Carte Blanche at the Tier 1 banks. As regulators strangle the OTC sector, largest FX interbank dealers run amok

Barclays, the world’s third largest FX dealer, continues to dictate to the OTC industry in every aspect from trade execution/rejection to prime brokerage, yet gets away with all manner of transgressions from fraud to undercapitalization. We examine the double standards of those upon who our industry rely

Barclays FX

Traditional folklore suggests that cats have nine lives.

If this could be scientifically substantiated, then it would be quite appropriate to liken Barclays Bank to the feline species.

Currently, the Western world’s OTC electronic trading centers are the subject of vast regulatory scrutiny, ranging from perceived lobbying attempts by the exchange traded derivatives sector in order to make draconian adaptations to the method by which CFDs – a core OTC product that has a massive, loyal and often perfectly satisfied clientbase – are traded, and the costs and infrastructural changes that will arise in order to comply with MiFID II in Europe, combined with the vast restrictions that have reduced the OTC retail sector in America down to just two companies.

Over the past few years, undercapitalization has been one of the regulatory tenets that has resulted in extremely harsh penalties to many firms, an example being IBFX, MONEX Japan’s US subsidiary, which eventually packed its bags and exited the US market after several reprimands and penalties for dropping below the statutory $20 million capital adequacy requirements.

The regulators across the world’s major financial centers are watching the OTC FX industry’s activities like a hawk, however the Tier 1 banks which are at the very top of the institutional financial sector’s chain, are able to continue to operate and dominate the market despite their transgressions.

Transgressions which run counter to the banks’ collective curtailing of counterparty credit extension to the OTC industry which has resulted in prime brokerage relationships becoming extremely difficult to maintain. Risk management may be conservative, but corporate governance is most certainly not.

This week, Barclays, which is the third largest FX dealer by global market share, and has recently been terminating prime brokerage agreements with firms that do not put up larger than previous capital on their balance sheets, and continues to pick and choose orders on its BARX platform by operating a last look execution model, is in the spotlight as its most senior executives along with itself as a commercial entity, find themselves in extremely hot water in the form of a probe by the Serious Fraud Office which has resulted in charging Barclays itself and four former directors with fraud.

Before the details of this can be examined, let’s imagine that this was directed at an OTC firm. The company would be wound up and that would be an end to it, even if it had no previous form.

In this case, however, Barclays has a litany of blots on its regulatory copybook that have not curtailed its operations in any shape or form.

This particular case dates back to the financial crisis of 2008, when Barclays needed emergency funding. The bank raised £4.5 billion in June that year and £7.3 billion in October from investors including Qatar Holding and Challenger Universal.

Over the last five years, the Serious Fraud Office (SFO) has been investigating “advisory services agreements (ASA)” that were struck with Qatari investors in 2008, which resulted in payments of £322m to them. Barclays did not fully disclose the details of these ASAs.

Barclays then loaned the State of Qatar $3bn in November 2008. It is unlawful, under the Companies Act 1985, for banks to lend money to themselves.

Barclays at the time used this deal to project to its own investors and to the public that it was maintaining the moral high ground by avoiding being bailed out by the government and being nationalized, which is what Lloyds Bank and Royal Bank of Scotland did.

Barclays, its former chief executive John Varley, and executives Roger Jenkins, Thomas Kalaris and Richard Boath are charged with conspiracy to commit fraud by false representation in relation to a June 2008 capital raising.

In addition, Barclays, along with Mssrs Varley and Jenkins are then accused of conspiracy to commit fraud by false representation in relation to an October 2008 capital raising. These three defendants are also charged with unlawful financial assistance.

Yes indeed, the former directors may face up to ten years in jail, however the acts will be settled within the company in the form of a regulatory fine. Barclays will pay another several hundred million in fines and then it will be business as usual.

To the general public, tabloid headlines that sensationalize the hundreds of millions in fines that are directed at banks for such activities (along with those levied for FX benchmark manipulation and LIBOR fiddling) appear to instill shock and give the public the impression that these are gargantuan figures and that the punishment is severe.

But it is not.

Tier 1 banks are not run by innumerate buffoons who hope they do not get caught for their ineptitiudes and then flounder when a vast fine has to be reported to shareholders and investors.

Quite the contrary. They are run and operated by mathematical scientists who fully understand risk and reward, return on investment and how to dominate a market place in such a manner that every single institutional entity in the world is fully dependent on their extension of liquidity, and that any transgression is worth the fine.

Barclays is a company that understands this very well indeed. By the end of last year, it had completed its absolute divestment from European branch banking, 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.

That occurred well after the gavel fell in court, ruling the firm one of the manipulators of FX benchmarks on both sides of the Atlantic. Perhaps this can be construed as a tax write off.

Source: Euromoney

Now let’s revisit Barclays’ viewpoint on capitalization as touched on a few paragraphs above, as the bank was deemed undercapitalized by the Bank of England’s Prudential Regulatory Authority at the end of 2016 and has done nothing to rectify the regulator’s findings, yet carries on as normal.

What would that exact same bank do if it considered a prime brokerage with which it had until now had a first class relationship, to have less than its own stipulated capital base, which in the case of extending credit to OTC counterparties is the bank’s continually changing criteria, not a set of concrete rules set in place by a regulator?

The answer is that the bank would terminate the prime brokerage relationship. Five years ago, it was possible to maintain a prime relationship with $5 million capital, now it is approximately $50 to $100 million just to maintain an existing one, let alone forge a new one, yet the bank that stipulates this is under its required capital adequacy stipulations, which are part of its regulatory obligation.

RBS is one of two banks in this situation, the other being Barclays, which is the third largest FX dealer by global market share, and has recently been terminating prime brokerage agreements with firms that do not put up larger than previous capital on their balance sheets, and continues to pick and choose orders on its BARX platform by operating a last look execution model.

Barclays did not meet its CET1 systemic reference point before AT1 conversion in the Bank of England’s stress tests. In light of the steps that Barclays had already announced to strengthen its capital position, the PRA Board did not require Barclays to submit a revised capital plan. While these steps are being executed, its AT1 capital provides some additional resilience to very severe shocks.

Even so, this is still a severe case of double standards. It is like a police officer, whose livelihood depends on doing his job properly in a public community, therefore being reliant on the citizens he serves, fining someone for jaywalking, and then jaywalking back to his car after issuing the ticket.

As of that time, Barclays retained its position as the third largest FX dealer, with 8.11% of the entire world’s FX volume going through its books.

Focus on interbank FX demonstrates Barclays priorities

It is clear that economies of scale are vital for large financial institutions, however Barclays is conducting its dominance by focusing on FX and other interbank derivatives asset classes rather than its traditional business, as today the British company has completed its complete exit from the European market’s traditional banking sector, culminating in the sale of the final remaining 74 branches in France to private equity firm AnaCap Financial Partners, meaning that it now can concentrate its efforts solely on being at the very forefront of London’s global electronic trading epicenter.

So, that signaled the end of Barclays’ operation of branch banking across European high streets, a direction that concluded the Bank’s offloading of its entire Barclaycard credit card operations in Spain and Portugal to Bancopopular-e, a total divestment of its stake in Barclays Africa, a complete dispensement of its Egyptian operations and the sale of its wealth and investment management business in Singapore and Hong Kong.

Meanwhile, on home territory, Barclays continues to stand out in terms of procedure and its domination of market practice with regard to electronic trading with its BARX single-dealer platform.

Barclays is one of the world’s most prominent proponents of the last look execution procedure, its BARX platform which provides FX liquidity by streaming indicative prices on an in house and third party platform basis.

Barclays’ corporate standpoint on the reasons why it uses last look methodology is that being one of the world’s largest interbank FX dealers, it does not generally seek to reject trade requests. However, electronic spot FX market-making is a highly competitive industry and for the reasons set out above it necessarily exposes the liquidity provider to the risk of trading on incorrect pricing.

Barclays maintains that last look functionality is used to protect against these risks and allows liquidity providers to show considerably tighter electronically streamed prices than they otherwise could – something that the bank considers beneficial to every user of electronic FX trading platforms.

Beneficial to who? That is the question.

In January this year, the Foreign Exchange Professionals Association (FXPA), held a webinar on examining the implications of last look for the FX markets.

Attorneys with Steptoe & Johnson on the ‘last look’ webinar, advised market makers to be more transparent about how their last look systems operate.

“Regulators take a very dim view of institutional practices that emphasize a lack of transparency and that encourage employees to give either misdirection or less than complete information to counterparties when direct questions are asked,” said Mike Miller, litigation partner at Steptoe & Johnson, who spoke during the webinar.

In one high-profile case, a global bank used its spot FX trading platform to reject unprofitable trades. When customers asked why the trades were rejected, the bank reportedly gave “vague or misleading answers,” said Steptoe partner Jason Weinstein who analyzed the case during the webinar.

After a regulatory settlement, the bank posted detailed disclosures on its web site and also paid a steep fine, setting a precedent that could impact other banks, brokers and market-making firms.

FinanceFeeds has spoken at length with a number of senior executives within the institutional and prime brokerage sector recently, many of which have openly stated that banks do not like firms that offer ‘no last look’ execution, despite the regulatory and government derision aimed at the practice.

Despite a $50 million settlement agreement with regulatory authorities this summer which was part of an agreement to settle a class action suit instigated by Axiom Investment Advisors over last look execution practices, the firm continues to operate in that basis, much to the annoyance of prime of primes and ECNs globally.

The practice of executing trades via ‘last look’ methodology has been the subject of regulatory discourse over recent times, however Barclays’ institutional BARX platform continues to offer a last look execution facility.

In May last year, Thomson Reuters and BATS Global Markets, some of hte largest institional FX platforms in the world, concurrently limited the last look facility on their platforms in order to move toward greater transparency in the FX market.

At that time, regulatory authorities in prominent institutional FX centers on both sides of the Atlantic, namely New York, Chicago and London, had begun to express concern about the efforts of interbank and institutional traders which sought to manipulate a range of financial markets.

Last summer, at the time during which BATS Global Markets and Thomson Reuters which owns the FXall ECN platform having bought it for $625 million in 2012, continued to offer last look, along with Barclays in the interbank sector, whilst most FX platforms had already prohibited last look execution.

Under MiFID II, regulated marketplaces, ETFs and MTFs, along with Systematic Internalizers (market makers) will have to publish their entire trade reports and how they executed trades. Banks will not have to do so, and can continue to pick and choose whether they want to reject or accept trades.

One rule for me, one rule for you, M’Lord.


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