Today, the Financial Stability Board (FSB) published their comprehensive report on foreign exchange benchmarks after a long investigation. Katie Martin's WSJ recent article (link WSJ: Basel’s Super-Regulator On FX Benchmarks (And Traders) 15 Jul 2014), offers a concise summary of the FSB's findings, which I recommend reading. Martin notes several points from the report, which I have listed below.
- The benchmark does not need to be changed significantly, which somewhat differs from the situation we had with LIBOR.
- Banks should ensure that guidelines are followed around the fix (eg "address potential conflicts of interest arising from managing customer flow")
"FSB: It also creates a market where the dealer is agreeing ahead of the fixing time to execute
at an unknown price, which is established subsequently during the fixing window as the
clearing price which reflects the balance of those fixing transactions and other transactions
undertaken in the calculation window. In many cases, the dealer agrees to give the client the
mid-rate of this (as yet unknown) fix price, rather than applying a spread, whether they are
buying or selling. Given the market structure, the dealers can be placed under strong pressure
to try and offset the risks they face given the price commitment."
The FSB's report also presents some interesting quant results. The FSB notes that whilst FX volume is higher around the fix, as we might expect, the pick up in EUR/USD volatility is less than it is at other times of day (such as US data releases), which tallies with my earlier report (chart below). In my report I also analysed intraday volatility for other currency pairs too.
"FSB: The group recommends that asset managers, including those passively tracking an index, should conduct appropriate due diligence around their foreign exchange execution and be able to demonstrate that to their own clients if requested. Asset managers should also reflect the importance of selecting a reference rate that is consistent with the relevant use of that rate as they conduct such due diligence."
Whilst I still haven't read the FSB report yet in its entirety, what I have read so far is well worth a read. It also seems to be well balanced, acknowledging the risks which market makers face when offering the fix, which seems to have been lost in a lot of the media coverage. At the same time, it makes suggestions on how banks could better manage the execution of the fix.
Please also take the time to read my paper on 4pm FX from earlier this year.