FMSB Publishes Large Trades Standard

The FICC Markets Standards Board (FMSB) has published a final Standard for the execution of large trades in FICC markets – a transparency draft was published in late 2020 for consultation.

The timing of the release is propitious, coming so soon after the Australian regulator ASIC, brought charges against Westpac for its actions around the largest trade executed in Australian interest rate swap markets.

FMSB says that large trades, which it describes as transactions that are greater than the available liquidity prevailing in the market, can create undue pressure on markets, across all FICC asset classes. It adds these trades create real execution challenges, both for market users and for dealers, often lead to market impact and price volatility, and can sometimes give rise to conflicts of interest for those managing the resulting market exposures.

It does note that what constitutes a large trade will vary across markets and over time and explains the latest Standard focuses on transactions substantially larger than the observed liquidity in the relevant product market around the time of execution, and which could be reasonably expected to have a material impact on prices in the market or related markets.

This aim of the Standard is fourfold. To reduce information asymmetries between dealers and clients in relation to the execution of large trades and enhance the understanding of clients as to the method of execution and potential impact of these trades on the market and price the client receives.

It also seeks to clarify and codify the principles governing the pre-hedging of large trades, building on the FX Global Code and extending principles compatible with the Code to the fixed income and commodities markets, as well as establish clear expectations with regard to client confidentiality given the potentially heightened impacts of information leakage in the context of large trades.

Finally, the Standard seeks to ensure that clients communicate with dealers in a transparent manner so as to not have a detrimental impact on the effectiveness of the execution of a large trade by a dealer.

Key relevant elements of this guidance dovetail closely with the Global FX Committee’s evolving guidance on pre-hedging.

It remains to be seen whether the latest Standard will be used in the aforementioned ASIC case against Westpac, for while it is clear there are several relevant factors in the latest document the Standards are aimed at European markets and have no legal standing. According to the FMSB website, Westpac is not a member organisation, however it should be noted that FMSB – at least initially – was a UK-orientated body.

The six core principles within the Large Trade Standard are:

1. When a large trade is contemplated dealers should (at an early stage where practicable) communicate to the client that the trade may be large in the relevant market.
2. When acting as agent, pre-hedging is never permitted in the relevant market.
3. Dealers should not disclose the details of large trades to other market participants unless required to give effect to the clients’ instructions and to execute the transaction. Dealers should also ensure that they treat all clients fairly.
4. Clients should communicate in a transparent manner that is clear, accurate and not misleading.
5. Market participants should implement such policies and associated control processes as necessary to demonstrate adherence to the Standard.
6. Pre-hedging should only be undertake where: (i) the dealer legitimately expects to take on market risk and the pre-hedging is undertaken at the dealer’s own risk; (ii) the trading activity is reasonable, relative to the size and nature of the anticipated transaction; (iii) It aims to minimise the impact of the activity on the market; and (iv) it is designed to benefit the client and not executed in a manner that is meant to disadvantage the client.

This Standard applies to all participants in the wholesale FICC markets in Europe, subject to any applicable local regulatory restrictions, but market participants may elect to apply this Standard in other jurisdictions.

“Ensuring fair and transparent execution of out-sized orders has been a significant challenge for dealers for my entire career in FICC markets, and I daresay well before then too,” says Mark Yallop, Chair of FMSB. “It is an extremely important topic, of current interest to many market participants, in all jurisdictions globally. Ensuring that markets can deliver fair and effective outcomes for large trades is a challenge for both dealers and their clients: both sides of the transaction have important responsibilities.

“FMSB’s mandate to represent the interests of all market participants make it the natural venue to tackle this long-standing challenge and it is particularly pleasing to have been able to collaborate with the Global FX Committee. It is also very gratifying that this work has been led for FMSB by one of our long-standing corporate, end-user members. I thank them and all our members who have supported the drafting of this new Standard.”

Michael Dawson, head of liquidity and FX at Shell and chair of the FMSB large trades working group, adds, “By their nature large trades can have a significant impact on the market, as well as there being the potential for heightened conduct risks associated with their execution. This Standard therefore seeks to establish principles for how market participants should behave in relation to the execution of such trades. The core principles set out in this Standard are relevant across asset classes and we believe this should be of value to all market participants involved in transacting large trades.”

Meanwhile, James Kemp, managing director at Global Financial Markets Associations, says, “Key relevant elements of this guidance dovetail closely with the Global FX Committee’s evolving guidance on pre-hedging. Creating a clear and consistent industry position on these topics is helpful in providing all market participants with well understood guidance that serves to underpin effective market functioning.”