Transcript of Question & Answer Session Remarks to a panel discussion at the Thomson Reuters FX Benchmark Event

What do you think would work better, do you think a spread in the traditional way or a fee based incentive?

Okay so you guys did what three months on this and you couldn’t come up with an answer?

Nine.

Nine months okay. Personally I think probably a fee is going to be better, because I think you can … The asset managers can then pass the fees on. The problem if you suddenly start imposing spreads on them, they will get a bit antsy about it. Having said that active managers are happy to pay spreads, so probably making a choice for that customer, but I would say in principle the fees will be easier to explain further down the line, which is where ultimately we have got to explain this.

I mean I would broadly agree with that and I think one thing which is interesting, have to be careful using the word agency because that apparently has particular meanings in the US context, so without – so I’m using agency with a ‘small a’ I think. But that’s a fee based model is effectively that’s what it is, which is obviously different from where the market has been, but again for similar reasons I think that may work. I mean one thing which I thought was interesting in doing this work is that there is the issue of tracking error and asset managers were comfortable enough in taking tracking error on the component portfolios when it came to FX suddenly tracking error was a no no.

Yeah, yeah which is a …

Which is sort of interesting.

… and it’s a nonsense because if you think of it this way you’ve got these asset managers taking positions in Korea, Singapore, Tokyo, Australia and they’re letting the market go for 12 hours before 4pm London, before it’s keeping FX. What about the tracking error in that 12 hours between you doing the underlying trade guys and the actual fix? Active asset managers as the report noted, generally take that into account and execute closer to the time of the underlying trade. The other point I would probably point out as well is that as the report notes it’s in their index trackers, so typically I would argue that the amount of netting available, if they’re all tracking index is going to be fairly minimal. So you’re still going to have the same issue with the residue.

MR DEBELLE: Yeah. One thing we had to be careful was, you have to be careful saying it’s not all the asset managers’ fault.

Yes, yeah.

MR DEBELLE: When particularly sitting in a room full of FX traders.

I’m curious about the comments or the recommendation on separating the flow business from the fixed business, how in reality will that work? Does that involve more use of electronic netting machines to do it and take the human element out of it or how do you see that transpiring?

I mean that’s roughly the State Street model is that is what you just – well not roughly, that is the State Street model what you just described, but there are others who I know, I mean it’s literally sticking I mean almost literally as well as figuratively a cone of silence around a trader – so you cut off the fixing orders at a particular point, someone goes and then sits out there, sitting in another room who receives those orders, they then execute it through the fix window completely separate from the sort of spot trader sitting there on the desk. I know one, at least one bank, who’s gone down that route, well aware that this implies cost, either if you’re going down the algo route or if you’re going down amongst other things if you’re going down the separation route it requires two traders, which is more than some dealing rooms have at the moment, or two humans at least. But as I said it’s again coming to Col’s point about the net, it’s not necessarily the optimal thing in terms of execution, but it’s really a function of the circumstance as to where the market got, not necessarily something you’d ideally dial up.

Traders are still going to be left with residual balances, particularly months and quarter end they’re going to be large and they are going to take a bit of a kicking on that. But if you at least make it a bit fairer by at least saying that there’s a fee based business around this. And I guess the other thing is for the trader as well is if you put them in that cone in that separate room, you can then separate that business from their normal day-to-day activity, so then you don’t have this fear of I’m losing money in this trade, this is going to come against my bottom line, which is a fear that drives a lot of people, everyone’s got families so you want to earn a living. I think the experience that I’ve been told of with moving people in different rooms isn’t working, and I think the answer to your question is yes it lies in the algos, because I mean ultimately what are we doing here, we’re automating, the recommendations say industry netting utilities, let EBS and Reuters, let TruCross have a go at it, they’re basically automating what the voice broking desk used to do, as you know Keith and John know very well.

Yeah.

So if you’re automating that, automate the balance. My question is what happens with the algos are they allowed to interrogate internal bank liquidity, because you’re going to lose a massive amount of efficiency.

I was going to say I mean algos can gain probably more efficiently than traders, I mean …

I think we need to randomise the process. The observations over the five minute window they can’t be the last second, the last 10 milliseconds of every second, it’s got to be randomised so that you can’t … So the algos aren’t going to gain this, because there are clever guys out there and they will work it out.

And that’s the sort of interaction when WM sets up this group to determine that they’re sort of issues I would expect that they would be looking at.

You’d hope so yeah. And I think also one … so one of the points you made there about venues needing to fulfil criteria, please God let it be that they have to have no last look.

Yes I expected you to say that.

Because ultimately it’s going to be gained. If I know there’s a fix going on I can just stick in any price I like on last look and I don’t have to deal on it. There’s the next level.

The line in the model code needs to be discouraged and then excuses for it.

I understand, there are needs in certain areas for last look apparently. And I understand certain relationships will probably require that, I don’t believe the traditional asset manager, corporate bank relationship requires it.

Agreed.

Keith, curious also too, obviously this is focussing on the fix – the fixes and the benchmarking in the Code of Behaviour how clearly did or how do you define front running? And how clearly do you go into those definitions. I mean it’s a very difficult having been a trader myself, where you draw the lines on those is extremely difficult how far is the ACI gone in distributing the finding?

They don’t go particularly specific but it’s again, it’s behaviour that’s not encouraged and should be stamped on by the superior. So we’re hoping that the model code gets read by the Chief Dealers as well as the traders. But it’s very general …

And above.

… and above. But it’s very general in the way that it tries to discourage front running, it doesn’t give specific examples it just says again it shouldn’t be encouraged and should be monitored by the bank’s own people.

But as you say and as I said earlier once you try and get specific you can say the word front running and say okay that’s not good, but as I think Col basically said front running and hedging are observationally equivalent even from a … even the trades which go through.

Once you get specific someone will try and find a way round it that is … Well it wasn’t in the model code so this isn’t particularly front running, but it’s a form of someone will find a way around.

If you get specific the model code will be about the size of War and Peace.

Yeah.

Keith I mean do you think that we need to have more teeth around it? I mean the FX committee I mean I know you’re involved in that work to unify the codes of conduct, but you actually need to give these codes teeth in some form? Maybe not legal but you know just …

So I mean … Well I mean that’s again something the ACI has strong … So the question … As banks have internal codes of conduct to which they get their traders to sign up to. The question is can you have this sit alongside that or be part of that process. I mean that said in most jurisdictions illegal trading behaviour is indeed illegal. And I mean some of this is around defining, providing a little more detail around that but only sort of as I said reasonably high level principles around that.

It’s a global business we need a global code really that everybody signs up to and that’s what ACI are aiming for.

I mean in … As most people in this room are aware you know we the Australia Foreign Exchange Committee endorse the ACI code. That’s true of a couple of other foreign exchange committees around the world, but clearly not true of all of them.

So do you think that when you talk about incentive, do you think it’s important for the banks to incentivise their traders not just to sort of try and make money on every deal and in terms of curbing behaviour or is that too difficult to do?

Well as best as I can understand and again from only reading in the press, that and without picking on one or highlighting one institution, Deutsche has sort of gone down that route, I’m not saying that no one else has either, but they’ve most publicly at least or at least been given the most coverage around the sort of stuff they’ve done around behaviour. And again coming to some of the stuff which is in there, in some cases it’s about providing, at least providing information about what isn’t appropriate. If people want to get around it, they will get around it, that’s always going to be the case. But in some cases at least giving people some guidance as to what is and is not appropriate information.

Sharing and information is the big one that was …

I mean in an over-the-counter market though defining what is and is not an appropriate amount to share is actually … can get difficult. I mean one thing which was … is fairly straightforward is you probably don’t need to pass on which customer you’re acting on behalf of, right, that’s not necessary to complete the trade generally. To that’s fairly straight forward. Much further … too much further than that it starts to get tricky quite quickly so I think … I mean a lot of banks have obviously been going through this compliance process over the last few years or last year or two at least, and in setting up internal training or whatever and these sort of issues become very tricky, very quickly, as I think most people in this room have probably discovered.

What’s the difficulty in co-ordinating this globally there’s different laws in different countries and there’s different, as Guy mentioned before there’s different groups working on similar type of things and it’s not I guess purposely not co-ordinated at this stage. What’s the difficulty there and what’s the time frame do you think Guy?

Well I mean we are trying to co-ordinate it across the global foreign exchange committees at the moment, and we had the meeting this year, it was this year, in Sydney in April and that’s put out in the public domain that there’s something we’re actually trying to work on. I think basically in time for the next meeting of the global FXCs early, not too far into next year and that process is underway to at least get a bit of global co-ordination around this. What the final form of that will take we’ll have to … it’s still in train. Well the train’s actually moving, I’d have to say it is moving pretty well. But at least that provides some, maybe again fairly high level but some high level commonality of some principals across the major FX centres. As probably most of you are probably aware, the UK has the Fair Markets Review underway at the moment, so that process will probably come up with something not just for the FX market but for a much wider set of market segments which may provide something which others can have a look at as well.

Do you think this … Are we going down the road, this was brought up to me last week by someone I didn’t have an answer I’ll open this up. I mean will foreign exchange go towards some sort of central exchange because it is a big 24 hour market, you’ve got four or five markets operating at the same time et cetera, et cetera, I mean is that where the train is headed?

I don’t know, I think one … So one concern I have was whether, yeah I mean the FX market has moved in the direction of one of your favourite themes, the FX market has moved in the direction of the equity market over the last number of years. What I don’t think would be useful would be to see it move even more in the direction of the US equity market. One thing which was being mildly helpful to that cause was the publication of (Michael) Lewis’ book (Flash Boys) earlier this year which highlighted some of the things why you might want not to go down that route. So I think some of that pressure may have backed off a bit. I mean I still think it’s difficult to see where exactly the market evolves to but I think the pressure on it to become another version of the equity market it’s abated a little bit. I mean the other thing which I’m pretty sure we said it in the final version of the report, it’s there at some point, one thing which we’ve always got to get across to people is that executing large trades is difficult regardless of market structure which I’m sure everyone in this room is familiar with. There is no … Ever since people started talking to each other under a tree in London, that’s been a problem and no one has yet come up with a solution to that.

With the segregation of orders, were you just looking at the London 4pm benchmark or all benchmarks? Because most of the day it’s …

I mean we’re actually, we basically say it around all benchmarks but I mean in terms of materiality, its the London fix really. But I mean as I said earlier it’s really around information flow. I mean as I said one thing was interesting as we looked across the world is that you just don’t see anything like London in pretty much in any currency pair at any other time. In terms of orders of magnitude it’s materially different so, I mean the focus of the report was basically on London 4pm, but in terms of elsewhere then it really comes down to … It’s more about the information sharing as much as anything, what is appropriate and what’s not.

Because the problem comes if you do have it around every fix. You’ve got dealers popping out of your room or down into their cones, along the half hour I mean these guys are meant to be trying to track the market and give – get a feel for it, that makes it a lot harder. So again I guess that ends up with maybe the agency.

Without wishing to plug anyone’s model, but only because it’s out there, but State Street does allow, if you read what they’ve got, it’s actually they’ve got that there for every fix, it’s actually not there just for London 4pm, just as an example of what is potentially possible.

And if this stuff is going to go to an algo then ultimately they can be deployed at any time.

Yeah exactly.

There’s argument out there that says why 4pm? Because actually Europe has gone home, London typically is handed over to New York there’s much more liquidity available at 3pm London time, because then you’ve got New York, London and Europe in full swing.

So we’ve got an answer to that question, which is … and it’s a function of existing work practices but everyone in the general vicinity of London quite liked the idea of just gradually accumulating the orders through the day and then sometime around mid afternoon you’d sort of collect them all up and then hand them off to to your bank somewhere around about three o’clock was just sort of a nice time in the afternoon to be … to doing that in terms of the working day. It had no relevance whatsoever to here for instance, but anyway it’s sort of …

I think one of the big challenges though is going to be do we need to actually investigate practices of the other side more. And do we actually need to get these asset owners to accept that their managers have to change some of their practices, because you’re talking about a fairly conservative you know segment of the industry, so maybe the question we should be asking is where do they need to change.

I mean and the interesting question … So then you get into the world of mandates and trustees and which is.

Educating those guys yeah.

No, no but it’s always pretty slow moving.

But then we have, but you have to start moving somewhere.

Yeah, yeah that doesn’t mean you don’t start.

If it takes us years, it take us years, but I think at least if you can turn around now and say look guys this is palpably not best execution, this is palpably not fair, and we’re now going to charge you this, that’s fine, they may solve the problem and they may turn around and say we’re fine.

And that’s why I think price it’s always a good behavioural changer.

Thank you, how will you summarise the thoughts and views from the buyer side as you conducted your interviews and discussions to events as to how they’ve unfolded and their reaction to the suitability of the current situation?

To be honest I’m not sure, in our conversations, I don’t think the buyer side weren’t overly … I mean again no one knew anything that knows exactly what the allegations were, but the buyer side weren’t overly, they were coming back to something Col said earlier, what they were happy with was getting dealt at the rate against which they were being benchmarked. The indexes we’re using, so zero tracking error against whatever that … What the price … What the FX rate actually happened to be by and large they weren’t that fussed about that, as long as the rate that they were getting dealt at was that rate, whatever that happened to be. And so I mean I’m sure there won’t be necessarily overjoyed to be recommendation that you might actually have to pay for this, given it being free, but I mean there wasn’t … Well I haven’t had any direct push back against it, let me put it that way.

So what one could be mischievous and say the Australian situation when the customer themselves are quite happy with this situation.

Oh definitely. And my experience talking to asset managers they were perfectly happy with the conversation because zero tracking error means one less conversation you have to have with the end client.

Or zero tracking error for free too.

Yeah exactly.

Even better.

So they’re perfectly happy. Having said that a lot of asset managers I speak to also do acknowledge that this is not best execution and that they could actually execute the business better away from the 4pm fix.

I mean I would have to say … I mean there was no uniformity in terms of the conversation with asset managers, there are some who have extremely detailed knowledge about the way their business is executed, that wasn’t, by the way, necessarily correlated with size either. And some have made a conscious decision not to execute at the fix and were very much interested in best execution, so the … I think and that’s changed I think, and is still changing.

For me I’m looking at more the index providers and one of the things I’ve often wondered is why the index providers like MSCI and the like don’t say splash up the fixes onto the regional closes. So on the end of the Japanese equity market you benchmark there for your Yen, similar for Europe, similar for UK, similar for US, so at least your diluting the concentration around the 4pm, and you’re also covering your risk a lot more time efficient manner. Is that something that the index providers, until the index providers change then a lot of managers are just going to continuously their benchmark to it, there’s no upside in taking any risk against it and I just … Something that if you have any response for that?

Yeah I mean we asked that question of a number of them. And one thing they made very clear, if there’s demand for it they will provide it. I mean they’re in the business of providing what people demand. I mean you note there’s a bit of a chicken and egg problem here of course, but the index providers made it very clear that if people want something along the lines you were talking about, they’re quite happy to provide it, I mean that’s more business for them, so not surprising that they’re happy enough to do that. I mean one thing was interesting when … I mean it’s a bit like LIBOR in the sense of where it started is not where it has ended up in terms of use. I mean those global indices were primarily there as a valuation metric right, so I need something to provide … And then valuation turned into performance measurement right, so the original incarnation was, you’ve got a cross-border portfolio I have to have some way of just you know marking that to market for want of anything else, or evaluation metric, so here’s a foreign exchange valuation metric out there, it’s the London 4pm, I’ll just take that. And then … So that was its origin and then it moved to a point where actually I want a … So it didn’t have to valuation and execution don’t have to be the same thing that just happens to be the way the market evolved. In coming to Col’s point there was no necessarily reason why that state of affairs – and to your point – why that state of affairs necessarily has to.

I’m just interested whether any of the panel members were surprised by I guess the strong feedback you’ve had in terms of moving from the one minute window to five minutes. Is there anyone that’s got any strong opinion in terms of I guess that’s a halfway house but the move from one minute to five minutes? Is there any alternative views from the panel?

Well you like 10.

My very scientific method. I believe that a longer window is a much better solution because we can at least smooth activity within that time. It also allows other participants to maybe put their interest into the market in a longer window. Within one minute so much happens and it becomes a frenzy, whereas for the other 23 hours and 59 minutes of the okay maybe pre- maybe at a pre Australia open, things can get a bit lively, but to my mind you’re smoothing the volume into the market and you’re attracting more volume to the market there as well. I also think as a related point that the calculation whilst I agree with Guy is fine in principle I believe there should be a VWAP element to it whereby we actually put volume into this calculation. There are plenty of algos and plenty of calculations out there that have a VWAP, TWAP combination, we can use that in conjunction with a longer window we should then hopefully smooth access to liquidity and if I’m a corporate, if I’m a hedge fund and I’ve got natural business to do, if I’ve got a five or 10 minute window I’ll stick it in there. Particularly if I think I’m counter-trend to the index follows.

And also I mean it’s still going to be the most liquid time in the day and potentially you’re potentially spreading that liquidity out. I mean the market dynamics will probably change we’re aware of that. I mean we had a lot of discussion within the group about VWAP and TWAP and different members of the group have different views on the merits of that and I’m pretty sure it’s still in there we have an appendices at the back which discusses that a bit. I think it’s potentially something again that WM may well discuss with their user group.

The residue is going to be executed according to VWAP, not a TWAP, so therefore I think you can maybe bring it into the calculation would be my point on that.