March 12, 2014

Javier Paz, Aite Group
Javier Paz, Aite Group

Despite the still-unfolding London FX fixing scandal and its ramifications in other major global FX centers, I venture to say that Mark Carney, the Bank of England's governor,still enjoys plenty of general support for his courage (folly?) to accomplish unenviable tasks such as setting aright the U.K.’s monetary policy, maintaining London’s reputation in financial circles, and correcting oversight problems in the functioning of over-the-counter markets.

Carney’s Monday grilling by the House of Commons Treasury Committee — and it was a grilling — tested the BOE governor’s suave demeanor multiple times. What drew my attention was not Carney’s command of the problem or of the before and after of a BOE staff member suspension (he did fine on both accounts) but rather the fact that the Bank of England has been placed on the defensive. Treasury Committee members bashed the BOE for not picking up on now compromising comments recorded during four-to-six FX committee meetings (and for not escalating these issues over more than five years), for failing to look at similar problems in different markets (such gold and swaps), for having "at the heart … a governance structure that is still opaque, complex, and byzantine [that] desperately needs to be sorted out."

While Carney made it clear that the roles of market surveillance and conduct investigation are under the purview of the Financial Conduct Authority, he subtly suggested he would be involved in international efforts to institute more fair play to preserve the credibility of capital markets and root out two core issues in the FX scandal: (1) collusion by dealing banks and (2) sharing of confidential-deal information for a particular client among banks or to bankers’ top clients/prospects. Monday revealed that a Lloyds’ senior dealer allegedly tipped off a British Petroleum dealer colleague and client of a large (and still pending) Lloyds FX transaction, causing the trader to be one more of two dozen or so bankers across the industry who have been suspended over the past month or two for their involvement in clubby, allegedly improper, FX dealing activities.

The fallout from these developing events will very likely dramatically alter OTC FX operations in coming years. Discretion and trader communication oversight will be important themes going forward. To begin with, banks will institute their own measures to regulate and curtail dealing activity, both internally and externally. Certain of these measures will completely redraw how OTC traders are able to communicate, what they can and cannot say, and how such activity will be monitored.

The changes may address some of today’s problems, but they could also introduce new risks, such as lower bank willingness to take on large deals (i.e., lower liquidity) during a time of macro-instability and less willingness to talk about industry problems.

Now that banks know that the BOE and other central bankers are closely monitoring bank OTC activities, we can safely expect less candid discussions at central bank-sponsored FX committees meetings. While discretion is usually a praiseworthy attribute, the kind of discretion we are likely to see evolve in OTC markets is not. Carney’s methodical and well-calibrated approach to issue resolution, however, gives me a measure of hope that while more OTC regulatory changes are now inevitable, there’s a chance they might strike a happy equilibrium between zealous and complacent oversight.

About The Author: Javier Paz is a senior analyst at Aite Group within the Wealth Management practice. In this role, Mr. Paz examines retail trading trends in business, regulations, and technology across asset classes. Areas of expertise include FX markets, active trader segmentation, front-end trading technology, and margin-trading regulations. His coverage of retail trading markets is global in nature, with particular emphasis on the United States, Japan, and emerging markets. He has also written about systemic risks facing global capital markets, such as asymmetric FX regimes and cross-asset class contagion.