Be Careful What you Wish For- FX The Final Frontier



Osborne and the FX Market “Clean Up”






As news of alleged manipulation of FX rates broke last summer traders and regulators have been under increasing scrutiny to ensure that the investigation reveals any evidence of criminal behaviour .This has led to ever increasing calls to regulate the £3 trillion –a day foreign exchange market .Treasury officials are working with the International Financial Board to “clean up” the market by introducing a more formal pricing system and usage of ever increasing electronic pricing systems. However upon further inspection this veritable opening of Pandoras box could lead to an even bigger crisis.


George Osborne clearly thinks that it is politically expedient to pre-announce his plans to make the Foreign Exchange market “more transparent”. His proposals will be unveiled later this month at the Mansion House speech.  He expects that this will be a vote winner as the public love to give “bankers” a good kicking. What exactly constitutes “a banker” has never actually been defined, but the Spot FX Dealer is the latest to be caught by this generic  term.


Osborne’s knee-jerk reaction is typical from a politician, and as usual it has not been thought through properly. It takes 2 to make a Foreign Exchange deal. One is the bank trader, and the other is (very often) a Fund Manager – maybe a Pension Fund Manager.


The Pension Fund Manager is highly likely to have a nice cosy relationship with the Bank salesperson who will have encouraged him to place his 4.00 pm Fixing business with that bank.  The Pension Fund Manager has completely abrogated his fiduciary duty to the investors in his fund. He has a duty to maximise the value of a client’s portfolio and he has clearly failed to do this. Fixing rates may serve a valid purpose for portfolio valuation, but they certainly do not represent “best execution”.


The pursuit of the utopian “best execution” has led to a myriad of problems for both counterparty and executor alike as the probe into the 4pm Fix has shown. Instead of being an arbitrary transparent benchmark for market participants its very often a multi headed hydra that means different things to different people.


Fund Management is a business where relative performance is more important than absolute performance, and because many (most) Fund Managers do not want to invest in the skills required to manage their FX risk properly, and treat FX as an asset class that can offer additional returns, they are happy that they (and their peers) all get rid of the risk at the same prices, thus ensuring no performance can be lost (or gained) from FX transactions.


A study by Morgan Stanley in 2010 estimated that an International equity portfolio systematically executing at the 16.00 London Fix each day could lose as much as 500 basis points (annualised) of value, due to sub-optimal execution relative to executing at, for example, the Flow Weighted Average Price.


All of this opportunity cost will have come out of the pocket of the man-on-the-street who has an expectation that his Fund Manager is “maximising the value of a client’s portfolio”.


So before George Osborne goes gung-ho to gain votes by kicking “the bankers” again, he should stop to think why this business is executed in this way, and he should realise that the tin of worms he has opened will make LIBOR look like a vicar’s tea party, because EVERY pension holder will have a potential claim against the firm that has been managing their money.The desire to bring tacit law and order to the perceived  old wild west of FX trading could backfire spectacularly.


It’s the law of unintended consequences.








About Hetal Patel - Chief Editor, Europe

Hetal Patel has written 58 post in this blog.