ASIC hits the major FX dealers: Two large Australian Tier 1 banks hit for risk management issues on wholesale spot FX operations

In Europe, the regulatory authorities wrangle with the retail firms and side with the large venues and Tier 1 dealers, making for a difficult landscape to navigate in terms of obtaining liquidity from Tier 1 banks and conducting OTC retail business on a live market basis.

On the other side of the world, however, the interbank FX dealers have become a bete noire of one of the most highly respected and technologically advanced regulatory authorities that exists today.

The Australian Securities and Investments Commission (ASIC) has censured National Australia Bank Limited (NAB) and the Commonwealth Bank of Australia (CBA) in relation to the banks’ wholesale spot foreign exchange (FX) businesses.

In Britain, large, London-based Tier 1 giants such as Citibank, which holds over 16.1% of the world’s FX market share, and Barclays, which is the third largest Tier 1 dealer by market share, are concentrating on ensuring that their ‘risk’ exposure when extending FX liquidity to OTC participants is one of extreme conservatism, whereas in Australia, the regulator is bearing down on two of the nation’s largest interbank FX desks.

Earlier this year, Citigroup published a report which stated that the bank considers a potential default rate of 56% when extending credit to OTC firms, hence the remainder of the banks with significant FX market share sat up and took note, hence a liquidity crunch occurred and now it is very difficult to operate a live market with a bank-based prime brokerage as they will in most cases not extend credit.

Barclays is a case in point. The company continues to provide its ‘last look’ execution method on its BARX platform, and is becoming more and more centered toward electronic trading as a major focus and away from traditional retail banking – the firm completed its full divestment from Europe this week, selling its remaining 74 branches in France to AnaCap Financial Partners. This means a complete concentration – and domination – in the interbank FX markets for Barclays BARX platform, as last look execution lives on and becomes even more of a core business activity.

ASIC, however, has taken this lead in Australia. As a result of ASIC’s investigation, ASIC is concerned that between 1 January 2008 and 30 June 2013, both banks failed to ensure that their systems and controls were adequate to address risks relating to instances of inappropriate conduct identified by ASIC.

ASIC Commissioner Cathie Armour said, “A well-functioning foreign exchange market depends on all participants acting with integrity and fairness. ASIC is committed to ensuring that major financial institutions have in place effective mechanisms for ensuring that their employees are trained, monitored and supervised to provide financial services efficiently, honestly and fairly.”

ASIC identified the following conduct by employees of NAB between 1 January 2008 and 30 June 2013:

• on several occasions, a NAB employee on an offshore spot FX desk, acting together with an employee of another Australian bank, shared confidential information and entered offers into the trading platform without any apparent legitimate commercial reason for placing the offers;
• on a number of occasions, NAB employees disclosed specific confidential details of pending client orders to external market participants, including identification of the client through the use of code names; and
• on several occasions, NAB employees on an offshore spot FX desk inappropriately exchanged confidential and potentially material information about the bank’s client flow or proprietary positions.

ASIC identified the following conduct by employees of CBA between 1 January 2008 and 30 June 2013:

• on two occasions, CBA employees on an offshore spot FX desk acquired proprietary positions in a currency after coming into possession of knowledge of large CBA fix orders in that currency;
• on at least two occasions, CBA employees traded in a manner that may have been intended to cause the trigger price for a stop loss order to trade when it might not have traded at that time; and
• on a number of occasions, CBA employees on an offshore spot FX desk disclosed confidential details of pending client orders to external third parties, including identification of the client through the use of code names.

Under the Enforceable Undertaking that has now been issued to NAB, the bank will develop a program of changes to its existing systems, controls, monitoring and supervision of employees within its foreign exchange business to prevent, detect and respond to attempts to manipulate the market for a currency, including by placing offers without a legitimate commercial reason and attempts to influence benchmark rates; inappropriate trading while in possession of confidential and potentially material information; and disclosures of client confidential information.

The program and its implementation will be assessed by an independent consultant appointed by ASIC.

Upon implementation of that program, for a period of three years, NAB will provide to ASIC an annual attestation from its senior executives that the systems and controls in its spot FX business are appropriate and adequate to effectively prevent, detect and respond to specified conduct. The program will also be subject to annual internal reviews and assessment by the independent consultant for a period of three years.

NAB will also make a community benefit payment of $2.5 million towards advancing financial literacy education related to the aged care sector and the promotion of ethical behaviour in Australian financial markets.

ASIC is concerned that CBA did not ensure that its systems, controls and supervision were effective in relation to such conduct by its employees. Such conduct had the potential to undermine confidence in the proper functioning of the market.

Under the EU, CBA will develop a program of changes to its existing systems, controls, monitoring and supervision relating to the management of fix orders, management of stop loss orders, and external communications containing specific confidential information to address such conduct. The program will incorporate changes already made by CBA as part of an existing review of its Global FX business.

The program and its implementation will be assessed by an independent consultant appointed by ASIC. Upon implementation of the program, CBA will also provide ASIC with an annual attestation from a senior executive, for a period of three years, that the systems and controls in its spot FX business are appropriate and adequate to effectively manage specified conduct risks.

CBA will also make a community benefit payment of $2.5 million towards advancing financial literacy education related to the aged care sector.

The question is, will this lead to a curtailing of spot FX activity by key Australian banks, and therefore could signal Australia’s potential following suit of the British regulators in an attempt to reduce the top level activity by banks and encourage exchange traded FX.

Times they are (ex)changing …..