FXPA Paper Cites FX Platform Regulatory Gap Risk
Posted by Colin Lambert. Last updated: September 16, 2024
The Foreign Exchange Professionals Association (FXPA) has waded into the ongoing debate around the regulation of FX platforms with a new white paper that argues the regulatory gap could continue to widen, leading to weakened FX market integrity.
While the paper, Regulating FX Derivatives Trading venues: Promoting Fair and Orderly Markets, uses some terms more associated with the retail and small institutional end of the FX market (leverage and deposit requirements for example), it is a timely addition to the debate given the ongoing focus on the uncertainty created by European regulators’ apparent unwillingness to enforce the Trading Perimeter.
The paper recommends that FX market participants pay attention to the regulatory status of the venue they are using for non-spot products (spot FX remains outside the Trading Perimeter regulatory scope), noting, “The presence or absence of regulatory oversight can impact a range of issues, including the role of affiliated market makers, permitted trading practices, market surveillance, and overall market integrity.”
It further discusses the different structures of regulated and non-regulated venues, as well as fairness and market integrity considerations. Chief amongst these are the transparency of a venues regulatory status – it notes that some do not always disclose their lack of regulation, but “purport to operate as a technology intermediary or will use a central counterparty and function in similar ways” to a regulted venues. “These unregulated FX derivatives trading venues compete directly with regulated FX derivatives trading venues, but do not always disclose that they are not regulated, introducing the risk that consumers will choose unregulated FX derivatives trading venues in light of some of the benefits they can provide without complete knowledge to evaluate the attendant risks,” the paper warns.
The FXPA paper also looks at the cost of regulatory adherence, observing that an FXPA member firm conducted an internal analysis that found that operating a single regulated venue could cost between $1.3 and 1.5 million per year.
The importance of impartial access is also stressed, the paper notes it is “crucial” to market fairness and competition, and warns that unregulated venues may not prevent discriminatory practices that do not allow participants to trade on equal terms, thus raising the risk of market abuse.
Looking deeper into the problems such regulatory gaps create, the FXPA paper notes that the barriers to entry to compete are “largely tilted against” regulated entities, adding that as markets are generally efficient and react predictably to incentives, the costs of regulatory adherence for regulated FX derivatives trading venues acts as a negative incentive, non-regulated players are incentivised by the large cost savings associated with not complying with transparency and reporting obligations, and the ability to, in some cases, offer benefits to customers including higher leverage, lower deposit requirements to trade, lower fees for customers and less onerous onboarding requirements.
“Moreover, the uneven playing field between regulated FX derivatives trading venues and unregulated FX derivatives trading venues can also have knock-on impacts to overall market liquidity,” the paper argues. “Many customers are price sensitive (taking into account liquidity) and as a result, cost savings are material to the market. As volumes on unregulated FX derivatives trading venues grow, a cycle of liquidity draws more volume in and away from regulated FX derivatives trading venues. These liquidity draws, in turn, reduce price discovery and price fairness for market participants.”
The Full FX View
There is one line in the FXPA paper that no-one should be willing to argue against – “A regulatory framework that treats functionally similar market participants differently does not promote a fair and orderly market” – and this is something that has been vexing market participants for some time. Both ESMA and the UK’s FCA have published guidance around the Trading Perimeter, but neither seems, at this stage at least, disposed to actually provide further clarity or actually enforce the guidelines.
This inertia does the FX industry no good, for as observed by the FXPA, it creates an unlevel playing field that favours the non-compliant. It is good that the paper takes the approach that compliance should be made easier, and cheaper, to achieve, because we don’t want to regulate innovation out of the market, but the fact is, several venues have put a lot of time and effort into adherence to the rules, and while perhaps they should not be rewarded for that effort, at the very least they should not be disadvantaged by it.
There are aspects of the FXPA that confuse a little – it would be helpful if there was more clarity around when it is talking venues offering things like leverage, compared to those claiming to be a “technology provider” – but overall this is a timely and important paper that sends a message to the regulators. The current regulatory regime is creating uncertainty and is, frankly, a half-completed work, that potentially disadvantages everybody.
For the good of the entire market, clarity should be established, for while the focus is rightly upon the harm caused to compliers, the lack of clarity means unregulated venues operate with a Sword of Damocles above their head, waiting to fall at the first hint of enforcement. The regulators are not, with their current stance, helping the FX industry, it is to be hoped that appears like this get their attention and provoke further clarity.
The paper closes out by listing some considerations for policy makers, urging that they promote the use of regulated venues. It adds that some participants “may believe that risk is borne by the trading venue and not the market participant”, adding, while unregulated FX derivatives trading venues may offer certain perceived benefits to customers, the latter should be aware of the significant risks involved.
“Policymakers and regulators should also consider supporting regulated entities by enabling decreased regulatory cost burdens through normalising regulatory norms amongst jurisdictions and allowing greater equivalence or substituted compliance for entities operating in multiple jurisdictions,” FXPA states. “These efforts have a supplemental benefit of making it easier for customers to understand the regulatory standards of the marketplace and how they can participate in the market on a multi-jurisdictional basis.
“Absent formal guidance or action from regulators, the regulatory gap between compliant and non-compliant activities could continue to widen, further increasing the risk to market participants and weakening market integrity,” it continues. “By taking into account the considerations discussed in this paper, policymakers can develop a regulatory framework for OTC FX derivatives markets that promotes an efficient and fair-trading environment while balancing the need for market innovation and development.”
