrom experiences in other financial markets about the waysthat alternative or evolving market structures could impacton competition in FICC markets. For example, technologicaladvances in the equity market (combined with regulatorychanges like MiFID) have allowed greater market entry from

Multilateral Trading Facilities (MTFs), providing investorswith alternative options for executing trade orders andreducing margins for incumbent exchanges. In turn, that hasled to a material change in the market structure, with newentrants taking significant market share away fromincumbents. At the same time, however, competitionbetween rival infrastructures has also been associated withan evolution in pricing structures, with a number ofplatforms offering fee rebates to intermediaries (includinghigh-frequency trading firms) who direct larger volumes totheir venues. The associated growth of high-frequencytrading techniques has affected market dynamics in anumber of ways. Whether these developments have, on net,increased or decreased fairness and effectiveness is ofinterest to the Review.

Is market discipline effective?10 The extent to which market discipline can successfully beself-imposed by FICC markets is an important consideration indetermining whether fair and effective outcomes can beachieved. It has historically been assumed that marketdiscipline would play a primary role in policing conduct in FICCand other wholesale markets. Buy-side firms and end-userswho felt their interests had been harmed would withdraw orcurtail their business with the firms suspected of abuse; andknowledge of that potential reaction would help to ensureappropriate market conduct.

11 In the Review’s opinion, there is clear evidence that thismechanism has been effective on occasions in the past. Butit is also important that it should remain a powerfuldeterrent. Whilst some of the largest investors andcorporates believe they can still exercise market disciplinewhen required, others have highlighted a number of factorsthat may have weakened this mechanism over time. First,some buy-side firms have noted that, with increased marketconcentration on the sell-side, it can be more difficult to stepback from trading with any one counterparty for fear thatthe firm’s remaining exposures become too concentratedamong the remaining counterparties. Second, theincreasingly broad product offering by the sell-side maymake it harder to act on misconduct affecting only oneproduct amongst many. Third, where abuse is perceived tobe widespread, or affects the market as a whole (rather thanan individual investor) there may be no easy way to exercisediscipline, or prove who has lost. And, fourth, there may becircumstances where misconduct (for example the selectivedisclosure of confidential information) results from a desireto win or retain valuable business from one or more buy-sidefirms: in such circumstances, the interests of the individualclient and the market as a whole may be at odds. TheReview would be interested in hearing respondents’ views onwhether market discipline between firms needs to bestrengthened in FICC markets, and if so how that might beachieved.


Box 6Conflicts of interest and information flows

Financial market participants are often subject to conflictsof interest. Market makers may, for example, act as bothprincipal and agent or may be co-located with other functionsin horizontally-integrated investment banks, and assetmanagers may have interests that are sometimes at odds withthose of their customers, for example when purchasingresearch.

These conflicts can be particularly acute when managing flowsof confidential information, either within firms or betweenfirms and their clients. Some forms of information sharingclearly constitute market misconduct. Examples include: thedisclosure of information in breach of market abuse rules; thespecific disclosure of a client’s positions or orders to a trader inanother firm; use of information on a firm’s client order flowin its own proprietary trading; or securing benefit to favouredparties by a firm underwriting a debt offering. At the sametime, the market making model that has historically been atthe heart of many FICC markets relies on the efficient flow ofinformation about client transactions and order flow, asdiscussed in Box 2 on pages 13–14. So the issues ofFICC market structure and conduct are intrinsically linked.

There are a variety of possible ways to deal with conflicts ofinterest, implying an increasingly active degree of intervention(summarised in Figure A):

(a) Some firms provide staff with guidance on whatconstitutes inappropriate use of information, take steps tomonitor communications and other information use(including by making use of new data techniques), andhave robust controls to manage conflicts of interestappropriately. Firms can back these measures up by usingappropriate disciplinary actions, as discussed inSection 5.6.

(b) Physical separation of certain functions may further helpto minimise the chance of clients being adversely affectedby conflicts of interest. This may be most effective at

reducing casual, or inadvertent, exchange of inappropriateinformation. For example, some banks locate syndicationand secondary market bond traders on different floors, aswell as separating areas that act as principal and agent.

(c) Clear standards on identifying and managing conflicts ofinterest can be set out in market or regulatory codes, asdiscussed in Section 5.4. The FCA’s Principles forBusinesses would apply, including Principle 8, whichrequires FCA-regulated firms to manage conflicts ofinterest fairly, both between themselves and theircustomers, and between the different customers theyserve. The FCA Handbook of Rules and Guidance (whichimplements MiFID) outlines firms’ responsibilitiesincluding: taking all reasonable steps to identify conflicts;operating effective arrangements to prevent damage toclients’ interests; and, where conflicts may still exist,disclosing them to clients. Market-led codes can also helpto establish best practice, with a number of relevantFICC-related codes (such as the NIPs Code and the ACIModel Code) already incorporating relevant guidance onthis issue.

(d) Contractual terms of business may disclaim or limit thescope of a fiduciary relationship with the client under thegeneral law. They may also describe, and seek the client’sacknowledgment of, conflicts that are inherent in amulti-service FICC business. In relation to activities withinthe scope of regulation, such provisions cannot limit theapplication of regulatory requirements, but may preventfirms being subject to overlapping or more extensiveobligations. In relation to unregulated activities, suchprovisions may raise questions of fairness. A possible wayof addressing this would be to ensure that any marketcodes stipulating best practice in FICC markets limit theuse that can be made of such contractual exclusions.

(e) Changes in market structure and business models mayaffect the scope for conflicts of interest. For example, infirms with lower levels of horizontal integration there maybe less scope for inappropriate sharing of information andclearer distinction between principal and agent roles.

Structural break-up of FICC firmsto separate market making and

other complementary FICCbusinesses

Improved use and monitoringof information barriers and

functional/physical separation ofbusiness lines

Clearer guidance on, and greatermonitoring of, the use of

electronic communication

Improved design of trading floorsand development of related

standards which can be monitored

Incorporating more detailedprovisions regarding informationflows and contractual standards

into market/firm codes of conductSource:

RegulatorySource:

Market/Firm

Figure A Spectrum of responses to ‘information flows’ issue


5.2.3 Promoting effective competition throughregulatory and legislative initiatives12 As described in Section 1, the Review is keen to harnessmarket forces, incentives and competition to shape marketstructures. Nonetheless, these markets are also subject tocompetition scrutiny by the authorities, and if competition isdeemed not to be working effectively, there may be benefitsto further regulatory intervention. Such intervention couldrange from creating new regulatory rules to promotetransparency, to more significant structural reforms. TheReview is nevertheless conscious of the risk of unintendedconsequences. The current market structure of multi-servicefirms combining both principal market making and agencybroking flowed from the abolition of so-called ‘single capacity’firms at the time of the ‘Big Bang’ — a decision in whichcompetition considerations played an important role. Sothere can be no guarantee that using competition policy toremove one vulnerability will not introduce others. TheReview would nevertheless welcome respondents’ opinions onwhether there is a need for competition authorities to assesscompetition levels in any of the key FICC markets.

13 The Review would be interested to hear views on whetherthere are any other regulatory interventions that could behelpful in promoting competition and market discipline inFICC markets. In replying to this question, respondents shouldtake the post-crisis package of regulatory changes designed toreduce the probability of future crises as given.

14 There is a well-developed body of competition law andregulation in the United Kingdom and at EU level. Broadlyspeaking, FICC market participants are prohibited fromentering agreements which have as their object or effect: therestriction of competition; abusing a dominant marketposition; or engaging in cartel activity. Levels of fines forinfringement of such prohibitions can be significant, with theUnited Kingdom and the European Commission for examplecapable of imposing fines up to a maximum of 10% of afirm’s worldwide turnover for the preceding business year.Evidence from recent misconduct cases suggests that thepotential applicability of this law to FICC market structuresand practices may be under-appreciated. The Review wouldbe interested in understanding the extent of awareness of

these competition issues among firms and individualsoperating in the FICC markets, and the extent to whichrespondents judge that these implications should be moreclearly highlighted.


Q14: Is there a relationship between the level ofcompetition in FICC markets globally and the fairness andeffectiveness of those markets? What risks are posed bythe increase in concentration seen in some FICC markets?In answering this, please have regard to the geographicalscope of any relevant markets.

Promoting effective competition through market forces Q15: To the extent that competition is currentlyineffective in any of the FICC markets, are there market-ledinitiatives, technological or structural changes that mayremedy this situation?

Q16: Are there any lessons that can be drawn fromexperiences in other financial markets (or indeed othermarkets) about the ways that alternative or evolvingmarket structures could impact on competition inFICC markets?

Q17: How effective is market discipline in enforcing soundmarket practices in each of the key FICC markets? Whatcould be done to strengthen it?

Promoting effective competition through regulatory andlegislative initiativesQ18: In what ways might competition in any of the keyFICC markets usefully be addressed by competitionauthorities (eg by assessing the state of competition inrelevant markets)?

Q19: Are there any additional regulatory reforms thatcould be helpful in promoting competition and marketdiscipline in FICC markets?

Q20: Is there a need for better awareness andunderstanding of the existing competition frameworkamong FICC market participants, both at firm and individuallevel? How do you think that might be best achieved?

Such changes may be effected by market forces includingdisruptive innovations, by regulation or by a response toconcerns at the level of competition within a market asdiscussed elsewhere in Section 5.2.


Q12: Where do potential conflicts of interest arise in thevarious FICC markets, and how do they affect the use andpotential abuse of confidential information, both withinand between firms?

Q13: How can the vulnerabilities posed by such conflictsbe reduced? Are existing internal structures and controlprocedures sufficient? Where they are not, are furtherinternal management controls required (such as bettertrading floor design and/or closer monitoring ofelectronic communications within and between firms) oris more radical action required to remove conflictsaltogether?


5.3 Benchmarks

5.3.1 Overview1 As a preliminary output, and separate to the Review’sengagement with the Market Practitioner Panel and itsbroader outreach, the Review produced a report forHM Treasury in August 2014 recommending the extension ofthe UK regulatory framework to cover a range of majorbenchmarks.(1) HM Treasury has now consulted on this reportand plans to lay secondary legislation before Parliament. Theinclusion of new benchmarks under existing legislation is animportant additional step in ensuring consumers and marketparticipants are protected against the risks associated withmajor benchmarks. However, as set out in its report toHM Treasury, the Review considers that this measure onlyforms one part of an overall solution for ensuring theeffectiveness and integrity of benchmarks.

2 Some of the weaknesses in the governance, design andadministration of benchmarks have been well documented inwork undertaken initially by the Wheatley Review in 2012, andsubsequently by IOSCO and the FSB in its work on interestrate and foreign exchange benchmarks.(2) The FCA is activelyengaged with this work. In September 2013, the EuropeanCommission also proposed legislation that will regulate theprovision of financial benchmarks at the EU level, oncenegotiations with the European Parliament and the Council ofthe European Union are completed.

3 Taken together, these initiatives set the direction for thelonger-term international framework for managing the riskssurrounding benchmarks. Given the importance ofbenchmarks within the FICC markets, the Review believes it isimportant to evaluate whether they provide a comprehensivesolution to the problems that have arisen in recent years.Such a solution will necessarily involve collective action byindustry, measures taken by UK authorities, and measures thatrequire collective action at the international level.

4 The Review’s earlier report to HM Treasury focusedpredominantly on measures that could be taken byUK authorities. The European legislation will replace theUK regulatory framework in due course. The Review istherefore focusing on whether there are further industry-levelmeasures or regulatory actions at the international level thatmight be necessary to complete the package of reforms. Theremainder of this section sets out some of the issues that mayneed to be addressed in both of these areas.

5.3.2 Industry-level measures5 One of the key structural issues in financial markets hasbeen how widely investors and end-users have come todepend on benchmarks in recent years, despite the seriousdesign flaws highlighted by Libor and other cases. Thisdemand reflects a number of factors, including a lack of

transparency and valuation challenges in some FICC markets,and changes in asset management performance tracking inrecent years. For example, the recent FSB report on foreignexchange benchmarks highlighted how the WM Reuters fixesare embedded in many multi-currency indices, incentivisingasset managers who track those indices to place foreignexchange trades at the same time as the fix in order toeliminate the tracking error from their portfolios. The reportalso pointed to the need for asset managers to considerwhether the best price for their FX transactions was achievedthrough trading only at the WM Reuters 4pm fixing orwhether it could be achieved at other times of day. TheReview believes this is an important consideration for users ofall benchmarks. Widespread use of a particular benchmarkcan lead to concentration of order flows around a fixing whichcan provide incentives for both front-running andmanipulation. The Review is interested to know more aboutmarket-led initiatives that could reduce the dependency onbenchmarks in order to address this problem.

6 It is also important that market participants make use of arange of reference rates that best suit their particular businessrequirements. For example, the recent FSB report onreforming interest rate benchmarks noted that some financialinstruments (for example, interest rate derivatives) might bebetter served with a risk-free or near risk-free reference rate,rather than one that incorporates a bank credit riskcomponent (like Libor), and recommended the developmentof these alternative rates. Market participants, working inconcert with the official sector, have an important role to playin advancing this initiative.

7 The Review notes there have been several other market-ledreforms to some of the most significant FICC benchmarks.Some important benchmarks have transitioned by changingtheir administrators or evolving their methodology. Thesechanges have been driven by the need to improve thegovernance, quality and viability of these benchmarks and, insome cases, to address conflicts of interest. The Review isinterested in views on whether there are other benchmarksthat should move to a more robust design.

8 There are a number of potential evolutionary steps thatcould be taken to improve the quality and effectiveness ofbenchmark construction — many of which have currently beenimplemented (or are in the process of being implemented) bya number of major benchmark administrators. For example:

• The quality of benchmark design can be strengthened bymaking greater use of data sources that are independently

(1) SONIA, RONIA, WM/Reuters 4pm London Fix, ISDAFix, London Gold Fixing,LMBA Silver Price and ICE Brent futures contract (seewww.bankofengland.co.uk/markets/Documents/femraug2014.pdf for further details).

(2) www.financialstabilityboard.org/publications/r_140722.pdf andwww.financialstabilityboard.org/publications/r_140930.pdf.


verifiable as representative of the market to which thebenchmark relates, for example by using tradeable inputprices rather than subjective quotes. Various administratorsare in the process of developing ways to make greater use ofsuch prices in the construction of these benchmarks.

• The transparency of the benchmark fixing process could befurther increased through other methodological changes, forexample through the development of electronic auctionplatforms or publishing the price inputs used to constructthe benchmark.

• The robustness of benchmarks could also be improvedthrough modifications to their design methodology. Forexample, the FSB has recently proposed widening thelength of the window used to calculate the WM ReutersFX fixes in order to reduce the sort of ‘point in time’ risksdiscussed above. It also suggested alternative benchmarkcalculations (such as a volume-weighted or time-weightedbenchmark price calculated over a longer time period) andchanges to the centring and exact timing of the fixingwindow.

9 These represent just a few examples of how benchmarkgovernance, transparency and methodology can be mademore effective. The Review recognises that each benchmarkis different and that some of these approaches, such asauctions or the use of transparent and tradeable input prices,will not be feasible for every benchmark. The Review wouldlike to know more about potential mechanisms for improvingthe construction of benchmarks, and whether an industrypanel would be desirable as a means of reviewing theconstruction of benchmarks.

5.3.3 Regulatory action10 In July 2013, IOSCO published a report on Principles forFinancial Benchmarks. The IOSCO Principles set out standardsfor benchmarks in four main areas:

• Governance: covering the overall responsibility ofadministrators for the production of benchmarks andtheir responsibility for overseeing every aspect of eachbenchmark’s production.

• Quality of the benchmark: covering benchmark design,the importance of having robust input data and thetransparency of benchmark determinations.

• Quality of the methodology: covering the calculationmethodology of benchmarks, how such methodologies areupdated, and the role of submitters.

• Accountability: covering complaint handling, auditing, andco-operation with regulatory authorities.

11 IOSCO asked benchmark administrators to disclose theircompliance with the principles publicly by July 2014, andintends to review the extent to which the principles have beenimplemented by January 2015. The Review believes that theIOSCO Principles provide a strong framework within which toseek further international convergence. The Review welcomesthe process of self-assessment against the principles that hassubsequently been undertaken by benchmark providers.However, the Review believes there is more work to do toensure there is compliance with these principles for allbenchmarks.

12 In order to achieve this objective, there is a balance to bestruck between further regulation and the role of industry intaking on responsibility for benchmark standards. In itsAugust 2014 report to HM Treasury, the Review recognisedthat the benefits of the United Kingdom’s current regulatoryframework would only outweigh the costs for the mostsignificant UK-based benchmarks. The Review also noted thatthis left open the question of how to deal with the many otherbenchmarks to which the UK regulatory framework will notapply. For these other benchmarks, the Review believes theonus lies on industry to ensure that there is compliance withthe IOSCO Principles. The Review would like to know moreabout the measures industry could take to ensure thiscompliance is achieved.

13 The Review’s benchmark recommendations excludedbenchmarks administered outside the United Kingdom,because the current legislation cannot easily be applied in suchcases. The Review acknowledges that this leaves an issue overhow to ensure there is sufficient regulatory protection for themany overseas benchmarks that UK market participants relyon. This issue will, in practice, be dealt with as part of theEU benchmarks Regulation currently being negotiated.

14 The Review believes that compliance with the IOSCOPrinciples should be the starting point for ensuring thatUK consumers are protected when using benchmarksadministered in other jurisdictions. The question is then howthe new EU regulatory framework will reflect whether abenchmark in another jurisdiction is compliant with theseprinciples or not. The Proposal for an EU benchmarksRegulation proposes a system based on the EuropeanCommission assessing whether a third country provides for alegal framework and supervisory practices for benchmarksequivalent to the EU’s own regime. The Review is interestedto know stakeholders’ views on how an equivalence systemcould be designed to ensure adequate protection for marketparticipants, whilst recognising that other countries may takedifferent approaches to implementing the IOSCO Principles.



Q21: Do current domestic and international initiatives byindustry and regulators to improve the robustness ofbenchmarks go far enough, or are further measuresrequired?

Industry-level measuresQ22: What steps could be taken to reduce the reliance ofasset managers and other investors on benchmarks?

Q23: What additional changes could be made to thedesign, construction and governance of benchmarks?

Q24: Should there be an industry panel to discussbenchmark use and design with the aim of assisting industrytransition?

Regulatory actionQ25: What further measures are necessary to ensure fullcompliance with the IOSCO Principles for financialbenchmarks by all benchmark providers?

Q26: How can the regulatory framework provideprotection to market participants for benchmarksadministered in other jurisdictions in a proportionate way?


5.4 Standards of market practice

1 Sections 5.1–5.3 reviewed possible solutions to structuralchallenges in FICC markets. The next three sections reviewpossible conduct-based solutions — starting in this sectionwith the question of how to ensure agreement to, andcommon understanding of, appropriate standards of marketpractice. Section 5.5 then considers how such standards mightbe embedded in firms’ governance and incentive structures;and Section 5.6 discusses ways to identify and punish breachesof those standards.

5.4.1 Are current standards of market practicesufficient?2 As set out in Section 3, the Review believes that fair andeffective markets require clear and consistently appliedstandards of market practice. Recent enforcement casesreflect clear breaches of basic standards. However such casestypically capture only the most extreme forms of behaviour.To operate effectively, firms and individuals must be in aposition to judge appropriate conduct across a wider spectrumof potential situations.

3 Some market participants have reported that they areuncertain about a number of current FICC market practices.Those reported uncertainties or ‘grey areas’ cut acrossdifferent markets, including foreign exchange and fixedincome, and are summarised in Box 7 on pages 36–37. Many,though not all, relate in some way to the current marketmaking trading model prevalent in many FICC markets. TheReview is seeking feedback from respondents about whetherthere are indeed uncertainties over some or all of thesepractices in one or more FICC markets, and whether there areany other areas that should be added to the list.

4 On one view, these perceived uncertainties are alreadyadequately dealt with by existing, or prospective, regulatory ormarket-wide standards. Fundamental standards in relation tofraud, insider dealing, and market manipulation are set out inlaw. All firms operating in the United Kingdom and authorisedby the FCA are subject to the Principles for Businesses to agreater or lesser degree, as set out in Box 8 on page 38,including in particular Principles 1 (‘a firm must conduct itsbusiness with integrity’), 3 (‘a firm must take reasonable careto organise and control its affairs responsibly and effectively,with adequate risk management systems’) and 5 (‘a firm mustobserve proper standards of market conduct’). Those dealingin exchange-traded FICC products are subject to the rules ofthat exchange. From 2016–17, the provisions of MiFID 2 andMAR will extend protections relating to transparency, thehandling of information, the standard of care owed tocounterparties and clients and market integrity to many moreFICC markets — as discussed in Section 2 and the Appendix.FX and other OTC FICC markets are also covered by variousvoluntary codes of conduct (see Box 9 on page 39). And most

if not all financial firms have their own codes of conductsetting out expectations of management and staff behaviour.

5 On this view, the existing and prospective set of standardsdo the best possible job in setting out appropriate behaviour,recognising that there will always be an important element ofjudgement to trading practices, and being mindful of thevulnerability of overly detailed rules to ‘gaming’ behaviour andtheir limitations in responding to evolving market practices. Inthose circumstances, the main priorities would be, first, toensure that all FICC market participants understand theimplications of those provisions; and, second, to ensure theyabide by them, through a combination of stronger firm-levelcontrols and incentives, and stronger surveillance andpenalties from firms and regulators. Ways of improvingunderstanding are discussed in Section 5.4.2. Controls andincentives are discussed in Section 5.5. Surveillance andpenalties are discussed in Section 5.6.

6 On another view, reported by some market participants tothe Review, market participants would welcome more specificmarket-wide guidance or rules on acceptable market practice.That reflects some combination of: (i) a desire for greatercertainty than that provided by current regulatory provisions;(ii) a perception that existing voluntary market codes areeither too numerous, too focused on technical market issuesrather than market practices, too dated, too legalistic to havetraction with FICC traders, or lacking in enforcement powers;or (iii) gaps in the regulatory perimeter in a small number ofFICC markets. On that view, it would be unwise to leave thedetermination of market standards to bilateral negotiationbetween FICC market participants alone.

7 Section 5.4.3 asks about the extent to which the industry,working with the authorities, may be able to develop its ownset of more specific standards whilst avoiding some of thepitfalls of previous attempts to develop industry codes.Section 5.4.4 asks whether the regulatory perimeter needsadjusting.

5.4.2 Improving knowledge of existing standards8 The Review seeks views from respondents on whether morecan be done by industry, firms and regulators to improve theunderstanding of existing codes and regulations by FICCmarket participants and their managers. Part of the answermay involve doing more to translate existing requirementsinto simple, clear language that can be widely used on tradingfloors. A number of firms have been undertaking suchexercises in recent years — but report it to be a challenge todevelop guidance that is neither too broad (and thus hard toapply to specific cases) nor too specific (and thus long andoverly fitted to individual cases).

9 Another approach would be to introduce some form ofcompulsory professional qualification or attestation for FICC


Box 7Reported uncertainties over FICC marketpractices

This box summarises areas of perceived uncertainty over theboundary between acceptable and unacceptable practicereported to the Review in some of its preliminary discussionswith market participants. There will always be at least apotential conflict of interest where market participants aretrading on their own behalf as well as trading for or withclients, and hence competing incentives may be in play.Many of the cited examples relate to intrinsic features of themarket making trading model, and as such are neither new norlimited to FICC markets. Enforcement cases across a range ofmarkets show that there is a high degree of certainty aboutbehaviours that are in clear breach of standards of marketconduct. The questions of interest to the Review are: (a) theextent of any uncertainty amongst FICC markets participantsover how they should apply these standards in less clear-cutsituations; and (b) the extent to which, looking forward,further steps should be taken to reduce any uncertainty, suchas developing more detailed guidance for FICC markets onpractices or appropriate controls, drawing on insights fromparticipants in a range of markets both within and outsideFICC.

Lack of clarity regarding trading relationship betweendealers and end-users In FICC markets, some participants report that there can beconfusion as to whether a dealer is acting in a principalcapacity, or whether they are acting in an agency capacity(with the fiduciary responsibilities that implies). A relatedconfusion can arise around whether a counterparty is placingan ‘order’ or merely communicating an expression of interest.These distinctions have material follow on implications forhow a trade is executed, how information related to that tradeis handled, and what disclosure is appropriate. Thesedistinctions and the potential conflicts that arise also have astrong bearing on most of the issues discussed below.

Distinction between legitimate trading activity andinappropriate ‘front-running’ Dealers in FICC OTC markets act in a principal capacity andmay need to trade at times when they have private knowledgeof a forthcoming trade — in order to respond to other tradeenquiries, hedge pre-existing inventory, and potentially evento pre-hedge the trade in question. Where such tradingactivity may affect the market price, some participants reportthat otherwise legitimate activity may be constrained by aconcern that such trading could be misconstrued as‘front-running’ (ie principal trading in possession of privateinformation designed to take advantage of the anticipatedprice effect of a future order). When a dealer is acting in an

agency role, participants report that the distinction is usuallymuch more straightforward.

Distinction between legitimate trading activity andmarket manipulationMarket participants may need to trade around a specificmarket event, such as a benchmark setting, as part of alegitimate activity such as portfolio rebalancing or riskmanagement. Some participants report a perception thatlegitimate activity may be constrained by a concern that itcould be misconstrued as trading designed to move themarket deliberately in order to secure a specific outcome(such as a favourable payout in a contract referencing abenchmark).

Standards for external communication of marketactivityWhere dealers provide commentary and opinion on currentmarket developments to buy-side clients, this is often referredto as ‘market colour’. Participants report that suchcommunication is an important component of client servicefor dealers in FICC markets. Dealers report that they may alsoneed to share market information with other dealers in orderto risk manage anticipated trading flows. Some marketparticipants report a lack of clear industry guidance, forexample, as to where market colour crosses the line betweengeneral market descriptions and market sensitive informationabout other participants’ trading activity, and whereinterdealer communication crosses the line into collusivebehaviour.

Standards for internal communication of marketactivityA firm acting as principal may need to communicate levels ofclient activity and short-term directional flows internally inorder to assess the risk associated with the firm’s tradingpositions. A firm acting as agent may need to keepinformation about client business confidential. Effective riskmanagement resulting from internal communications maynonetheless adversely impact client execution levels. Somemarket participants report a lack of clear industry standardsregarding internal information sharing.

Lack of granular market-wide standards for clientsuitability In FICC and other markets, dealers use their subjectiveassessment of a client’s suitability for transacting in differentproducts, for example, assessing the clients’ level ofknowledge and sophistication. Some market participantsreport that the lack of common detailed standards for suchassessments leaves scope for interpretation, leading todiffering standards being applied by different dealers,especially in varied jurisdictions. In certain circumstances itmay also incentivise some firms to compete over client

traders and their management to ensure staff understand boththeir general obligations and the specific standards that applyin their markets. In the United States, the Financial IndustryRegulatory Authority (FINRA) requires staff seekingregistration with it to pass an exam — the most relevant toFICC being the General Securities Representative ‘Series 7’qualification. A number of related qualifications already existin the United Kingdom, but none are compulsory. Theseinclude: the Chartered Financial Analyst qualification for assetmanagers and investment analysts; the Chartered Institute forSecurities and Investment qualifications for staff working inthe financial services industry, including one on capitalmarkets; and the Chartered Banker Code of ProfessionalConduct, to which individuals within the supporting banksmay adhere by signing an annual declaration agreeing to bebound by the Code. Approaches in other jurisdictions include,for example, Dutch banking regulators requiring all bankemployees in the Netherlands to swear an oath to upholdstandards. Market participants vary in the extent to whichthey believe such qualifications would prove useful in a FICCcontext. The Review would welcome respondents’ views onthese and other ways to improve understanding of existingstandards.

5.4.3 Can the industry help to establish standards ofmarket practice?10 Some market participants have told the Review that theybelieve that the perceived need for more detailed standards ofacceptable market practice will not be fully addressed byforthcoming regulation alone, and see merit in exploringwhether the industry should develop its own standards forFICC markets, in language that market practitionersunderstand, with the guidance and support of authorities inthe United Kingdom and other jurisdictions. They notehowever that such an exercise would first need to tackle anumber of important design issues that have reduced theimpact of codes in the past:

(a) How to ensure sustainability over time, given industryinnovation? Principles-based standards allow room forinnovation and the exercise of judgement, but lack thespecificity of detailed guidance — something that somefirms indicate they would favour. By contrast, moredetailed guidance is vulnerable to gaming and can quicklybecome out of date unless it is actively refreshed. Thetwo are not necessarily incompatible however: Box 10 on

page 40 describes how the UK Takeover Panel combineshigh-level principles with mechanisms for updatingguidance in real-time through the accumulation of ‘caselaw’ from live cases and the involvement of an active,market-savvy Executive. In FICC markets, such ‘case law’currently tends to be developed by individual firms andtheir legal advisers. Today this analysis is seen asproprietary — but there may be scope for the industry tocentralise this process.

(b) How to differentiate from existing codes? There arealready numerous codes in FICC markets, reflecting theevolution of financial instruments and markets in differentlegal jurisdictions (see Box 9 on page 39). The existenceof multiple codes arguably limits their collectiveeffectiveness, but reflects the desire of individualjurisdictions and markets to retain control over their owndomain. The ACI Model Code, for example, has globalcoverage, but is not universally adopted. And there aremany national codes covering FX markets — althoughFX Global Committees are currently working to introducea common global preamble to those codes. In principle,market participants see merit in developing a single,global approach across a number of FICC markets,commanding broad-based industry support. The Reviewwould welcome respondents’ views on whether that is arealistic objective and, if so, how it might be achieved.Careful thought would also be needed to ensure anyinitiative was consistent with other ongoing exercises,including, for example, the BSRC’s work to establishstandards of good practice for UK banks.

(c) How to give codes teeth? One of the main weaknessesof most current codes is that they lack mechanisms forensuring compliance. Box 11 on page 41 outlines possibleoptions to achieve this. A key challenge wouldbe ensuring that the terms of any code were consistentwith regulatory requirements in each of the jurisdictionsin which the code applied.

(d) How to communicate codes to trading teams? In manycases existing codes are complex, drafted in legal languageand cover many different issues within one document.The Review believes that it is important that the coreprinciples and guidelines should be expressed in a clear,concise way that is accessible and can be communicatedto staff at trading desks.


categorisation, or ‘regime shop’ to limit their liabilities,triggering an inappropriate diminution of market-widestandards.

Allocation of new issues Some market participants expressed concern regarding theopacity of the process for allocating new issue bond

syndications to investors. Currently, new issues are allocatedto investors based on a combination of issuer and dealerjudgement that varies not only between primary dealers butalso between different syndications, rather than followingwell-defined and widely understood market-wide or industryguidelines.


(e) Whether, and how, to customize codes for individualasset classes? Many of the areas of uncertainty so faridentified to the Review are common across FICC markets.But some relate to specific products or asset classes; andsome markets may not face uncertainties. Whether anycode should seek to cover all relevant FICC markets, orwhether there should be a short core code coveringprinciples that apply in all markets, supplemented byadditional modules that deal with specific issues inindividual asset classes, is something the Review wouldwelcome feedback on.

5.4.4 Should the scope of regulation be extended?11 Where existing regulatory requirements and industry-ledinitiatives are judged insufficient to secure markets that arefair and effective, the Review would be interested inrespondents’ views on whether there is a case for extendingthe scope of regulation. Such an extension could involveeither: (a) extending the range of firms and individuals towhom obligations apply; or (b) extending the range offinancial instruments covered by regulation.

12 Regarding the first of these possible extensions, thecurrent regulatory regime for investment business in theUnited Kingdom, derived from MiFID, calibrates theapplication of the FCA Principles for Businesses and otherregulatory requirements according to the nature of the clientand the activities that firms are undertaking. For participantsin wholesale markets, there are two classes of client:

professionals and eligible counterparties (ECPs). ECPs areconsidered to be the most sophisticated investors and theclient categorisation regime provides fewer constraints forthose firms that transact with them. For business done withan ECP, firms are also not generally required to apply some ofthe FCA Principles, for example, Principle 1 (Integrity) andPrinciple 2 (Skill, care and diligence).

13 Certain aspects of this regime will change under the newMiFID 2, which introduces high level principles for firms, intheir dealings with ECPs, to act ‘honestly, fairly andprofessionally’, and communicate in a way that is ‘fair, clearand not misleading’. This is a change from the currentstandard and the FCA will be considering whether it mayextend the application of its Principles to ECP business in thecontext of implementing MiFID 2.

14 The second question is whether there are any financialinstruments that should be brought more fully into the scopeof regulation in order to improve the fairness and effectivenessof specific FICC markets. For any such case there are threesubsidiary questions: (a) what protections does the currentframework provide?; (b) what gaps remain of relevance tofairness and effectiveness?; and (c) what is the cost/benefitcase, bearing in mind the Review’s Terms of Reference as setout in Section 1?

Box 8FCA Principles for Businesses

The FCA Principles for Businesses provide a general statement of the fundamental obligations of firms under the regulatorysystem. This includes provisions which implement EU rules and requirements.

1 Integrity A firm must conduct its business with integrity.

2 Skill, care and diligence A firm must conduct its business with due skill, care and diligence.

3 Management and control A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequaterisk management systems.

4 Financial prudence A firm must maintain adequate financial resources.

5 Market conduct A firm must observe proper standards of market conduct.

6 Customers’ interests A firm must pay due regard to the interests of its customers and treat them fairly.

7 Communications with clients A firm must pay due regard to the information needs of its clients, and communicate information to them in away which is clear, fair and not misleading.

8 Conflicts of interest A firm must manage conflicts of interest fairly, both between itself and its customers and between a customerand another client.

9 Customers: relationships of trust A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for anycustomer who is entitled to rely upon its judgement.

10 Clients’ assets A firm must arrange adequate protection for clients’ assets when it is responsible for them.

11 Relations with regulators A firm must deal with its regulators in an open and co-operative way, and must disclose to the appropriateregulator appropriately anything relating to the firm of which that regulator would reasonably expect notice.


Box 9Codes of Conduct

A wide range of voluntary codes of conduct affect FICCmarkets. These broadly divide into two kinds: those aimedprimarily at traders and other sell-side participants; and thosedesigned for the asset management industry. This box givessome of the more prominent examples.

Codes for sell-side market participants

ACI Model Code (Global):(1) Developed by ACI, the ModelCode was designed to provide a minimum standard for allOTC product markets globally in areas including ethics,trading practices, organisational structures and riskmanagement.

The Non-Investment Products Code (United Kingdom):(2)

Developed by the London Foreign Exchange Joint StandingCommittee, a group of senior FX market participants (underthe auspices of the Bank of England), this code was designedto provide guidance to UK market participants on best practicein wholesale markets for non-investment products, specificallysterling, FX and bullion wholesale deposit markets, and spotand forward foreign exchange and bullion markets.

Guidelines for Foreign Exchange Trading Activities (UnitedStates):(3) Published by the Foreign Exchange Committee,which is sponsored by the Federal Reserve Bank of New York,these guidelines seek to educate FX market participants onbest practices, with the aim of improving market efficiencyand transparency.

Code of Conduct and Practice (Hong Kong):(4) Produced bythe Treasury Markets Association of Hong Kong, and endorsedby the Hong Kong Monetary Authority, this code sets outminimum standards for participants in wholesale treasurymarkets, including FX, money market instruments, debtsecurities, OTC derivatives, repo, commodities and creditderivatives.

Singapore Guide to Conduct and Market Practices forTreasury Activities (Singapore):(5) Designed by the SingaporeForeign Exchange Market Committee, a group of senior FXmarket participants, this code lays out principles to governtrading in OTC FX (spot and forwards), fixed income, moneymarket instruments and derivatives.

Code of Conduct (Orange Book) (Japan):(6) Written by theTokyo Foreign Exchange Market Committee, a group of seniorFX market participants, the Orange Book lays out principlesfor the maintenance of high ethical standards in the Tokyointerbank FX markets.

CISI Code of Conduct (United Kingdom, Ireland, Singapore,India):(7) This set of eight principles was created by theChartered Institute for Securities and Investment and appliesto all its members. Any material breach of the Code isconsidered grounds for terminating membership.

SIFMA Principles and Practices for Wholesale FinancialMarket Transactions (United States):(8) Published andoverseen by the Securities Industry and Financial MarketsAssociation, the Principles are applicable to wholesaletransactions in US OTC markets.

Codes for the asset management industry

CFA Code of Ethics and Standards of Professional Conduct(Global):(9) Developed by the CFA Institute and designed forindividuals involved in either managing client portfolios orproducing investment research. Violating the Code may resultin expulsion from the CFA.

Global Investment Performance Standards (Global):(10)

These standards, also composed by the CFA, relate to howasset managers report their investment performance.

Hedge Fund Standards (Global):(11) These standards focus onissues around fund governance, disclosure and riskmanagement, and are administered by the Hedge FundStandards Board on a ‘comply or explain’ basis.

(1) www.aciforex.org/docs/misc/20131104_ACI_The_Model_Code.pdf.(2) www.bankofengland.co.uk/markets/Pages/forex/FXjsc/default.aspx.(3) www.newyorkfed.org/FXC/2010/tradingguidelinesNov2010.pdf.(4) www.tma.org.hk/pubfile/tmacode.pdf.(5) www.sfemc.org/pdf/Singapore_Blue_Book.pdf.(6) www.FXcomtky.com/coc/code_of_conduct_e2013.pdf.(7) www.cisi.org/bookmark/genericform.aspx?form=29848780&URL=ethics.(8) www.sifma.org/services/standard-forms-and-documentation/cross-product/.(9) www.cfainstitute.org/ethics/codes/ethics/pages/index.aspx.(10) www.gipsstandards.org/Pages/index.aspx.(11) www.hfsb.org/?section=12512.


15 The Review would welcome respondents’ views on thesequestions. In view of recent allegations, one market that hasbeen highlighted to the Review is wholesale transactions inspot FX. The trading of spot FX in the United Kingdom isalready (or will be) subject to a number of protections. First,regulated firms are subject to the FCA’s Principles forBusinesses in limited circumstances when trading spot FX ifeither (a) that trading is ‘ancillary’ to a regulated activity; or(b) that trading is judged to have a negative effect on theintegrity of the UK financial system or the ability of the firm tomeet certain minimum standards for being authorised.Second, manipulation and attempted manipulation of FX benchmarks will be covered as an offence under the EU’s MAR Regulation (which comes into force in July 2016).The Review has also separately recommended that theWM/Reuters 4pm London Closing Spot Rate is subject toregulation, and that attempted manipulation of thisbenchmark is made a criminal offence. Third, standards oftrading practice in the spot FX markets are subject to variousvoluntary codes overseen by central bank-sponsored foreignexchange committees — including the Non-InvestmentProducts (NIPs) Code in the United Kingdom. In April, thoseCommittees agreed to issue a joint global high-level principles

statement on FX trading.(1) Finally, in certain circumstancesthe criminal law can apply to spot FX trading, for example,where behaviour amounts to fraud.

16 Against that backdrop, the Review would welcomerespondents’ views on whether there are further protectionsagainst misconduct in these wholesale markets that should bedelivered through regulatory means. Factors relevant to thecost/benefit assessment could include: the importance of aninternationally co-ordinated approach (given the global natureof FX markets, and the fact that many countries’ currenciesare traded outside of their borders), the interaction withmacroeconomic policymaking (given the variety of exchangerate regimes operated by central banks around the world) andthe extent to which reporting of trading data, possibly frommultiple jurisdictions, is required to implement any extensionin regulation.

Box 10The Takeover Panel

In considering possible means of defining and enforcingstandards of conduct in the FICC markets, the Review hasconsidered examples of practice in other financial markets.Though operating in a very different environment, the Panelon Takeovers and Mergers (or ‘Panel’ for short), whichregulates takeovers of UK-listed companies under the CityCode on Takeovers and Mergers (or ‘Takeover Code’ for short),offers a number of potentially useful insights:

• The Takeover Code contains a set of high-level generalprinciples. These are broad enough to accommodatesubstantial developments in market practices withoutthemselves requiring major modification (the principles arelittle changed in substance since the Panel was set up in thelate 1960s).

• To give market participants greater certainty about theapplication of these principles, whilst also allowing thatapplication to adjust over time in line with marketdevelopments, the Panel uses two main tools. First, theTakeover Code contains a more detailed set of rules, whichare updated from time to time. Second, the Panel Executiveis available to advise or adjudicate on uncertainties ordisputes over specific applications of the Takeover Code asthey arise during the course of a takeover, if necessary atspeed. In so doing, the Panel builds up a large body of ‘case

law’ against which it is able to evaluate future cases. Thereis an appeals process for disputed rulings.

• The Panel has both formal and informal means of enforcingits decisions. The Takeover Code now has a statutorybacking through provisions of the Companies Act 2006,though it was for the majority of its life a whollyself-regulatory regime. Where breaches or abuses occur, thePanel can issue private and public censure of firms andindividuals, report the cases to the FCA, and, in the case ofthe most serious misconduct, ban individuals frominvolvement in transactions to which the Takeover Codeapplies. The threat of using the more serious of thesepowers is, however, sufficient to ensure they are deployedonly very rarely.

• The Panel maintains a close relationship with the marketthrough senior membership of its Code Committee (whichexercises the Panel’s rule-making functions and isresponsible for changes to the Code) and its HearingsCommittee (which reviews decisions of the Executive), andthrough regular secondments to the Executive of industryhigh fliers, who continually refresh the Executive’sknowledge of the market and take back an understanding ofthe Panel’s work to their respective institutions. The Panel isa self-funding body, relying on charges levied on marketparticipants in relation to transactions overseen by thePanel.

(1) Minutes of the Meeting of Global Foreign Exchange Committees, 11 April 2014,available at www.rba.gov.au/afxc/meetings/gfxc/2014/gfxc-minutes-20140411.html.



Q27: Are existing sources of information regardingstandards of market practice across FICC markets globally: (a) already sufficiently clear (or will be oncecurrent regulatory reform has concluded); (b) sufficient,but in need of clearer communication or education efforts;or (c) not sufficiently clear, requiring more specificguidance or rules to provide more detail or close genuinegaps?

Q28: Box 7 on pages 36–37 discusses a number ofuncertainties over FICC market practices reported bymarket participants, including: the need for greater clarityover when a firm is acting in a principal or an agencycapacity; reported difficulties distinguishing betweenlegitimate trading activity and inappropriate front-runningor market manipulation; and standards for internal andexternal communication of market activity. To the extentthat there are uncertainties among participants in thedifferent FICC markets over how they should apply existingmarket standards in less clear-cut situations, whatare they?

Q29: How could any perceived need to reduceuncertainties best be addressed: (a) better education aboutexisting standards; (b) new or more detailed market codeson practices or appropriate controls; or (c) new or moredetailed regulatory requirements?

Will these uncertainties be dealt with by current reforms?Q30: How can the industry, firms and regulators improvethe understanding of existing codes and regulations by FICCmarket participants and their managers?

Q31: Should there be professional qualifications forindividuals operating in FICC markets? Are there lessons tolearn from other jurisdictions — for example, the FinancialIndustry Regulatory Authority’s General SecuritiesRepresentative (or ‘Series 7’) exam?

Can the industry help to establish better standards ofmarket practice?Q32: What role can market codes of practice playin establishing, or reinforcing existing, standards ofacceptable market conduct across international FICCmarkets?

Box 11Methods for ensuring compliance with codes

(a) Self-certification: participants who claim to use a codecould be required periodically and publicly to certifytheir compliance, either on their websites or in theirannual reports. An example of an existing system ofself-certification in the financial markets is therecently-introduced regime relating to the IOSCOPrinciples for Financial Benchmarks.

(b) Comply or explain: participants could be required eitherto confirm their compliance or to explain their reasons fornon-compliance with specific provisions. An example ofexisting codes employing the comply or explain approachare the UK Corporate Governance Code,(1) which placesdisclosure obligations on premium listed companies in theUnited Kingdom; and the Hedge Fund Standards of theHedge Fund Standards Board,(2) which maintainsgovernance and transparency standards for the hedgefund industry.

(c) Contract: Market participants could incorporatecontractual undertakings to comply with a marketconduct code directly into their contracts with marketcounterparties, or their employment contracts withemployees. Trade bodies producing widely usedcontractual standards in the FICC markets (such as ISDAand ICMA) could have an important role in any suchapproach.

(d) Independent oversight body: A market conduct codecould be overseen and/or policed by an independent body,for example, a panel of market experts. While such amarket body would not have statutory power to enforce acode’s provisions, it could police a code through a mixtureof moral suasion, public/private direction or reprimand,and dispute resolution services between marketparticipants in relation to a code’s provisions. The UK’sTakeover Panel, which is described in Box 10, is anexample of such a body.

(e) Official regulatory endorsement: The status of a marketconduct code could be strengthened by formal regulatoryendorsement. Regulators in Australia, Hong Kong, Japan,Singapore, the United Kingdom and the United Stateshave publicly supported codes used in currency and bondmarkets, but there may also be potential for internationalregulatory bodies, such as the FSB or IOSCO, to endorseor sponsor market codes of practice. Even where aregulator does not have formal statutory powers toendorse a code, a certain amount of moral suasion by aregulator could significantly strengthen both a market’sawareness of a code and its compliance with theprovisions of such code. It is however very important thatthe precise relationship between codes and regulatoryrequirements is made clear.

(1) www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspx.

(2) www.hfsb.org/?section=12512.

www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspx

www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Corporate-Governance-Code.aspx


Q33: How would any code tackle the design issuesdiscussed in Section 5.4.3, ie: how to ensure it can bemade sustainable given industry innovation over time?How to differentiate it from existing codes? How to giveit teeth (in particular through endorsement by regulatoryauthorities or an international standard setting body)?How to communicate it to trading teams? Whether, andhow, to customise it for individual asset classes?

Should the scope of regulation be extended?Q34: In the context of implementing MiFID 2, which ofthe FCA Principles for Businesses should apply in relationto MiFID business with Eligible Counterparties?

Q35: Are there any financial instruments that shouldbe brought more fully into the scope of regulation inorder to improve the fairness and effectiveness ofspecific FICC markets? For any instruments proposed:(a) what protections does the current framework provide;(b) what gaps remain of relevance to fairness andeffectiveness; and (c) what is the cost/benefit case, bearingin mind the Review’s Terms of Reference as set out inSection 1?


5.5 Responsibilities, governance andincentives

5.5.1 Overview1 Section 5.4 reviewed the need for clearer standards of goodmarket practice in FICC markets. This section asks how suchstandards can be embedded within firms’ internal processes ina way that ensures they have lasting impact, and aresafeguarded against the pressures that can arise at differentpoints in the financial cycle. In terms of governance, thequestion is how firms can create a framework of responsibilityand accountability for their management and staff whichsupports and enforces standards of behaviour, and embedsthese in day-to-day operations. In terms of incentives, thequestion is how firms can incentivise employees to behave inthe right way.

2 Important initiatives are under way in this area, within firms,at an industry level (eg through the proposals of the BankingStandards Review Council) and through regulation (includingthe proposed new Senior Managers and Certification (SMC)Regime). The Review is keen to consider what further stepsmay be needed to strengthen and deepen the impact of thesechanges in a FICC context.

5.5.2 Firm-wide initiatives to improve incentives andgovernance 3 Since the crisis, CEOs in many major financial institutionshave signalled a determination to improve standards ofbehaviour within their businesses, taking steps such asre-writing internal codes of conduct, strengthening boardoversight, and re-training staff. There has also been a push tostrengthen the so-called ‘first’, ‘second’ and ‘third lines ofdefence’ in FICC trading operations (referring to theresponsibility of line management, compliance andindependent auditors respectively to ensure sound riskmanagement).

4 There are mixed reports on the extent to which suchinitiatives have so far produced lasting change. In some cases,firms appear to have made genuine progress. Marketpractitioners have told the Review that it could play animportant role in highlighting these examples of goodpractice. However, they have also identified a number ofsignificant challenges delaying progress more widely. Withouta degree of consistency or minimum standards across theindustry — something the authorities might be able tocatalyse — there was felt to be a risk that some firms mightseek to ‘free ride’ on the efforts of others, slowing or haltingthe pace of continued change. The following areas wereidentified as particular priorities by practitioners.

(a) Improved performance measures:

(i) Individuals — market practitioners highlighted theimportance of a more balanced approach to individual

performance assessment and remuneration. Narrowrevenue-based measures of performance assessmentshould be complemented by a wider set of metricsreflecting good client outcomes and other subjectivecriteria to reinforce best practice in culture andbehaviour. But ensuring these metrics receivedsufficient attention over the cycle was a keychallenge.

(ii) Firms — performance measures might also be used toincentivise better conduct risk management by firmsas a whole — for example, by measuring conductperformance against public yardsticks. Some firmsalready do this on a stand-alone basis, but there maybe scope for a consistent industry-wide approach, asproposed, for example, by the Banking StandardsReview Council (see Section 5.5.3). A single,objective, industry-wide definition of costs arisingfrom misconduct and its transparent disclosure infirms’ annual (and/or corporate social responsibility)reports could also be explored as a way ofincentivising improved ethical behaviour across theFICC sector.(1)

(b) Adjustments to remuneration: some firms have reducedbonus pools and other forms of remuneration to reflectmisconduct issues — but this has been variable across theindustry. In the United Kingdom, banks and investmentfirms are covered by the FCA and PRA RemunerationCode, which obliges the larger and more significant firmsto reduce or cancel deferred variable remuneration(known as ‘malus’) in the event of employeemisbehaviour, material downturns in firm performance, orfailures of risk management. Fund managers are alsosubject to the AIFMD Remuneration Code, which requiresthat delayed variable remuneration should only be paidout if that payment is sustainable and justified. Firms willneed to make full use of these powers,(2) and in future tomake use of new powers to reclaim remuneration alreadypaid (known as ‘clawback’).(3) Some market participantssuggested that powers and obligations such as thesemight be extended to other firms active in FICC marketswho are not already covered by these remunerationprovisions, including all asset managers, interdealerbrokers, and trading firms.

(c) Safeguards against inappropriate staff moves: manyFICC markets have close-knit trading communities across

(1) The work of the London School of Economics Conduct Costs Project and theCCP Research Foundation (www.ccpresearchfoundation.com) could provide aframework for further development in relation to industry-wide performancemeasures relating to conduct.

(2) Under the malus provisions in CRD 4 Art 94 (banks) or AIFMD Art 13/Annex II(investment firms).

(3) Under the new provisions inwww.bankofengland.co.uk/pra/Documents/publications/ps/2014/ps714.pdf.


the sell and buy-side. Traders commonly move jobsfrequently, and, it has been suggested, may sometimesfeel greater loyalty to their desks and peers in the marketthan to their current firms. In that context, a particularconcern voiced by some firms was that it was too easy foremployees who had to a greater or lesser extentcontravened standards of good market practice at onefirm simply to move to another firm, even if they hadbeen subject to qualified withdrawals under the existingApproved Persons regime. Ongoing regulatory reforms gosome way to address this. For example, the PRA and FCAare seeking views on rules to prevent an employee’sdeferred bonuses being shielded from forfeiture aftermoving to a new employer. And for important roles theproposed SMC regime will require firms to seek jobreferences covering the last five years. Other possiblesolutions, subject to the requirements of employmentlaw, may include: mandating greater openness from firmsabout cases of staff misconduct; and improving thesupply of information about employees’ past records.

(d) Promotion and advancement: firms’ decisions onpromotion and advancement can send powerful messagesto employees regarding expected standards of behaviour.In tandem with improvements in performance measuresas discussed above, a more consistent approach is neededtowards taking account of behavioural factors whenpromoting staff to senior positions within FICC businesses.For example, the decision to award a management role toan individual who has scored poorly on conduct issuesduring performance assessments could be subject toreview by senior management and the board prior to theappointment being made.

(e) Involvement by boards in the governance of FICCactivities: in general, boards have become much morefocused on the need to enforce higher standards on FICCtrading floors. In some major FICC firms, new governancestructures have been introduced to strengthen the weightplaced on reputational considerations in trading decisions,including new (and existing) product and transactionreview committees and reputational oversight groups.However, practitioners highlight the challenges ofensuring that boards can in practice identify gaps betweentheir stated values and what is happening on tradingfloors, particularly where business has developed in silos(as is common in many FICC firms). The proposed SMCregime addresses this at a high level by defining seniormanagement responsibilities in relation to culture andbehaviours. Market practitioners have neverthelesshighlighted the importance of improving the metrics thatboards use to monitor conduct in FICC business. And theBasel Committee’s recent consultative document oncorporate governance(1) highlights the importance ofensuring during selection processes that board members

have skills relevant to the firm’s business and risk profile.The Review is interested in the extent to which the boardsof institutions with a major FICC market presence couldbe required, or at a minimum encouraged, to includemore members with direct FICC market experience(current information suggests this coverage is extremelylimited).

(f) Front line responsibilities: market practitioners recognisethat delivery of higher standards in complex FICC marketscannot be left solely to a central compliance or auditteam. The key responsibility in the first instance lies withtraders themselves and those managing them. This firstline of defence is closest to actual transactions and clients,best able to observe misconduct by colleagues, andtherefore best placed to form an understanding of how aparticular form of behaviour could impact clientoutcomes. Market participants have however told theReview that the role, responsibilities and powers of frontoffice supervision needs to be more clearly defined, aswell as supported by more regular training for front officestaff to remind them of the standards to which theyshould adhere. The role, size and reporting lines ofcompliance and audit functions also needs careful reviewto ensure they complement the efforts of front officesupervision. The role of compliance and audit wasreported to be more challenging in FICC businesses, whichwere subject to less formal regulation, and required agreater ability to form judgements and compare emergingrisks across business silos. Some participants stressed theimportance of ensuring high fliers were rotated throughcentral functions in order to strengthen the impact ofthose functions, and improve knowledge of their roles.

5.5.3 Market-wide initiatives to align market conduct,incentives and governance 5 Participants stressed to the Review the importance ofensuring a common commitment from all of those engaged inFICC markets to raising standards in the areas covered in thissection. The need for such improvements in the bankingsector was recognised by the Parliamentary Commission onBanking Standards, which expressed support for a professionalbody to promote higher standards in the banking industry.Leading on from this, one of the aims of the newly-establishedBanking Standards Review Council (BSRC) will be to develop aprocess by which banks can assess and improve their standardsof behaviour and professionalism against a commonframework. Firms, which participate on a voluntary basis, willsubmit the results of their self-assessments to the BSRC, whowill collate, validate and publish the information. The BSRC’swork will also cover improving the uptake and value ofprofessional qualifications and training in the banking industry.

(1) See www.bis.org/press/p141010.htm.


6 The BSRC aims to attract participation from all firms in theUK banking industry, including those with a FICC marketpresence. This is not however expected to include othernon-banking firms that are participants in the FICC markets,such as hedge funds, asset managers and end-users. TheReview would be keen to hear views on whether these otherkey FICC institutions should engage in a similar process ofassessment — either by seeking to participate in the BSRC’swork, or by developing a parallel process for the wider FICCmarkets. This would help to ensure that efforts to raisestandards in governance and culture eventually benefit FICCmarkets as a whole, and not just a segment of the firmpopulation.

5.5.4 Regulatory initiatives to improve governanceand incentives 7 In response to recommendations from the ParliamentaryCommission on Banking Standards, a number of UK regulatoryinitiatives are under way, seeking to align market conduct,incentives and governance more closely. Two key initiativescurrently being jointly consulted on by the PRA and FCA arethe revised remuneration rules(1) and the proposed newSMC rules.(2)

8 The remuneration regime has recently introduced clawbackprovisions for bonuses in certain circumstances. There areproposals under consultation to extend the length of bonusdeferrals for up to seven years to allow more time for ex-postadjustments, which in turn will allow firms to alignremuneration more closely with any subsequent discovery ofmisbehaviour. The PRA and FCA are seeking views on thetreatment of ‘buy-out’ awards, which result in an employee’sdeferred bonuses being shielded from forfeiture after movingto a new employer.

9 The proposed SMC regime will introduce three broadchanges in governance. First, it will introduce the allocation ofdetailed responsibilities to specific individuals who hold seniormanager roles and may be held accountable for failures in thearea for which they are responsible. Second, the SMC willrequire firms to assess and certify the fitness and propriety ofemployees whose role presents significant risk of harm to thefirm or its customers. Third, the SMC will introduce a set ofenforceable conduct rules which will apply to all seniormanagers and to their respective populations within thecertification regime. In addition, the FCA proposes to applythe Conduct Rules to all other employees of relevant firmsexcept staff carrying out purely ancillary functions. These

proposed measures will apply to banks, building societies,credit unions and PRA-designated investment firms. There is aquestion about whether similar measures should also beapplied to other types of firm engaged in the FICC market,such as hedge funds and interdealer brokers, either in a full ora more tailored version.


Q36: How much of a role did inadequate governance,accountability and incentive arrangements play in therecent FICC market abuses, and to what extent do theseremain potential vulnerabilities in FICC markets globally?In addition to on-going regulatory changes, what furthersteps can firms take to embed good conduct standards intheir internal processes and governance frameworks?And how can the authorities, either internationally ordomestically, help to reinforce that process, whetherthrough articulating or incentivising good practice, orthrough further regulatory steps?

Firm-wide initiatives to improve incentives and governanceQ37: Do respondents agree that the thematic areashighlighted in Section 5.5 are key priorities for FICC firms(fine-tuning performance measures; adjustments toremuneration; attitudes towards hiring, promotion andadvancement; closer board involvement in governance ofFICC activities; and clearer front line responsibilities)?What specific solutions to these challenges have workedwell, or could work well? And how best can the authoritieshelp to support these initiatives?

Market-wide initiatives to align market conduct, incentivesand governance Q38: To what extent could the Banking Standards ReviewCouncil help FICC market participants to raise standardscollectively — in particular, are there other steps that couldbe taken to help complement or extend this initiative inFICC markets for non-banks and internationally?

Regulatory initiatives to improve governance and incentivesQ39: Are there other regulatory measures the authoritiescould take to strengthen personal accountability orotherwise improve the way firms manage incentives andgovernance? In particular, should any or all of the measuresin the Senior Managers and Certification regime beextended to non-bank firms active in FICC markets?

(1) See www.bankofengland.co.uk/pra/Pages/publications/cp/2014/cp1514.aspx.(2) See www.bankofengland.co.uk/pra/Pages/publications/cp/2014/cp1414.aspx.


5.6 Surveillance and penalties

5.6.1 Overview1 Sections 5.4 and 5.5 discuss ways to improve standards ofmarket practice in FICC markets, establish clear responsibilitiesfor reaching those standards, and provide positive incentivesto do so. This section discusses how to deal with those whonevertheless engage in misconduct, looking in turn atmeasures that increase the likelihood of being caught(surveillance) and/or increase the cost to those responsiblefor wrongdoing when they are caught (penalties).

2 The Review notes that looking out for, and punishing,misconduct is a shared responsibility between the industry,firms and authorities. Though the focus is often greatest onregulatory surveillance, supervision and enforcement, theReview believes there is scope to strengthen firm andindustry-level action as a first line of defence. A key questionfor this Review therefore is identifying areas where, once clearstandards for FICC markets are established, firms can play amore prominent role in enforcing them. Sections 5.6.2 and5.6.3 discuss such areas, while sections 5.6.4 and 5.6.5 coverthe potential role of regulatory-led initiatives.

5.6.2 Firm and market-level surveillance3 Firms have a range of systems and controls in place todetect misconduct by their staff. During its preliminaryfact-finding, the Review has heard views that these systemswere underdeveloped or had atrophied in some firms prior tothe crisis, partly reflecting the perceived lack of detailedregulatory requirements compared with other markets and themodest level of price transparency. Since the crisis, firms haveincreased investment, including through innovative techniquessuch as electronic surveillance. This subsection focuses onhow surveillance measures could be developed further or usedmore uniformly.

4 At the most basic level, employees must feel able to reportinstances of malpractice and be confident that these will bedealt with seriously and effectively, and that reporting will notbe to their detriment. However, there are examples in pastmisconduct cases of staff reporting concerns within theirorganisations, but appropriate action not being taken. TheUK authorities believe that effective whistleblowingprocedures that establish clear ways to report while offeringprotection to the whistleblower can play an important role inhelping to prevent and detect wrongdoing.

5 There has been debate in the United Kingdom andelsewhere about whether more could be done to encouragewhistleblowing in the financial sector. The ParliamentaryCommittee on Banking Standards (PCBS) published a numberof recommendations on this issue, many of which areaddressed to the industry. The FCA and PRA have already

expressed their agreement with many of the PCBSrecommendations, noting that a culture where people areprepared to speak up can significantly improve behaviourthroughout a firm. In particular, they agree that firms shouldhave effective whistleblowing mechanisms, and that a seniormanager should have accountability for these, and forprotecting whistleblowers. The proposed new SeniorManagers and Certification (SMC) regime includes arequirement for a senior manager to have explicitresponsibility for overseeing the integrity of whistleblowingprocedures within firms.

6 But it is not just the responsibility of the authorities topromote whistleblowing. The industry can also play a role inhelping to promulgate best practices on how to makewhistleblowing regimes more effective, and how to ensurethat employee concerns about more ‘borderline’ issues arealso escalated, alongside those involving clear breaches ofpolicy/regulations. In that context, the Review welcomes therecent launch by the Chartered Institute for Securities andInvestment of a ‘Speak Up’ programme designed to encouragefirms to adopt policies that help staff report violations ofcompany policy, the law or any other failing that impactsstandards.

7 The significant increase in availability of real-time tradingdata in some markets and advances in analytical techniquesmean that firms can now use ‘big data’ tools to complementother existing techniques for monitoring trading behaviour.Such approaches are currently being explored by some marketparticipants, and offer scope to detect anomalies in tradingbehaviour which could reflect malpractice. Advanced versionsof these tools also incorporate analysis of email, chatroom andphone usage (including digitised voice recording) to highlightpossible misconduct by identifying certain words and thecontext in which they are used. The Review has neverthelessheard of a number of challenges to applying these techniquesmore widely, including the variation in availability ofmarket-wide pricing and trading data across FICC markets,and siloisation in some firms of staff and systems. The Reviewis interested to hear respondents’ views on whether these orother techniques and processes could help increase thechances of misconduct being identified at a firm level.

5.6.3 Firm-level penalties and market discipline8 Firms should have sufficiently strong sanctions in place todeter bad behaviour. In the pre-crisis period, someparticipants have described a ‘low’ or ‘no consequences’culture in which misconduct by high-earning staff was quietlydisregarded, or dealt with by an unpublicised dismissal. Insuch circumstances, traders released by one firm could oftenreappear in the market soon after at another firm.

9 As discussed in Section 5.5, penalties that could be used totackle this include: disclosure to another firm of an


individual’s bad behaviour (subject to employment law-relatedrestrictions); the ability of firms to apply malus to unvestedbonus awards; and, from 1 January 2015 for PRA-regulatedfirms, the claw back of remuneration already paid out.

10 As well as firms using penalties to discipline individualmembers of staff, there is also scope for the market as awhole to police itself more effectively, punishing firms withpoor conduct records through the removal of business. Theability of the buy-side to punish poor behaviour of thesell-side (or vice versa), for example, by reducing or stoppingbusiness with a misbehaving bank for a period of time, is animportant form of market discipline. However, as discussedin Section 5.2, the Review has heard from some marketparticipants that the scope for such policing may havebecome more limited following the financial crisis asconcentration in certain markets, combined withresponsibilities to execute at the best available prices onbehalf of clients, and the consequent need to maintainaccess to liquidity, has limited the scope for firms to movetheir business away from firms perceived to be engaging inabusive behaviour. In addition, it may be difficult for marketsto self-police when there is partial or incompleteinformation. The Review would be interested to hear viewson whether market discipline is being constrained and, if so,how these constraints could be overcome.

11 On occasions there may be cases where a firm chooses totake business away from another firm in response to what are(or are perceived to be) regulatory breaches. The FCAPrinciples for Businesses require firms to disclose to theappropriate regulator anything relating to the firm of whichthat regulator would reasonably expect notice. In addition,firms arranging transactions in certain financial instrumentsare required to report suspicious transactions to the FCAwithout delay under the Suspicious Transaction Reporting(STR) regime. The current regulatory architecture meansmost FICC markets remain out of scope of the STR regime;but the Market Abuse Regulation (MAR) and MiFID 2 willextend coverage to most FICC markets. It is crucial that allFICC market participants report suspected misconduct to theFCA in addition to any bilateral action against the relevantfirm, for example, through a temporary suspension of newbusiness.

5.6.4 Regulatory-level surveillance and supervision12 Although substantial responsibility for policing behaviourlies with firms, that must be backed by strong surveillance,supervision and enforcement by the public authorities. Inrecent years, the supervision of wholesale market conduct hasbecome more forward looking in orientation around the world,reflecting the experience of the financial crisis. The FCA has astrategic objective to make markets function well. Its threeoperational objectives are to protect consumers, to upholdmarket integrity and to promote competition.(1)

13 The FCA has set out what it expects of firms operating inwholesale markets, which includes: that firms behave in amanner consistent with the capacity in which they act(eg agent or principal); that firms know when to keepinformation confidential, or share it; and that firms haveadequate controls over their traders and ensure that theyobserve market conduct rules. In addition, the FCA has beenclear that it expects market participants to act as the first lineof defence against market abuse and has articulated itsexpectations for market infrastructure focused on:operational resilience; effective systems and controls toidentify and prevent abusive trading activity; and effectivegovernance.

14 In its Business Plan for 2014/15(2) the FCA set outspecific plans for more intensive supervision of wholesaleconduct, including: evaluating controls at investment banksover conflicts of interest; evaluating controls over the use ofinformation by investment banks; and evaluating controlsover traders contributing to benchmarks. As part of itswholesale conduct strategy, the FCA has also implementeda new supervisory approach for trading firms (interdealerbrokers, agency brokers, high frequency traders and otherswith an impact on the market infrastructure). That includesreviewing firms’ activities, analysing business models and thedrivers of conduct risks (including trading culture, behaviourand controls), and identifying forward-looking risks throughspecialist sector teams.(3) Other areas of focus for the FCAhave included establishing regulatory priorities for thecommodities markets,(4) and setting more robust expectationsfor the timely and proper dissemination of regulatedinformation by issuers.(5)

15 Within this, however, supervision of the FICC marketsposes a number of particular challenges. Comprehensivetransaction and pricing data are not currently available to theFCA (although that will improve once MiFID 2 has beenimplemented in January 2017). The FICC markets are alsoglobal in scope, draw in many players from the regulated andnon-regulated sectors, and are subject to a complexpatchwork of regulatory requirements, as set out in Section 2and the Appendix. All of these factors mean that there is aglobally evolving understanding of the extent and nature ofsupervision for FICC markets.

5.6.5 Regulatory level penalties16 In 2008 the predecessor to the FCA, the FinancialServices Authority (FSA), announced that enforcementpowers needed to become a credible means of deterring

(1) See Financial Services Act 2012.(2) See www.fca.org.uk/news/business-plan-2014-15.(3) See www.fca.org.uk/static/documents/corporate/annual-report-13-14.pdf#chapter-3.(4) See www.fca.org.uk/static/documents/commodity-market-update-1402.pdf.(5) See www.fca.org.uk/static/documents/policy-statements/ps14-02.pdf.

www.fca.org.uk/static/documents/corporate/annual-report-13-14.pdf#chapter-3


wrongdoing in financial markets, and that wrongdoers had torealise that they would face a real risk of being caught and ofincurring significant financial penalties. More recently, theFCA confirmed it would take the same approach andhighlighted its intention to pursue a more assertive andinterventionist approach to wrongdoing in wholesalemarkets.(1) It has since issued fifteen final notices formisconduct in FICC markets and imposed more than£700 million in financial penalties.

17 In May, HM Treasury published a consultation on a reviewof the UK enforcement regime, looking at the fairness,transparency, speed and efficiency of the institutionalarrangements and processes for enforcement decision makingat the FCA and PRA. That includes the decision makingprocess for referring cases for enforcement investigation andpossible action; incentives for early settlement; and thearrangements for referring cases to the Upper Tribunal. Thereview will also consider how UK arrangements compare withinternational practice.

18 The ability to bring criminal prosecutions for seriousfinancial misconduct is an important form of deterrence.While criminal convictions are already possible for a range offinancial crimes, such as insider dealing, market manipulationand fraud, the PCBS noted that these generally apply toindividuals or groups and do not cover mismanagement bysenior banking staff. The Government introduced a newcriminal offence in the Financial Services (Banking Reform)Act 2013, which includes reckless misconduct by senior bankmanagers that leads to bank failure. This means that seniormanagers covered by the SMC regime can face criminalpenalties (including imprisonment) if they are involved intaking a decision which causes the institutions to fail, whileknowing the risks around this decision, and if their conduct inrelation to that decision fell far below what could reasonablybe expected of someone in their position. As this is a criminaloffence, the ‘presumption of innocence’ applies and aprosecution can only be brought if it is in the public interest todo so.

19 HM Treasury has also committed to taking domesticaction to ensure that the criminal regime for market abuse isup-to-date and fit for purpose, and to make changes to reflectforthcoming regulatory changes (such as MiFID 2). As part ofthis approach the Government has decided that theUnited Kingdom will not opt into the EU rules set out in theCriminal Sanctions Market Abuse Directive (CSMAD), but thatthe proposed UK criminal regime for market abuse will be atleast as strong as CSMAD. CSMAD creates new minimumcriminal standards for the offences of insider dealing andmarket manipulation, and for behaviour which amounts toinciting, aiding or abetting market abuse. It also makesmanipulating or attempting to manipulate benchmarks acriminal offence. The Review would be interested in views

on whether the coverage of CSMAD is appropriate andwhether activities and instruments should be covered in thedomestic criminal regime that are not currently envisagedunder CSMAD.

20 The Review notes the widespread view amongst marketparticipants that recent high profile enforcement actions havebrought sharply renewed focus on conduct issues, particularlywhere they are seen as targeting individuals. The Reviewbelieves it is important that enforcement actions in FICCmarkets continue to support and enhance credible deterrence.Of particular interest is the appropriate balance betweenfinancial penalties, prohibition of individuals and criminalprosecutions.

21 HM Treasury’s enforcement review will consider theeffectiveness of the current enforcement process. Butenforcement actions generally conclude long after theoffences concerned have taken place, and require a highstandard of evidence. In light of this, the Review is interestedin views on whether there would be a case for making evengreater use of early intervention, including informal toolswhich have been used successfully in the past, such asreaching a voluntary agreement with a firm; or formal tools,such as the FCA and PRA’s existing OIREQ (own-initiativerequirement) and OIVOP (own-initiative variation ofpermission) powers, to impose temporary requirements on, orvary the permission of, authorised firms.(2) Such formal toolscan only be used in respect of firms performing activities thatrequire FCA or PRA authorisation, so their application in FICCmarkets would be limited. But they could potentially be usedas preventative measures when malpractice is suspected tosuspend or limit a particular regulated trading activity,pending further investigation of conduct failings. The promptand effective use of such protective and forward-looking toolswould require a different approach, and potentially a differentlevel of evidence to that needed for full-scale enforcementaction.

22 The Review also notes that Basel III capital requirements,as implemented in the EU under CRD IV, allow nationalauthorities to impose specific add-ons where justifiedfollowing an individual supervisory review. Given this, theremay be greater scope for regulators to impose additionalcapital requirements on firms in respect of conduct orgovernance failings. While the power to do this isdiscretionary, regulators both in and outside the EU could lookfor ways for this to be applied more consistently on a globalbasis given the international nature of FICC markets.

(1) ‘Journey to the FCA’, available at www.fca.org.uk/static/documents/fsa-journey-to-the-fca.pdf.

(2) Procedures for the use of such tools is set out in the FCA’s Handbook, EnforcementGuide and the Decision Procedure and Penalties Manual.



Q40: What role can more effective surveillance andpenalties for wrongdoing play in improving the fairness andeffectiveness of FICC markets globally? How can firms andthe industry as a whole step up their efforts in this area?And are there areas where regulatory supervision,surveillance or enforcement in FICC markets could befurther strengthened?

Firm-level surveillanceQ41: How can firms increase the effectiveness of their ownsurveillance efforts across FICC markets globally? Whatrole could the industry play in helping to explore bestpractices on how to make whistleblowing and other similarregimes more effective? Is there scope to make greater useof large scale market data sets and electronic voicesurveillance to help detect cases of abuse in FICC markets?Are there other potentially effective tools?

Firm-level penaltiesQ42: Are there processes or structures that can allowfirms to punish malpractice by their own staff moreeffectively (for example, penalties for breaching internalguidelines)?

Q43: Could firms active in FICC markets do more to punishmalpractice by other firms, for example, by shiftingbusiness and reporting such behaviour to the authorities?

Regulatory-level surveillance and supervisionQ44: Is the current supervisory approach and level ofintensity dedicated to supervising conduct within theUK wholesale FICC markets appropriate?

Q45: Are there ways to improve the data on FICC markettrading behaviour available to the FCA, whether throughthe extension of the regulatory perimeter or otherwise?

Regulatory-level penaltiesQ46: What further steps could regulators take to enhancethe impact of enforcement action in FICC markets?

Q47: Should consideration be given to greater use of earlyintervention, for example, temporary suspension ofpermission for a particular trading activity for firms orindividuals or increased capital charges?

Q48: Is there a need to widen and or strengthen criminalsanctions for misconduct in FICC markets?

Q49: Is the approach set out in the CriminalSanctions Market Abuse Directive appropriate for theUnited Kingdom? Are there additional instruments oractivities to those envisaged by the Directive that shouldbe covered by the domestic criminal regime?


6 Questions for feedback

This section summarises the questions posed in Sections 3 to 5of this document.

What does ‘Fair and Effective’ mean for FICCmarkets?

Q1: The Review would welcome respondents’ views on thedefinition of ‘fair and effective’ FICC markets proposed inSection 3. Does it strike the right balance betweensafeguarding the interests of end-users withoutunnecessarily impeding the effectiveness of FICC markets?Are the concepts of transparency, openness and equality ofopportunity appropriately specified? And how does thedefinition compare with those used in other markets,jurisdictions, organisations or legislation?

A framework for evaluating fairness andeffectiveness

Q2: Of the six themes identified in Table A on page 5(market microstructure; competition and market discipline;benchmarks; standards of market practice; responsibilitiesand incentives; and surveillance and penalties), which doyou consider to be the most important factors contributingto the recent series of FICC market abuses? In which otherareas do you believe the fairness and effectiveness of FICCmarkets globally may be deficient? Do these answers varyacross jurisdictions, or specific markets within FICC? Arethere any other important areas of vulnerability that arenot identified in the table?

Barrier and digital options

Q3: Do trading practices involving barrier or digital optionspose risks to the fairness and effectiveness of one or moreFICC markets? How hard is it to distinguish betweenhedging and ‘defending’ such options in practice? Shouldfurther measures be taken to deal with the risks posed bybarrier options, whether through market-wide disclosure ofsignificant barrier positions, an extension of regulation orsome other route?

Market microstructure

Q4: Does the market microstructure of specific FICCmarkets — including trading structures, transparency, assetheterogeneity or market access — enhance or diminishfairness and effectiveness? Where there are deficiencies,will recent or in-train regulatory or technological changesimprove the situation, or are further steps needed? How dothese answers vary across jurisdictions, or specific marketswithin FICC?

In fixed income:Q5: Is greater use of electronic trading venues for a widerrange of market participants possible or desirable? Arethere barriers preventing a shift to a more transparentmarket structure?

Q6: Is standardisation of corporate bond issuance possibleor desirable? Should standardisation be contemplatedacross a broader range of fixed income products? Howcould that be brought about?

Q7: Should the new issue process for bonds be made moretransparent through the use of auction mechanisms,publication of allocations or some other route?

In foreign exchange:Q8: Are there risks associated with internalisation and lastlook practices? Are there barriers preventing increased preand post-trade transparency in foreign exchange markets?

Q9: Are there barriers impeding the development of morecomprehensive netting and execution facilities fortransacting foreign exchange fix orders?

In commodities:Q10: Are there any material barriers preventing greatertransparency in OTC commodity derivatives markets? If so,what could be done to remove them?

Regulatory measures:Q11: Are there any areas of FICC markets where regulatorymeasures or internationally co-ordinated regulatory actionare necessary to address fundamental structural problemsthat exist?


Conflicts of interest and information flows

Q12: Where do potential conflicts of interest arise in thevarious FICC markets, and how do they affect the use andpotential abuse of confidential information, both within andbetween firms?

Q13: How can the vulnerabilities posed by such conflictsbe reduced? Are existing internal structures and controlprocedures sufficient? Where they are not, are furtherinternal management controls required (such as bettertrading floor design and/or closer monitoring of electroniccommunications within and between firms) or is moreradical action required to remove conflicts altogether?

Competition and market discipline

Q14: Is there a relationship between the level ofcompetition in FICC markets globally and the fairness andeffectiveness of those markets? What risks are posed bythe increase in concentration seen in some FICC markets?In answering this, please have regard to the geographicalscope of any relevant markets.

Promoting effective competition through market forces Q15: To the extent that competition is currentlyineffective in any of the FICC markets, are there market-ledinitiatives, technological or structural changes that mayremedy this situation?

Q16: Are there any lessons that can be drawn fromexperiences in other financial markets (or indeed othermarkets) about the ways that alternative or evolvingmarket structures could impact on competition inFICC markets?

Q17: How effective is market discipline in enforcing soundmarket practices in each of the key FICC markets? Whatcould be done to strengthen it?

Promoting effective competition through regulatory andlegislative initiativesQ18: In what ways might competition in any of the keyFICC markets usefully be addressed by competitionauthorities (eg by assessing the state of competition inrelevant markets)?

Q19: Are there any additional regulatory reforms thatcould be helpful in promoting competition and marketdiscipline in FICC markets?

Q20: Is there a need for better awareness andunderstanding of the existing competition frameworkamong FICC market participants, both at firm and individuallevel? How do you think that might be best achieved?

Benchmarks

Q21: Do current domestic and international initiatives byindustry and regulators to improve the robustness ofbenchmarks go far enough, or are further measuresrequired?

Industry-level measuresQ22: What steps could be taken to reduce the reliance ofasset managers and other investors on benchmarks?

Q23: What additional changes could be made to thedesign, construction and governance of benchmarks?

Q24: Should there be an industry panel to discussbenchmark use and design with the aim of assisting industrytransition?

Regulatory actionQ25: What further measures are necessary to ensure fullcompliance with the IOSCO Principles for financialbenchmarks by all benchmark providers?

Q26: How can the regulatory framework provideprotection to market participants for benchmarksadministered in other jurisdictions in a proportionate way?

Standards of market practice

Q27: Are existing sources of information regardingstandards of market practice across FICC markets globally:(a) already sufficiently clear (or will be once currentregulatory reform has concluded); (b) sufficient, but inneed of clearer communication or education efforts; or(c) not sufficiently clear, requiring more specific guidance orrules to provide more detail or close genuine gaps?

Q28: Box 7 on pages 36–37 discusses a number ofuncertainties over FICC market practices reported bymarket participants, including: the need for greater clarityover when a firm is acting in a principal or an agencycapacity; reported difficulties distinguishing betweenlegitimate trading activity and inappropriate front-runningor market manipulation; and standards for internal andexternal communication of market activity. To the extentthat there are uncertainties among participants in thedifferent FICC markets over how they should apply existingmarket standards in less clear-cut situations, whatare they?

Q29: How could any perceived need to reduceuncertainties best be addressed: (a) better education aboutexisting standards; (b) new or more detailed market codeson practices or appropriate controls; or (c) new or moredetailed regulatory requirements?


Will these uncertainties be dealt with by current reforms?Q30: How can the industry, firms and regulators improvethe understanding of existing codes and regulations byFICC market participants and their managers?

Q31: Should there be professional qualifications forindividuals operating in FICC markets? Are there lessons tolearn from other jurisdictions — for example, the FinancialIndustry Regulatory Authority’s General SecuritiesRepresentative (or ‘Series 7’) exam?

Can the industry help to establish better standards of marketpractice?Q32: What role can market codes of practice play inestablishing, or reinforcing existing, standards of acceptablemarket conduct across international FICC markets?

Q33: How would any code tackle the design issuesdiscussed in Section 5.4.3, ie: how to ensure it can be madesustainable given industry innovation over time? How todifferentiate it from existing codes? How to give it teeth (in particular through endorsement by regulatoryauthorities or an international standard setting body)?How to communicate it to trading teams? Whether, andhow, to customise it for individual asset classes?

Should the scope of regulation be extended?Q34: In the context of implementing MiFID 2, which of theFCA Principles for Businesses should apply in relation toMiFID business with Eligible Counterparties?

Q35: Are there any financial instruments that should bebrought more fully into the scope of regulation in order toimprove the fairness and effectiveness of specific FICCmarkets? For any instruments proposed: (a) whatprotections does the current framework provide; (b) whatgaps remain of relevance to fairness and effectiveness; and(c) what is the cost/benefit case, bearing in mind theReview’s Terms of Reference as set out in Section 1?

Responsibilities, governance and incentives

Q36: How much of a role did inadequate governance,accountability and incentive arrangements play in therecent FICC market abuses, and to what extent do theseremain potential vulnerabilities in FICC markets globally?In addition to on-going regulatory changes, what furthersteps can firms take to embed good conduct standards intheir internal processes and governance frameworks? Andhow can the authorities, either internationally ordomestically, help to reinforce that process, whetherthrough articulating or incentivising good practice, orthrough further regulatory steps?

Firm-wide initiatives to improve incentives and governanceQ37: Do respondents’ agree that the thematic areashighlighted in Section 5.5 are key priorities for FICC firms(fine-tuning performance measures; adjustments toremuneration; attitudes towards hiring, promotion andadvancement; closer board involvement in governance ofFICC activities; and clearer front line responsibilities)?What specific solutions to these challenges have workedwell, or could work well? And how best can the authoritieshelp to support these initiatives?

Market wide initiatives to align market conduct, incentivesand governance Q38: To what extent could the Banking Standards ReviewCouncil help FICC market participants to raise standardscollectively — in particular, are there other steps that couldbe taken to help complement or extend this initiative inFICC markets for non-banks and internationally?

Regulatory initiatives to improve governance and incentivesQ39: Are there other regulatory measures the authoritiescould take to strengthen personal accountability orotherwise improve the way firms manage incentives andgovernance? In particular, should any or all of the measuresin the Senior Managers and Certification regime beextended to non-bank firms active in FICC markets?

Surveillance and penalties

Q40: What role can more effective surveillance andpenalties for wrongdoing play in improving the fairness andeffectiveness of FICC markets globally? How can firms andthe industry as a whole step up their efforts in this area?And are there areas where regulatory supervision,surveillance or enforcement in FICC markets could befurther strengthened?

Firm level surveillanceQ41: How can firms increase the effectiveness of their ownsurveillance efforts across FICC markets globally? Whatrole could the industry play in helping to explore bestpractices on how to make whistleblowing and other similarregimes more effective? Is there scope to make greater useof large scale market data sets and electronic voicesurveillance to help detect cases of abuse in FICC markets?Are there other potentially effective tools?

Firm level penaltiesQ42: Are there processes or structures that can allow firmsto punish malpractice by their own staff more effectively(for example, penalties for breaching internal guidelines)?

Q43: Could firms active in FICC markets do more to punishmalpractice by other firms, for example by shifting businessand reporting such behaviour to the authorities?


Regulatory level surveillance and supervisionQ44: Is the current supervisory approach and level ofintensity dedicated to supervising conduct within theUK wholesale FICC markets appropriate?

Q45: Are there ways to improve the data on FICCmarket trading behaviour available to the FCA, whetherthrough the extension of the regulatory perimeter orotherwise?

Regulatory-level penaltiesQ46: What further steps could regulators take to enhancethe impact of enforcement action in FICC markets?

Q47: Should consideration be given to greater use of earlyintervention, for example, temporary suspension ofpermission for a particular trading activity for firms orindividuals or increased capital charges?

Q48: Is there a need to widen and or strengthen criminalsanctions for misconduct in FICC markets?

Q49: Is the approach set out in the CriminalSanctions Market Abuse Directive appropriate for theUnited Kingdom? Are there additional instruments oractivities to those envisaged by the Directive that shouldbe covered by the domestic criminal regime?


Glossary and acronyms

Glossary

Agent: An agent is a person or firm that arranges financialtransactions on behalf of others. The financial instrumenttransacted does not pass through the agent’s balance sheet.The agent typically receives a commission for arranging thetransaction.

Barrier option: Barrier options are a type of option which areeither activated or cancelled if a pre-determined level of theunderlying market price is reached.

Broker-dealer: A person or firm in the business of buying andselling securities and other financial instruments, either for itsown account or on behalf of its customers, depending on thetransaction.

Buy-side: Financial institutions holding and dealing infinancial instruments for investment or asset-managementpurposes. Examples include mutual funds, pension funds andinsurance firms.

Central Limit Order Book (CLOB): A pricing framework usedby most exchanges globally whereby customer orders (bidsand offers) are matched in a transparent and pre-definedmanner.

Dark pool: A private exchange or forum with restricted accesswhere parties can post trading interest without making suchinformation publicly available.

Delta: The ratio comparing the change in the price of theunderlying asset to the corresponding change in the price of aderivative referencing that asset.

Derivative: A financial instrument whose price is dependentupon or derived from one or more underlying assets orbenchmarks.

Digital option: Digital (or binary) options are options whichpay out a fixed amount or nothing, depending on whether theunderlying price reaches a level at a specific point in time.

Direct market access: Where participants can transactdirectly with other participants. The market participant is ableto choose who they transact with (either because they knowwho is posting what prices or because they can see a range ofprices and select the price they prefer).

Electronic Trading Platform: An electronic trading platform isa computerised system of trading for financial products.

Equitisation: The process of moving FICC products to anexchange or an exchange-like model.

Exchange: A regulated marketplace in which securities,commodities, standardised derivatives, and other financialinstruments are traded.

First/Second/Third Line of Defence: The lines of defence arethe governance and controls to protect against risks in anorganisation. The First Line of Defence is risk mitigation andcontrol within the business function that generates the risks,in particular through policies and procedures, training and linemanagement oversight. The Second Line of Defence is anindependent oversight function — commonly the riskfunctions monitoring each key risk category. The Third Line ofDefence is an independent assurance function — the internalaudit function.

Forward rate agreement: A forward rate agreement is acontract between two parties which sets a fixed interest ratefor a future period.

Front-running: Front-running is the practice whereby anindividual is trading in possession of private informationdesigned to take advantage of the anticipated price effect of afuture order.

IBD business: IBD encompasses client primary marketissuance for debt and equity markets as well as the corporatefinance division that advises clients on (and often provides andarranges finance for) mergers and acquisitions and other majorprojects. Sometimes referred to as corporate finance.

Indirect market access: Where participants cannot transactdirectly with other participants, but access the market througha broker or dealer, who may act as principal or as agent inexecuting the trade.

Institutional investor: A financial institution which poolslarge sums of money and invests those sums in securities,property and other investment assets on behalf of itself andothers.


Interdealer broker: A brokerage firm operating in the bond orOTC derivatives market that acts as an intermediary betweenmajor dealers to facilitate interdealer trades.

Interest rate swap: An interest rate swap is an exchange ofone interest payment for another, based on a specifiedprincipal amount for a specified term. Interest rate swapsoften exchange a fixed payment for a floating payment that isset with reference to a benchmark rate (such as Libor).

Internalisation: The process by which transactions arematched within an investment firm rather than in the openmarket.

Knock in option: An option which is activated when apre-defined price level is breached.

Knock out option: An option which is deactivated (andtherefore expires worthless) when a pre-defined price level isbreached.

Liquidity: Liquidity refers to the ease with which investors areable to transact in reasonable quantities of an instrumentwithout discontinuity of price formation.

Market maker: A market participant that facilitates trading ina financial instrument by supplying (tradable) buy and sellquotations and hence committing itself to hold a position inthe financial instrument.

Multi-dealer trading platform (MDP): An electronic platformused to provide transaction and associated services in financialinstruments from a range of banks to the wider market.

New issue: A new issue is an offering of a debt or equitysecurity, sold to public for the first time. Sometimes referredto as primary issuance, a new issue can involve the issuance ofa new security (an initial public offering) or can be an additionto an already existing security.

One touch binaries: A one touch binary option is an optionwhich gives the investor a pay out if the underlying assetbreaches a pre-defined price during the term of the option.These types of options are binary because the pay-out is eitherfull, if the pre-defined price is breached, or zero, if thepre-defined price is not breached.

Over-the-counter (OTC): Transactions that are bilaterallynegotiated between two market participants, as opposed totaking place on a central exchange.

Price discovery: The process by which market participantsobtain information about the prices at which counterpartiesare willing to buy or sell specific financial instruments.

Price formation: The process by which market participantsdecide the prices at which they are willing to transact.

Price transparency: The amount of information available tomarket participants about prices; price transparency takes twoforms: (1) pre-trade price transparency which is the prices atwhich counterparties advertise they are willing to buy or sellspecific financial instruments; or (2) post-trade pricetransparency which is the prices at which counterpartiesrecently bought or sold specific financial instruments.

Principal: A principal in a financial transaction makes anoutright purchase of the financial instrument and hence theprincipal takes the instrument onto its balance sheet (andbears all the risks of ownership), even if this is sometimes onlyfor a short period of time before it is sold to another party.

Private placement: A private placement is a non-publicoffering of a debt or equity security. Private placements aretypically offered to a small number of chosen investors.

Range accruals: Range accruals are options which pay aspecified interest rate only if another reference rate is within apre-defined range. Should the reference rate fall outside ofthe pre-defined range, no interest is paid.

Repo: A repurchase agreement (‘Repo’) is a form ofasset-backed financing, usually for the short term. Theborrower sells securities (usually government bonds or otherhigh quality securities) to investors and agrees to buy themback (at a price agreed at the start of the repo agreement) atthe end of the agreement.

Request for Quote (RFQ): Where a market participant asksfor a price quote from one or more market makers. In someorganised markets, market makers are required to quote aprice for a certain size (such as GEMMs in the gilts market);in other markets there is no obligation to quote. The marketmakers who do quote show a bid/offer price and the size theyare willing to transact. The market participant submitting theRFQ can then choose whether to trade and, if so, which priceto take.

Securitised asset: A financial instrument created throughrepackaging a combination of other financial assets (which caninclude mortgages, credit cards, and loans) into tiers of varyingcredit quality which are then sold to investors.

Sell-side: Financial institutions (predominantly banks andbroker-dealers) involved with the creation, promotion, analysisand sale of securities and other financial instruments.


Single-dealer trading platform (SDP): An electronic platformowned and provided by a bank or broker-dealer to providetransaction and associated services in financial instruments toits clients where the firm is the sole liquidity provider on theplatform.

Spot FX: The exchange of two currencies at a rate agreedtoday, where delivery of the currencies occurs within theshortest standard settlement period for the currency pair.

Two-way pricing: A quote where both a bid and an offer isshown at the same time.


Acronyms

ABS – Asset-Backed Securities.ACI – Association Cambiste International.AIFMD – Alternative Investment Fund Managers Directive.APAC – Asia Pacific = East Asia, South Asia, South East Asia,Oceania.ATS – Alternative Trading System.BBA – British Bankers’ Association.BIS – Bank for International Settlements.bps – Basis Points.BSRC – Banking Standards Review Council.CDS – Credit Default Swap.CFA – Chartered Financial Analyst.CISI – Chartered Institute for Securities and Investment.CLOB – Central Limit Order Book.CLS – Continuous Linked Settlement.CMA – Competition and Markets Authority.CME – Chicago Mercantile Exchange.CRD – Capital Requirements Directive.CSMAD – Criminal Sanctions Market Abuse Directive.DMO – UK Debt Management Office.ECP – Eligible Counterparty.EMEA – Europe, Middle East & Africa.EMIR – European Market Infrastructure Regulation.ESMA – European Securities and Markets Authority.EU – European Union.Euribor – Euro Interbank Offered Rate.FCA – Financial Conduct Authority.FICC – Fixed Income, Currencies and Commodities.FINRA – Financial Industry Regulatory Authority.FSA – Financial Services Authority.FSB – Financial Stability Board.FSMA – Financial Services and Markets Act.FX – Foreign Exchange.G20 – The Group of Twenty major world economies.GDP – Gross Domestic Product.GEMMs – Gilt-Edged Market-Makers.HFT – High-Frequency Trading.HMT – Her Majesty’s Treasury.ICB – Independent Commission on Banking.ICE – Intercontinental Exchange.ICMA – International Capital Markets Association.IMA – Investment Managers Association.IOSCO – International Organization of SecuritiesCommissions.IPO – Initial Public Offering.ISDA – International Swaps and Derivatives Association.LBMA – London Bullion Market Association.Libor – London Interbank Offered Rate.LME – London Metal Exchange.MAD – Market Abuse Directive.MAR – Market Abuse Regulation.MiFID – Markets in Financial Instruments Directive.MIFIR – Markets in Financial Instruments Regulation.

MMLG – Money Market Liaison Group.MTF – Multilateral Trading Facility.NIPs – Non-Investment Products.OTC – Over-the-counter.OTF – Organised Trading Facility.OIREQ – Own-Initiative Requirement.OIVOP – Own-Initiative Variation of Permission.PCBS – Parliamentary Commission on Banking Standards.PRA – Prudential Regulation Authority.REMIT – Regulation on Wholesale Energy Markets Integrityand Transparency.RFQ – Request for Quote.SIFMA – Securities Industry and Financial Markets Association.SMC – Senior Managers and Certification Regime.STR – Suspicious Transaction Reporting.TRACE – Trade Reporting and Compliance Engine.USFXC – US FX Committee.


Appendix: Further detail on theoperation and regulation of FICCmarkets

1 This Appendix provides further detail on the purpose,instruments, trading structures and trends in the four majorFICC markets (foreign exchange, fixed income rates, fixedincome credit and commodities) in parts A to D. Part Edescribes the current structure of regulation and marketcodes.

A Foreign exchange

Purpose and key instruments2 The foreign exchange (FX) market has a wide range ofpurposes. It is used to provide foreign currency to businessesto facilitate the import or export of goods and services, and serves many other users, ranging from corporate andfinancial hedging or investment, to central banksimplementing macroeconomic policy, and individuals fortravel and holidays.

3 The FX market has the highest turnover of any market in theworld and (particularly for the core currencies) is the mostliquid of the FICC markets. In 2013 the global average dailyturnover was US$5.3 trillion. Although FX turnover is globallydispersed, London is home to 40%(1) of overall turnover. TheFX market is also concentrated. As at April 2014, six firmsaccounted for 61% of overall FX turnover in the UK-basedinterdealer market; the equivalent figures for business withother banks, other financial firms and non-financial firms lay inthe range 64–81%.(2)

4 There is a high degree of integration between cash andderivatives, and the combined market comprises six maininstruments (Table D).

5 As at April 2013 interdealer trading accounted for 39% ofoverall FX market turnover, much lower than in the late 1990swhere interdealer trading was in excess of 60%. The primaryreason for this decline is the growth in ‘internalisation’: ie theinternal netting of trades by dealing banks. A breakdown of FXmarket turnover by counterparty type and instrument can beseen in Table E.(3)

Trading structures6 FX markets remain predominantly quote-driven ‘over-the-counter’ (OTC) markets. The need to exchange onecurrency for another physically when spot, swap and forwardtransactions settle, involves the risk of paying away the fullnotional in one currency without receiving the full notional inthe other. The need to manage this risk, referred to assettlement risk, is one of the most important drivers of marketstructure in the FX markets and led to the development of theContinuous Linked Settlement (CLS) system used by manymajor market participants to mitigate this risk. CLS group,which is owned by its member banks, now accounts for 46%(4)

of daily FX volumes across all products.

(1) BIS Triennial Survey 2013.(2) Bank of England FXJSC Turnover Survey April 2014.(3) BIS Triennial Survey 2013.(4) CLS and Bank calculations.

Table D Foreign exchange instruments

Instrument Description Average daily % of turnover total

US$ billions

FX spot The exchange of two currencies at a rate 2,046 38%agreed today for delivery (cash settlement) within two business days.

Outright The exchange of two currencies at a rate 553 10%forwards agreed today for delivery at some time

in the future (ie more than twobusiness days).

Non-deliverable A forward that is settled with a single cash 127 2%forwards (NDF) payment for the net value, rather than

through the exchange of the two currencies.

FX swaps The combination of an FX spot and 2,228 42%outright forward in a single transaction.

Currency swaps The exchange of notionals in two 54 1%currencies at inception and expiry (as with an FX swap) and interest payments in those currencies over the life of the swap.

FX options An option gives the option buyer the 337 6%right (but not obligation) to exchange one currency for another currency at a pre-agreed exchange rate with the option seller during or at the end of a specified period.

Source: BIS Triennial Survey 2013.


7 The need for flexibility on settlement and tenor for themajority of FX products is cited as representing a barrier to thefurther development of organised exchanges and associatedclearing. Although the FX market remains predominantlyOTC, that business is executed in a number of different waysand via a number of different trading platforms (Charts 6and 7). The market trades mostly through major banks and isdivided between separate interdealer and dealer-to-clientmarkets. The advent of electronic platforms in both theinterdealer and dealer-to-client markets has resulted inincreased levels of transparency. Banks mostly offer theirclients access to the market via either ‘single-dealer platforms’or ‘multi-dealer platforms’. Single-dealer platforms restrictclients to trade against quotes from the platform owner,whilst multi-dealer platforms allow clients to trade againstquotes from other dealers. Electronic trading now accountsfor 64% of transactions in the FX spot market. However, theadded complexity of FX options has meant that only 36%(1) ofthis market trades electronically.

8 FX markets have some of the narrowest bid-offer spreads ofall the financial markets, which are often less than apercentage in point (PIP) in the most liquid currency pairs.(2)

Dealers typically generate low margins per trade compared toother markets, especially in the most liquid currency pairs,which means that only the largest players can remainprofitable when competing for volume business. Pricing in theFX market can differ by credit rating and client relationship,such that each participant sees a different subset of prices, andtherefore by definition there is no single price.

Current and future market trends9 Given the pressure on margins, banks have invested heavilyin technology in an attempt to increase their market share andreduce costs. This has led to an increase in ‘internalisation’ in

the spot FX markets where banks are able to match off clientorders internally without having to go to the interdealermarket to hedge their risk. Market participants have indicatedthat some dealers with large enough market share can nowinternalise up to 90% of their client orders in major currencypairs. Some argue that internalisation results in betterexecution for clients because it allows them to trade atbid-offer spreads that are narrower than those available in theexternal market. However, internalisation also reducestransparency to the wider market, whilst at the same timegiving platform-providers access to privileged informationabout their clients’ flows in the market.

10 As with other derivatives markets, international regulatorsare increasing their oversight of the FX derivative markets. Forexample, the G20 OTC derivatives regulatory reform agenda,

Other

Electronic multi-dealer platform

Electronic single-dealer platform

Voice broker Per cent

0

20

40

60

80

100

FX optionsFX swaps Currencyswaps

Outrightforwards

Spot

Source: BIS Triennial Survey 2013.

Chart 6 Execution method by product type

Voice broker Electronic multi-dealer platform

Electronic single-dealer platform

Electronic broking system Customer direct

Interdealer direct Per cent

Reportingdealers

Otherbanks

Other financialinstitutions

Non-financialinstitutions

0

20

40

60

80

100

Source: Bank of England FXJSC Turnover Survey April 2014.

Chart 7 Execution method by client type

Table E Foreign exchange turnover by counterparty

Total Spot Outright FX Currency FX forwards swaps swaps options

Reporting dealers(a) 39% 33% 27% 49% 54% 29%

Non-reporting(b) 24% 25% 14% 27% 15% 19%banks

Non-financial(c) 9% 9% 14% 6% 12% 9%customers

Institutional investors 11% 13% 19% 7% 3% 16%

Hedge funds and 11% 14% 17% 5% 7% 21%Proprietary trading firms

Official sector 1% 1% 1% 1% 1% 0%

Other(d) 6% 6% 8% 5% 8% 6%

Source: BIS Triennial Survey 2013

(a) Mainly large commercial/investment banks and securities houses that i) participate in the interdealermarket, and/or ii) have an active business with large customers, such as large corporate firms, governmentsand non-reporting financial institutions.

(b) Smaller or regional commercial banks, publicly owned banks, securities firms or investment banks notdirectly participating as reporting dealers.

(c) Non-financial end-users such as corporations and non-financial government entities.(d) Financial institutions that are not classified as ‘reporting dealers’ in the BIS Triennial Survey.

(1) BIS Triennial Survey 2013.(2) Defined as 1/100th of 1 unit of currency for YEN related currency pairs and

1/10,000th of 1 unit of currency for all other major currency pairs.


including Dodd-Frank in United States and both EMIR andMiFID 2 in the EU, will require the most liquid andstandardised derivatives to be both traded on electronicplatforms and centrally cleared, where applicable.

B Fixed income rates

Purpose and key instruments11 The fixed income rates market is split into cash andderivatives. The cash market provides financing forgovernment and government related agencies. Issuers such asthe government of the United Kingdom, through its giltissuance programme, use the market to obtain large volumesof funding. At end-June 2014 there was a notional value ofnearly £1.5 trillion(1) of gilts outstanding. The governments ofthe G7 countries together have over US$30 trillion(2) of debtoutstanding.

12 In developed economies, government debt securities aregenerally regarded as low risk investments, having little or nocredit risk. Purchasers of government debt range from smallretail investors to some of the largest institutional investors.Pension funds and insurance companies buy government debtto hedge their long term liabilities, and banks use governmentsecurities for liquidity management, as collateral, and forhedging debt and other derivative instruments. In addition,central banks often hold debt of other governments forcurrency reserve management, and many sovereign wealthfunds are active investors in this market. The composition ofinvestors in UK government debt is shown in Chart 8.

13 As government debt securities often have little or no creditrisk, they are also widely used as collateral in the ‘repo’market. A ‘repo’, or sale-and-repurchase agreement, is ashort-term loan which is secured against a highly liquid asset.

The repo market is an important part of the fixed income ratesmarket; it is used as a means of financing for dealers and amoney-like asset for risk-averse investors, including centralbanks in monetary policy operations. The size of the Europeanrepo and reverse repo market in June 2014 was €5.8 trillion.(3)

14 Derivatives also play an important role in the fixed incomerates market. Exchange traded derivatives include interestrate and bond futures. The major classes of OTC derivativesare interest rate swaps, cross-currency swaps, and forward rateagreements (FRAs). Swaps are used by a wide range ofinstitutions for many different purposes: corporate issuers useswaps to exchange their fixed rate exposure for a floating ratewhen they issue bonds; banks use swaps to hedge fixed ratemortgage portfolios and to manage other interest rate risks intheir balance sheet; and insurers and pension funds use swapsto manage the risks associated with both their assets andliabilities.

15 The total outstanding notional of OTC interest ratederivatives was US$577 trillion(4) as at end June 2013, with London home to around 50% of the market. Theexchange-traded derivatives market accounted for a furtherUS$66 trillion of notional.

Trading structures16 Government bond primary issuance is usually managed bya specific department within the government. In sterlingmarkets, primary auctions of UK government bonds areperformed by the Debt Management Office (DMO).Designated Gilt-edged Market Makers (GEMMs) are the onlyinstitutions eligible to submit competitive bids directly to theDMO, meaning that all other market participants wishing tobid competitively at a gilt auction must route their orderthrough a GEMM. Non-competitive bids may be placeddirectly with the DMO.

17 A liquid secondary market is critical for marketparticipants, many of whom need to adjust their portfolio ofgovernment bond holdings regularly. In addition to their rolein primary auctions, GEMMs are also obliged to provideliquidity in the secondary market, which continues to operateon an OTC basis. Ongoing concentration of the marketaround benchmark issues and larger trading volumes hasresulted in greater liquidity in the secondary market, and anincreasing amount of trading is now facilitated throughelectronic OTC platforms. Prices posted on such platformshave high visibility across the market and a wide range ofparticipants are now able to access the market through them.Post-trade data is less widely available. The average dailyturnover of gilts was £29 billion in 2012–13,(5) more than

0.1%

9.5%

26.4%

26.6%

7.0%

0.1%1.1%

4.4%

24.8%

Banks

Bank of England

Insurance and pension funds

Other financial institutions

Households

Overseas central banks

Other overseas

Source: UK DMO data.

Chart 8 UK Government bond holdings by investor type— 2014 Q1

(1) UK DMO data.(2) BIS Debt securities statistics.(3) ICMA European repo survey June 2014.(4) BIS Triennial Survey 2013.(5) UK DMO data.


seven times the value of daily turnover for shares listed on theLondon Stock Exchange. The average bid-offer spread for giltsin late 2013 was 0.8bps, demonstrating the liquidity of thismarket.

Current and future market trends18 Since the financial crisis the demand for government bondshas increased dramatically. Banks are now far more likely toseek secured rather than unsecured funding, which typicallyrequires high-quality assets as collateral, and participants inthe OTC derivatives markets also increasingly needgovernment debt to post as margin as a result of the G20derivative reforms. There has also been a large increase inissuance of government debt to fund budget deficits. Tradingvolumes of gilts have increased broadly in line with theincrease in issuance.

19 The European repo market has grown over the past fiveyears. However, levels remain lower than the pre-crisis peakof €6.8 trillion in June 2007.(1)

20 International regulators are increasing their oversight ofthe OTC interest rate derivative markets. Interest rate swaps,which are the largest class of derivatives, are expected to becaptured by the G20 trading and clearing obligations. Somemarket participants are anticipating these changes through theuse of contracts which seek to replicate traditional OTCcontracts, for example swap futures.

C Fixed income credit

Purpose and key instruments21 The fixed income credit markets provide banks andnon-financial companies with access to short-term andlong-term funding. Short-term fixed income credit marketscomprise certificates of deposit issued by banks andcommercial paper issued by banks and non-banks withrelatively high credit ratings. They are popular investments formoney market funds as well as financial institutions and largecompanies looking to invest surplus cash for the short tomedium term. The related market for short-term unsecuredinter-bank loans has declined in recent years as concernsabout counterparty credit risk have led to greater reliance onsecured lending. However, the unsecured lending marketcontinues to have wider significance for the fixed incomemarkets as the basis for Libor, the benchmark to which mostinterest rate swaps and many other derivatives refer. Theaverage daily turnover in the sterling unsecured and securedmoney markets as at May 2014 was £45 billion and £90 billion(2) respectively.

22 Bonds provide long-term finance to financial institutionsand other companies in both developed and emergingmarkets. In most cases, corporate bonds are issued via a‘syndication’, where a group of banks or investment firms

underwrite a bond issue and act as advisers on the timing,price and allocation to investors. The returns for corporatebonds usually exceed the returns on government bonds. As atend-2013 there were around US$50 trillion of corporate debtsecurities outstanding globally, of which around US$39 trillionwas issued by banks and other financial corporations.(3)

23 The credit ratings of issuers in the credit markets varysignificantly. Likewise, the investors vary. Life insurancecompanies can match their long term liabilities with highquality long term corporate bonds. Investors with a higher riskappetite and searching for higher yield can invest in bankcapital issues or issuers with lower credit ratings.

24 Asset-backed-securities (ABS) are an important subset ofthe bond markets. Securitisation is the process by which anumber of securities are created which reference a pool ofassets (eg residential/commercial mortgages, loans, creditcard receivables). ABS are constructed to achieve differentcredit ratings and therefore appeal to a range of differentinvestor groups.

25 The outstanding amount of securitisations in the EU at theend of 2013 was about US$2 trillion, or around one fifth of thesize of the US securitisation market. Since the crisis aggregateissuance has been notably lower, with only US$239 billion ofnew issuance in 2013 (including retained issuance), equivalentto roughly 40% of the pre-crisis annual rate.(4)

26 The fixed income credit derivatives markets grew sharplyin size following the development of the Credit Default Swap(CDS) in the mid-1990s. CDS are an important part of thecredit market and serve a range of purposes including allowingbanks to mitigate their credit exposures without having to cutcredit lines or liquidate bond or loan positions. Despite recentdeclines in volume, the CDS market remains one of the largestderivatives markets, with over US$24 trillion(5) notionaloutstanding as of June 2013.

Trading structures27 The issuance of new bonds involves banks acting asintermediaries between issuers looking for funding (throughthe banks’ Debt Capital Market desks) and investors lookingfor instruments to purchase (through the banks’ credit salesdesks). This dual role means that banks have to be verysensitive to the fact that they have a duty both to the issuer(to obtain the best price for their debt securities) and to theinvestors (to provide best execution relating to the sale of thesecurities).

(1) ICMA European Repo Survey June 2014.(2) Bank of England MMLG Sterling Money Market Survey 2014 H1.(3) McKinsey, based on a sample of 183 countries.(4) SIFMA, AFME and Bank of England calculations.(5) BIS Triennial Survey 2013.


28 A striking feature of the fixed income credit market is itsheterogeneity. Unlike the equity markets, where typically oneclass of common stock represents the entire equity value ofthe company, a large borrower will often have multiple debtsecurities outstanding of different sizes and maturities, oftenwith optional features. The large number of instruments inthe credit market means that secondary market liquidity inmost bond issues is limited, and investors therefore rely onOTC market makers to provide quotes rather than tradingthrough an exchange. Although there are a variety ofelectronic platforms that show live pricing for corporatebonds, they mostly reflect indicative bids and offers that needto be confirmed with the dealers supplying them beforeexecution can take place. Attempts to develop alternativetrading platforms to provide a central pool of liquidity have sofar failed to achieve a critical mass.

29 In the credit markets, banks often package bond issuancewith other services in bundled transactions, offering clientsreduced fees for a package of services. For example theissuance of new debt often prompts the creation or purchaseof related swaps and derivative securities, because mostinvestors are interested in fixed rate investments while issuersgenerally prefer to fund at floating rates. In such cases, issuerswill enter into a fixed to floating interest rate swap at thesame time as issuing the new securities. This was one factorbehind the increasing integration of banks in the pre-crisisperiod, as this bundling of services required greaterco-operation between departments.

Current and future market trends30 Many market participants consider liquidity to havedeclined in secondary corporate bond markets since the end ofthe financial crisis (see Box 4 in Section 4). European banks’net trading in securities has fallen since 2007; most of thatfall was in corporate bonds and ABS.

31 Investors have indicated that it is harder to sell corporatebond holdings as banks often refuse to bid in meaningful size.While inventories held by market makers have fallen, there hasbeen an increase of a fifth in the amount of non-financialcorporate debt outstanding globally between 2012 and 2014(1)

reflecting reparations to balance sheets post crisis andcompanies taking advantage of historically low interest rates.

32 In recent years, US markets have seen a trend towardincreased transparency with the introduction of the TradeReporting and Compliance Engine (TRACE) in July 2002.(2) TheTRACE system now provides close to real time post-trade(3)

transparency for a wide range of US corporate debt securitiesand asset-backed securities. Transparency in Europeanmarkets will be enhanced through the implementation ofMiFID 2.

33 The total amount of single name CDS outstandingdeclined by almost half between June 2007 and June 2013.(4)

The decline in CDS volumes has been ascribed in part toregulatory reforms implemented by regulators in the United States and Europe in response to the financial crisis,which have reduced both the capital benefits of CDS and theability to net CDS purchased and sold.

D Commodities

Purpose and key instruments34 The four main sectors of the commodities markets areenergy, agriculture, precious metals, and industrial metals.Commodities trade in ‘physical’ markets where prices arequoted based on very specific requirements concerning theprecise nature of the commodity in question. For example,deliverable crude oil streams include UK Brent Blend or US West Texas Intermediate. The physical market is globaland decentralised with a diversity of products and gradeswithin products. There is also often price differentiationbetween different delivery points for the same product.

35 The first formal commodity derivatives exchange wasestablished 160 years ago with the creation of the ChicagoBoard of Trade. Commodity derivatives can be used either tohedge or to speculate on the price movement of theunderlying. The main advantage of a commodity derivative isthat it allows the holder to gain exposure to price movementsin the underlying without having to hold (and pay for thestorage of) the underlying itself. Other advantages of tradingderivatives versus physical include lower transaction costs andthe ability to hold leveraged positions. A number of keyexchange-traded commodity derivative contracts are tradedglobally. However, OTC trading is also significant, althoughoutstanding notionals have fallen in recent years from US$8.3 trillion in June 2007 to US$2.7 trillion in June 2013.(5)

Trading structures36 Physical commodity markets are typically global in scope.Globalisation and economic development has resulted inincreased international movement in commodities anddisaggregation of the supply chain. However, despite theglobal nature of the business and the large trading flows, thesemarkets are still quite opaque because business is conductedbilaterally. Some of the most active participants in thephysical commodity markets are trading houses that are alsoactive in the derivative markets. The physical markets tradeinsignificant volumes. For example, the top ten firms in the oilmarket trade in the region of one billion barrels-equivalent ofoil and oil products per month against global consumption ofapproximately 2.7 billion barrels a month.(6)

(1) BIS Debt securities statistics.(2) TRACE was introduced by the National Association of Securities Dealers, a forerunner

of the Financial Industry Regulatory Authority in US.(3) www.finra.org/industry/compliance/markettransparency/trace/corporatebonddata/.(4) BIS Triennial Survey 2013.(5) BIS Triennial Survey 2013.(6) BP Statistical Review of World Energy 2014.

http://www.finra.org/industry/compliance/markettransparency/trace/corporatebonddata/


37 Physical commodity trading is mostly OTC, with brokerslinking buyers and sellers. Newswires and data providerspublish updates on commodity flows and aggregate marketinformation for reference pricing. Pricing in the physicalmarket is often influenced by pricing in derivatives markets.Market participants have to invest in the infrastructure thatgoes with the physical market, by either owning, or havingaccess to transportation and storage facilities.

38 There are a wide variety of exchange traded and OTCcommodity derivatives covering different products, grades anddelivery locations across agriculture, energy and metals.However, exchange traded commodity derivatives make uponly a small part of total exchange traded derivative volumesacross all asset classes; and at US$2.7 trillion notionaloutstanding, OTC commodity derivatives make up less than1% of total OTC derivative notional outstanding.(1)

Current and future market trends39 Many banks entered the commodities business in the late1990s when rules preventing bank holding companies fromoperating in these markets were relaxed. The physicalcommodities businesses of the banks were developed as acomplement to the derivatives business. However, somebanks have reduced their presence in physical commoditiesmarkets in recent years as a result of balance sheet andregulatory pressure.

40 Recent regulatory initiatives in the EU and the United States will require that position limits are appliedacross many of the major commodity derivative markets.However it is not yet clear what impact these provisions willhave on the market.

E Market conduct regulation of UK FICCmarkets

(i) Overview41 Market conduct regulations set standards for theorganisation of venues for trading financial instruments; fortransparency and reporting requirements in relation toinformation on prices and transactions; for required standardsof behaviour between market participants transacting infinancial instruments; and for the use of information bymarket participants. They also define the specific activitiesthat constitute market abuse. After a brief historical overview,this section summarises the current regulatory framework forUK FICC markets, covering; the FCA’s Principles forBusinesses; rules covering conduct of business and marketstructure (primarily the EU’s Markets in Financial InstrumentsDirective, or MiFID); market abuse rules (primarily the EU’sMarket Abuse Directive, or MAD); other regulation affectingthe fairness and effectiveness of FICC markets (such as Basel III); and voluntary market-generated codes of practice.

42 Historically, most provisions governing market conduct inthe United Kingdom related to markets organised asexchanges (notwithstanding the fact that firms themselvesmay have been regulated as banks). More limited provisionsapplied to the (OTC) bilateral dealings which characterisemost FICC markets: the general anti-fraud provisions of theFinancial Services Act 1986 covered transactions in allregulated investments and therefore many, but not all, FICCinstruments. Institutions permitted to trade in wholesalemoney market instruments were required to comply with theLondon Code of Conduct (a part of the so-called ‘Grey Paper’regime) in relation to all wholesale market instruments,whether regulated or not. When the Financial Services andMarkets Act (FSMA) superseded the Financial Services Act1986 in 2001, the London Code of Conduct was replaced bythe Non-Investment Products Code (the NIPs Code) whichonly applied to dealings in instruments that fell outside theregulatory perimeter, such as spot FX transactions. Similarprovisions in relation to wholesale market dealings inregulated instruments were for a time incorporated into theFSA (now FCA) rulebook.

43 The UK civil market abuse regime in place today,introduced by FSMA and since modified by the EU MarketAbuse Directive, applies only to behaviour in relation toqualifying investments admitted to trading on a prescribedmarket, and therefore has only limited application to FICCmarkets. However, the FCA (previously FSA) Principles forBusinesses (see Section (ii) below) apply generally to conductby authorised firms, including conduct relating to regulatedand, in some circumstances, unregulated FICC instruments;and over the past decade, various EU and domestic regulationshave introduced new obligations regarding conduct that applyto certain FICC markets.

(ii) The FCA Principles for Businesses44 Box 8 in Section 5.4 shows the eleven FCA Principles forBusinesses (the Principles), which set out high-level standardsof conduct applicable to all firms authorised by the FCA.Corresponding standards for approved individuals arecontained in the FCA Statements of Principle for ApprovedPersons. These requirements have statutory backing underFSMA and many of them are directly relevant to marketconduct; they include, in particular, a requirement to observeproper standards of market conduct (Principle 5 andStatement of Principle 3).

45 The FCA can take enforcement action for misconductagainst firms and individuals who contravene theserequirements, and has used the Principles, where necessary, torespond to misconduct in FICC markets. The FCA applies thePrinciples to the regulated activities of authorised firms, toactivities ancillary to the performance regulated activities and

(1) BIS.


to unregulated activity in limited circumstances, includingwhere that trading has a negative effect on the integrity of the UK financial system or the ability of the firm to meetcertain minimum standards for being authorised, giving thembroad scope. For example the FCA has fined authorised firmsfor misconduct in unregulated markets because themisconduct was ancillary to derivative transactions inregulated markets.

(iii) Conduct of business and market structure rules(MiFID)46 The EU Markets in Financial Instruments Directive (MiFID)took effect in the United Kingdom in November 2007. MiFIDrequires the authorisation of investment firms and sets outrules determining how such firms must behave when dealingwith clients and other market participants. It also sets outrules governing the operation of exchanges and other tradingvenues.

47 MiFID governs all transactions in financial instruments,which are broadly defined and include shares, fixed incomesecurities and derivatives, all commodity derivatives traded onauthorised venues, and most currency derivatives.(1) However,spot FX and, depending on context and purpose, some forwardcontracts in foreign exchange and physical commodities, arenot specifically covered. Investment services are defined astransactions involving financial instruments includingproviding advice, all forms of agency trading and many formsof principal trading. Any firm that provides an investmentservice relating to financial instruments must obtainauthorisation from the FCA or PRA, observe specifiedorganisational requirements, and hold capital.

48 The regulatory regime for investment services, derivedfrom MiFID, calibrates the application of the Principles andother regulatory requirements according to the nature of theclient and the activities that firms are undertaking. Forparticipants in wholesale markets, there are two classes ofclient: professionals and eligible counterparties (ECPs).

49 ECPs are considered to be the most sophisticated investorsor capital market participants and many participants inwholesale FICC markets fall into this category. Most MiFIDinvestor protection rules can be disapplied for business donewith or for an ECP, notably the requirement to act in clients’best interests, rules over the receipt of third party payments,the obligation to provide best execution, rules governing theuse of dealing commission, and many of those coveringcommunications with clients. For this ECP business, firms arealso not required to apply the FCA Principles of Integrity(Principle 1), Skill, care and diligence (Principle 2), Customers’interests (Principle 6), and Suitability of advice (Principle 9).However, importantly, firms dealing with ECPs are still subjectto the requirements to identify and manage any conflicts ofinterest that may arise from their activities.

50 For professional clients the MiFID investor protection rulesand Principles generally apply, but there are some differencescompared to when dealing with retail clients. Firms are ableto presume a certain level of knowledge and experience forprofessional clients and a professional client may be entitledto a higher level of regulatory protection in some FICCmarkets than in others.

51 MiFID also sets out rules for the organisation and operationof exchanges and other trading venues such as platforms. Inthe United Kingdom the FCA must authorise venues to tradeMiFID instruments and authorised venues must observeorganisational and operational requirements. Mostimportantly, venues are subject to transaction transparencyrules, which require venues to advertise all offers and quotespublicly prior to trading (‘pre-trade transparency’) and publishdetails of all completed transactions (‘post-tradetransparency’). At present, transparency rules apply only toequity markets.

52 Under the recently-agreed revision to MiFID (known asMiFID 2), which is due to come into effect in January 2017,regulation of the FICC markets will grow considerably. First,MiFID 2 will create a new category of regulated trading venue,the organised trading facility (OTF). OTFs will captureinterdealer brokers and a range of platforms that previouslywere not regulated as venues, meaning that a substantialamount of FICC business previously classified as OTC will nowbe subject to greater regulation. Second, rules on pre andpost-trade transparency will apply to many of the FICCmarkets for the first time. These transparency obligations willapply to all liquid bonds, structured finance products, emissionallowances and derivatives. Finally, the range of financialinstruments covered by MiFID will also be extended to cover agreater number of commodity derivatives and to cover EUemission allowances. However, spot FX and, depending oncontext and purpose, some forward contracts in foreignexchange and physical commodities will not be specificallycovered.

53 Certain aspects of the client categorisation regime will alsochange under MiFID 2, which introduces high-level principlesfor firms, in their dealings with ECPs, to act honestly, fairly andprofessionally, and communicate in a way that is fair, clear andnot misleading. This is a change from the current standardunder the Principles for Businesses and reflects the idea thatconduct risk should not be judged solely at the transactionlevel as ECPs will have responsibilities to the integrity of themarket as a whole.

(1) A full list of financial instruments covered by MiFID can be found in Annex I Section C of the Directive: http://eur-lex.europa.eu/legal-content/EN/TXT/?qid=1398325978410&uri=CELEX:02004L0039-20110104.

http://eur-lex.europa.eu/legal-content/EN/TXT/?qid=1398325978410&uri=CELEX:02004L0039-20110104

http://eur-lex.europa.eu/legal-content/EN/TXT/?qid=1398325978410&uri=CELEX:02004L0039-20110104


(iv) Market abuse rules54 Market abuse in the United Kingdom is covered by bothcivil regulations and criminal laws.

55 The EU Market Abuse Directive deals with the civil regimefor market abuse, and defines two broad categories of offence:insider dealing and market manipulation. The currentUK regime (implemented through FSMA) has seven specificoffences covering these two categories, namely: insiderdealing; improper disclosure of inside information; misuse ofinformation not generally available to market users;manipulating transactions; manipulating devices;dissemination of false or misleading information; and marketdistortion.

56 The application of the current UK market abuse regime toFICC markets is limited. Although broadly all FICCinstruments governed by MiFID fall within its scope, theregime applies only to behaviour in relation to (i) instrumentsadmitted to trading on a prescribed market (a list of which ismaintained by HM Treasury), (ii) instruments for which anapplication for admission has been made, and (iii) certainrelated instruments. This produces a somewhat wider scopethan might appear because a number of instruments that arein practice traded largely or wholly OTC are brought intoscope by virtue of being admitted to trading on a prescribedmarket, and also because physical trading in the commodityunderlying an exchange-traded derivative can be caught asbehaviour that occurs ‘in relation to’ the derivative. However,significant parts of FICC activity currently fall outside thescope of the regime: for example, many unlisted bonds,interest rate swaps and credit derivatives traded OTC, spot FX,and spot commodities and OTC-traded commodity derivativesare out of scope.

57 From July 2016, the new EU Market Abuse Regulation willreplace the current UK regulatory framework on market abuse.The new regime will significantly extend coverage in the FICCmarkets. First, the new regime will apply to all instrumentsadmitted to trading on venues(1) rather than only regulatedexchanges. In practice, this will mean that a far greater rangeof FICC instruments (which often are not admitted to tradingon regulated exchanges) are covered. Second, the scope ofthe regime will be extended expressly to cover transactions inthe commodity spot markets (where trading in spot affects afinancial instrument traded on a venue). Finally, the regimewill create a new civil offence of benchmark manipulation.This offence will cover any financial benchmark, regardless ofwhether the instruments that generate the benchmark arecovered by financial regulation.

58 The main areas of FICC not covered by the new MarketAbuse Regulation will be the spot FX market (with spot FX notfalling within the MiFID definition of financial instrument) andthose markets which trade exclusively OTC (for example

bespoke derivative contracts). However, abusive behaviour inthe foreign exchange markets will nonetheless be covered bythe new Market Abuse Regulation if such behaviour relates to the manipulation of a benchmark, or is linked to anexchange-based trade.

59 In addition to the civil regulations outlined above, theUnited Kingdom has an established criminal market abuseregime consisting of insider dealing offences set out in Part Vof the Criminal Justice Act 1993 and criminal offences ofmarket manipulation through misleading statements orimpressions and benchmark manipulation under the FinancialServices Act 2012. The Chancellor of the Exchequerannounced in his Mansion House Speech on 12 June 2014 thatthe United Kingdom will introduce a new domestic criminalmarket abuse regime to replace the existing legislation.(2)

(v) Other regulations60 There are a number of other recent regulatory initiativeswhich, whilst not dealing directly with conduct issues, have animportant bearing on the fairness and the effectiveness ofFICC markets:

Reform of the OTC derivatives markets61 In 2009, the G20 agreed to a range of measures designedto reduce counterparty risks and raise the transparency of theOTC derivatives markets. In the EU, these measures areimplemented by the European Market InfrastructureRegulation (EMIR) and elements of MiFID 2 (the latter due tobe implemented in January 2017). In the United States, thesemeasures are implemented by the Dodd-Frank Act. The newtrading venue categories created by these regulations (swapexecution facilities (SEFs) in the United States and, followingimplementation of MiFID 2, organised trading facilities (OTFs)in the EU) seek to deliver on the G20’s pledges regarding thereform of derivatives markets and their migration from anOTC to an exchange traded market model.

Basel III capital/liquidity requirements62 Recent developments in prudential regulation are alsocited by market participants as having a major impact on theFICC markets. The third Basel Accord (Basel III), which isimplemented in Europe via the Capital Requirements Directive(CRD IV), contains a number of measures including: highertrading book capital requirements to ensure adequatecapitalisation of positions that cannot be exited quickly; anon-risk based leverage ratio, requiring banks to assess capitalas a percentage of total exposure; and measures to ensurethat firms have sufficient liquidity coverage in times of stress.

(1) Whereas the current UK regulatory regime only applies to financial instrumentsadmitted to trading on regulated markets and to markets established under the rulesof a regulated market, the EU Market Abuse Regulation will also apply to financialinstruments traded on all MTFs and OTFs.

(2) Mansion House 2014: Speech by the Chancellor of the Exchequer, the Rt Hon GeorgeOsborne MP. www.gov.uk/government/speeches/mansion-house-2014-speech-by-the-chancellor-of-the-exchequer.

https://www.gov.uk/government/speeches/mansion-house-2014-speech-by-the-chancellor-of-the-exchequer

https://www.gov.uk/government/speeches/mansion-house-2014-speech-by-the-chancellor-of-the-exchequer


These new provisions will only apply to banks and other creditinstitutions (not to firms such as hedge funds and interdealerbrokers), and some are not due to be fully implementedinternationally for several years. Taken together thesemeasures are designed to ensure greater prudential stability offinancial firms, including those playing a key role in the FICCmarkets. The implications for liquidity in FICC markets arediscussed in Box 4 in Section 4.

Structural reforms to banks63 Various structural reforms are also being introducedglobally to address the ‘too big to fail’ problem of banks,which through their impact on market-makers may indirectlyaffect liquidity in the FICC markets. In the United Kingdom,the Banking Reform Act requires that, by 2019, banks ring-fence their ‘core’ activities (broadly, taking deposits fromindividuals and small businesses) from those activities whichgenerate exposures to the global financial system. Followingthe Liikanen Report, the European Commission has proposedthat the largest European banks should be prohibited fromundertaking proprietary trading, and that their supervisorshave powers to require the separation of other tradingactivities. In the United States, the Volcker Rule differs in thatit is an activity based rule applied at desk level to all deposit-taking banks and their affiliates, prohibiting themfrom engaging in proprietary trading. It provides limitedexemptions for systemically important activities, such asmarket-making and hedging.

Dark pools and high-frequency trading64 While there may be interaction between dark pool tradingand high-frequency trading (HFT) (for example a firm mayutilise HFT when trading via a dark pool), it should be notedthat the two are distinct topics and give rise to different risksand regulatory implications. The FCA recently set out itscurrent approach on the supervision of dark pools and firmsemploying HFT.(1)

65 In Europe, MiFID 2 (due to be implemented inJanuary 2017) addresses the regulation of both dark pools andHFT. MiFID 2 will significantly reduce the volume of equitytrading taking place in dark pools. Within FICC, automateddark trading (in the form of internalisation) is most common inforeign exchange; the issue of internalisation is considered in more detail in the main body of this document (see Section 5.1). MiFID 2 rules on HFT will also apply to FICCfinancial instruments, however given that the volume of HFT issignificantly higher in relation to equities, the majority ofthese rules will relate to trading in the equity market.

Alternative Investment Fund Managers Directive66 The EU’s Alternative Investment Fund Managers Directive(AIFMD) was transposed into UK law in July 2013. The broadscope of AIFMD covers the management, administration andmarketing of alternative investment funds (which include

hedge funds, private equity funds and investment companies),with a focus on the regulation of alternative investment fundmanagers. In relation to the FICC markets and conductconcerns within these, AIFMD contains specific conduct ofbusiness rules (for example, in relation to the fair treatment ofinvestors, and appropriate disclosure to investors andregulators).

(vi) Voluntary market codes of practice coveringUK-based FICC markets67 In addition to the regulations detailed above, a number ofvoluntary, non-statutory market codes of practice exist in theFICC markets. In the United Kingdom the most establishedmarket code covering certain parts of the FICC markets is theNon-Investment Products Code (the NIPs Code),(2) whichapplies to wholesale market dealings in non-investmentproducts, specifically the sterling, foreign exchange and bullionwholesale deposit markets, and the spot and forward foreignexchange and bullion markets.

68 The NIPs Code is drawn up by a wide cross section ofmarket participants (including the Bank of England and theFCA) and its content is consistent with the relevant parallelprovisions in the FCA and PRA Handbooks. The NIPs Code ismaintained and published by the London Foreign ExchangeJoint Standing Committee, in conjunction with the SterlingMoney Markets Liaison Group and the London Bullion MarketAssociation in relation to the sterling wholesale deposits andthe bullion markets respectively.

69 A number of trade associations and professional bodieshave endorsed the NIPs Code, including: the Association ofCorporate Treasurers, British Bankers’ Association, BuildingSocieties Association, Chartered Institute of Public Financeand Accountancy, London Bullion Market Association,Association of Financial Markets in Europe and the WholesaleMarket Brokers’ Association.

70 The NIPs Code comprises good practice guidelines whichapply equally to broking firms, PRA and FCA regulated entitiesand other ‘principals’, as defined by the code itself. It has nostatutory underpinning except where it refers to existing legalrequirements. It consists of three general sections (GeneralStandards, Controls, Confirmations and Settlements) as wellas more specific Appendices on the sterling wholesale depositmarket, the foreign exchange market and the bullion market.

71 The General Standards section covers, among other things, best practice regarding the responsibilities offirms/employees, the negotiation of contractual terms, theuse of intermediaries, commissions/brokerage fees, obtaining

(1) Letter from Martin Wheatley (CEO of FCA) to Andrew Tyrie MP of 23 July 2014,available here: www.parliament.uk/documents/commons-committees/treasury/Letter_and_briefing_on_HFT.pdf.

(2) www.bankofengland.co.uk/markets/Pages/forex/FXjsc/default.aspx.

http://www.bankofengland.co.uk/markets/Pages/forex/FXjsc/default.aspx

http://www.parliament.uk/documents/commons-committees/treasury/Letter_and_briefing_on_HFT.pdf

http://www.parliament.uk/documents/commons-committees/treasury/Letter_and_briefing_on_HFT.pdf


data for mark-to-market purposes and electronic trading. TheNIPs Code Controls section deals with best practice in relationto items such as ‘know-your-customer’, dealing withunidentified principals, confidentiality, taping, conflicts ofinterest (both when dealing for personal account and whenusing a connected broker), marketing/incentives/entertainment/gifts policies, drugs and alcohol abuse and theuse of mobile phones for transacting business. Finally, theConfirmation and Settlement section of the NIPs Code,includes provisions regarding best practice for

payment/settlement instructions, written/electronicconfirmations and settlement of differences.

72 It should be noted that the NIPs Code is just one of anumber of non-statutory, voluntary market codes coveringvarious parts of the wholesale FICC markets internationally.Other examples are listed in Box 9 in Section 5.4.

73 The question of how market codes might be made moreeffective is considered in Section 5.4.