IOSCO Publishes Report on Pre-Hedging

IOSCO has changed its recommendation around pre-hedging “slightly” to make clear that existing record keeping obligations could cover pre-hedging activity, as part of the regulator’s long-awaited set of recommendations around the controversial practice.

On Monday, IOSCO published its report which sought to clarify the rules around the practice that has remained a grey area even after earlier this year courts overturned the conviction of Mark Johnson, former head of trading at HSBC, which he received in 2017, largely because of uncertainties around the rules for risk management for large trades.

The final recommendations fail to give much clarity, aside from asking dealers to obtain prior consent to pre-hedge from the very beginning of the relationship, with the option for clients to revoke or modify this consent at any time. The regulator has also relied on established codes of conduct and existing rules, rather than coming up with new definitions or interpretations about what market participants can do and when.

“The final report seeks to facilitate greater consistency and clarity around pre- hedging, and to promote a level playing field for all participants across jurisdictions, asset classes and execution types,” the report stated.

IOSCO sought feedback from the industry during a consultation, responses to which showed “a commonality of understanding of pre-hedging issues but demonstrated a range of divergent opinions from different market segments and market participants on certain key issues.”

However, the regulator stopped short of saying that pre-hedging is right or wrong or prescribing circumstances in which pre-hedging is or isn’t appropriate.

“This final report also sets out IOSCO’s understanding of pre-hedging with the intention of promoting a consistent interpretation of the practice of pre-hedging across interested jurisdictions and markets. It presents a set of recommendations as guidance for regulators to the extent they are considering putting in place rules or adjusting existing rules relating to pre- hedging,” the report stated.

IOSCO’s final definition relied heavily on ESMA and other existing codes such as the FX Global Code of Conduct, noting that it can be practised when a dealer is dealing on its own account in a principal capacity; when the trades are executed in the same or related instruments after the receipt of information about one or more anticipated client transactions and before the client has agreed on the terms of the transaction(s) and/or irrevocably accepted the executable quote(s).

“It’s also acceptable when the trades are executed to manage the risk related to the anticipated client transaction(s); and the trades are executed with the intention of benefiting the client,” the final text said.