The world's top financial regulator on Tuesday urged deep-rooted change to how currency benchmarks are set, encouraging market players to tighten up their governance, practices and controls rather than imposing stringent new regulation.
The proposals come in response to allegations being investigated by regulators that dealers at major banks colluded and manipulated key reference rates in the $5.3 trillion-a-day market, the world's biggest and least-regulated.
At the center of the investigations is activity around the 4 p.m. currency fix in London, a 60-second window where key exchange rates are set. These prices are used as reference rates for trillions of dollars of investment and trade globally.
The Financial Stability Board, based in Basel, Switzerland, said it had no access to any evidence or knowledge of any details of the investigations.
Its report included a request for views on a number of recommendations, which include changes to market infrastructure, systems and how the benchmark is calculated.
The changes that have been proposed go deeper than many in the banking sector had expected just weeks ago. But they stop short of calling for outright replacement of the existing fix or any sort of direct regulation, although that could be "revisited."
"We have consistently argued it is not the fix that is broken, but rather it is the manner in which it is used by certain market participants that must be scrutinized," said Marshall Bailey, president of dealer association the ACI.
"In all cases in markets, ultimately it comes down to the behavior of individual market participants, and the ability of their supervisors to enforce high standards."
The report said banks should change the common practice of promising to deliver clients their currency at the "mid" exchange rate set at a fixing. Instead, they should either charge a clear fee or at least include a bid-offer spread depending on whether a client is buying or selling the currency.
Bid-offer spreads are standard in all other foreign exchange trading. They were effectively eliminated from the fixings for the market's biggest fund and corporate clients some years ago, as banks competed for volumes of orders.
"The group recommends that fixing transactions be priced in a manner that is transparent and is consistent with the risk borne in accepting such transactions," the report said.
The other major change signaled was support for a new independent system to net off the bulk of fixing orders by matching buy and sell orders, and execute the remainder.
Banking sources told Reuters last week that the FSB had been considering proposals for a system that isolated fixing orders to keep them out of the hands of speculative traders, mostly hedge funds and spot dealing desks at major banks.
"The group supports the development of industry-led initiatives to create independent netting and execution facilities," it said on Tuesday. "However, it also is interested in seeking feedback from market participants on the development of a global/central utility for order-matching to facilitate fixing orders from any market participants."
Industry sources have questioned whether regulators would be able to give control of such a business to one entity.
"The unintended consequences of further concentration of FX flows may not be what the regulators and supervisors want," the ACI's Bailey said. "We would have to be careful in the formation of such a utility, and ensure that all parties understood their role and their obligations."
Until just weeks ago, senior players in foreign exchange markets had thought the FSB's working group was likely to take a cautious approach on the fixings, preferring to wait for the conclusion of around a dozen regulatory investigations worldwide.
But two sources with knowledge of discussions with the FSB told Reuters last week that UK-based bankers and officials had exerted pressure for action that would help with efforts to quickly draw a line under the affair. They were concerned at the effect it was having on markets that are central to London's role as a financial center.
Britain's Financial Conduct Authority and the U.S. Department of Justice opened investigations last October into allegations that senior traders shared market-sensitive information relevant for the London fix.
London is the hub of the global currency market, accounting for some 40 percent of the $5.3 trillion average daily volume.
The WM/Reuters fix relates to several exchange rates and is compiled using data from Thomson Reuters and other providers. They are calculated by WM, a unit of State Street Corp. Thomson Reuters is the parent company of Reuters News, which is not involved in the fixing process.
The European Central Bank also has a daily fix in Frankfurt where the euro's benchmark rates are set.
The FSB said banks and other market participants have until Aug. 12 to respond before final recommendations are sent to G20 leaders in November.
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