Once more unto the breach - speech by Philippe Lintern

Introduction

‘Once more unto the breach, dear friends, once more;
Or close the wall up with our English dead!
In peace there's nothing so becomes a man,
As modest stillness and humility;
But when the blast of war blows in our ears,
Then imitate the action of the tiger’

This speech from Shakespeare’s Henry V seems apt to describe the history of the Foreign Exchange (FX) market. The FX market as we know it, was born from a crisis, namely the collapse of the Bretton Woods System in 1971 and the end of the dollar peg for many currencies. Thereafter, the FX market has prevailed over many crises, interspersed by calmer times.

The story of FX is one of huge success. The FX market has grown hand in hand with the global economy and has become the largest and most liquid market in the world, with over $7.5 trillion of FX turnover every day^{footnote [1]} (see Chart 1). London remains the heart of this market, representing close to 40% of the global turnover^{footnote [2]}. The FX market underpins the global economy by enabling the international flow of goods, services, and capital. It provides the infrastructure for households, businesses, and financial market participants to transact across international markets confidently, efficiently, and at fair market prices.

The FX market has been resilient, for instance weathering market wide disruption during Covid or the recent CrowdStrike IT outage. Part of the reason for this success is entrepreneurial spirit and open competition. But this success would not have been possible without forums, such as local FX committees, which allowed participants to convene, navigate challenges together and create common standards of best practice.

However, we should not be complacent. As market participants, every one of us has a responsibility to address the risks inherent to our market. For instance, the industry feedback ahead of the latest FX Global Code review highlighted that FX settlement risk continues to be a concern. We also all have a responsibility to maintain the integrity and trust in our market. Each market participant should uphold best market practice by signing up and re-attesting adherence to the FX Global Code. We must do this work with ‘humility’ in times of ‘peace’, and not wait to act until ’the blast of war blows in our ears’ in the form of the next inevitable crisis.

The FX Global Code

The FX industry has a long history of maintaining codes of conduct and best practice. Here in the UK, we had the (Mr) Stirling letter in 1967, the O’Brien letter in 1975^{footnote [3]}, the ‘Grey Paper’ in 1987^{footnote [4]}, the London Code of Conduct in 1988^{footnote [5]}, and finally, from 2001 The Non-Investment Products Code^{footnote [6]}, known as the NIPs code.

In 2013, the FX misconduct scandal shone a light on unacceptable practices in the FX market. The scandal occurred across several jurisdictions, exposing the weakness of a national approach to standards. The Fair and Effective Markets Review^{footnote [7]}, published by the UK authorities in 2015 also showed that market standards had failed to keep pace with the evolution of the market.

To restore trust in the market, central banks and a broad cross-section of the private sector, came together to produce the Global FX Code^{footnote [8]} (the “Code”) in 2017. The Code is a set of 55 principles outlining best practice for all FX market participants to promote the integrity and effective functioning of the wholesale FX market. The Global Foreign Exchange Committee^{footnote [9]} (GFXC) was then established, as a regular forum bringing together central banks and private sector participants. The GFXC regularly reviews the Code to ensure it keeps pace with market developments. Any market participant can feed into the GFXC’s work by participating in the periodic GFXC surveys^{footnote [10]} and public consultations on updates to the Code.

In 2021, the GFXC published a review of the Code adding guidance papers on Last Look^{footnote [11]} and Pre-Hedging^{footnote [12]}. The review also introduced standardised Disclosure Cover Sheets^{footnote [13]} to increase the transparency of market participants’ practices. The GFXC will shortly publish its latest revision to the Code. In line with industry feedback, the focus of this revision was on FX settlement risk and FX data.

Take up of the Code is voluntary. Market participants demonstrate their adherence to the Code by signing a “Statement of Commitment”. This statement attests that they have taken steps to ensure their FX activities align with best market practice. There has been strong take up of the Code by the sell-side, but much slower uptake from other parts of the market (see Chart 2). This uneven uptake raises questions about having a level playing field and risks the trust in our market which was so hard to rebuild after the 2013 scandal.

Some market participants ask me why they should sign up to the Code. But who would not want to ensure they adhere to best practice, and contribute to the integrity, functioning and trust in a market we all rely on?

There is a valid argument around proportionality for smaller market participants. To address this point, the GFXC rolled out the Proportionality Self-Assessment Tool in 2023^{footnote [14]}. This tool allows occasional or smaller market participants to focus their efforts on the Code principles most relevant to them, thereby alleviating the process of attesting.

However, the proportionality argument cuts both ways. There are many hedge funds that are large, sophisticated participants in the FX market, and yet virtually none have signed up to the Code. Why not? Likewise, there are hard questions to be asked of trading venues that choose not to adopt the Code or seek to remain unregulated.

Bank of Mexico, which currently chairs the GFXC, requires relevant FX market participants to confirm their adherence to the Code, or otherwise justify in writing their decision not to adopt the Code. In the absence of more widespread adoption, this type of approach will become more appealing to other central banks and regulators.

FX settlement risk

As mentioned in the introduction, the market feedback ahead of the Code review highlighted that FX settlement risk continues to be a concern. In this speech, FX settlement risk refers to the risk of outright loss of the full notional of a transaction resulting from the counterparty’s failure to settle^{footnote [15]}.

The spotlight first fell on FX settlement risk with the failure of Herstatt Bank in 1974. At the time of its failure, Herstatt Bank had already taken its foreign currency receipts, but its counterparties did not receive their US dollar payments and suffered substantial financial losses. The widespread impact of this failure conveyed a clear lesson on the risks created by gross settlement. This incident also demonstrated that all market participants, big and small, have an essential role to play in reducing overall FX settlement risk.

In 1996, the Allsopp report^{footnote [16]} noted the growth of the FX market to $1.25 trillion daily turnover and the risk it posed to the wider financial system. The report called upon the industry to improve practices and devise mechanisms for addressing settlement risk. Work by central banks and the private sector led to the launch of Continuous Linked Settlement (CLS) in 2002 which offered a Payment-versus-Payment (PvP) settlement mechanism for seven different currencies.

Unfortunately, the mitigation of FX settlement risk has not kept up with the growth and development of the market since the launch of CLS^{footnote [17]}. Existing PvP facilities do not cover all currencies, or trade types – for instance short-dated trades. Furthermore, some market participants cannot, or choose not to, use PvP settlement.

There are other risk mitigating measures beyond PvP, such as multilateral or bilateral net settlement, or settling both payment legs across the books of a single institution. However, a recent estimate suggests that between 10 to 15% of trades by value are settled on a gross bilateral basis without any risk mitigation. Given the size of the FX market, this amount of gross, unmitigated settlement represents a material risk. In 2023, the failure of a mid-sized US bank which did not use PvP brought this risk into sharp relief.

The Bank of England, in conjunction with market participants, central banks and the Bank for International Settlements (BIS), designed a new survey for collecting FX settlement data. The survey quantifies the different risk mitigation approaches and the drivers of remaining gross settlement risk. This new survey will be used by the BIS as part of their Triennial Survey in 2025, which will give us, and regulators, a global and granular picture of FX settlement risk.

The mitigation of FX settlement risk is made more urgent by the global trend of shortening settlement cycles. North America and India moved to T+1 securities settlement recently, the EU and the UK are looking to do the same by 2027. This trend will add pressure to back-office processes and infrastructure. A market contact recently compared FX front office to Formula One teams using the most advanced technology available to trade in milliseconds, while their back-offices were left riding rusty old bicycles to try to keep up. The knock-on impact on FX settlement risk is all too obvious.

The upcoming revisions to the Code make clear that each market participant has a responsibility for reducing FX settlement risk by reviewing their own practices. The updates also urge firms to carry out regular reviews of FX settlement practices. A common issue is that counterparties agree settlement methods when they establish a trading relationship and never revisit those decisions. That needs to change.

Concluding remarks

In conclusion, each of us has a responsibility to maintain the integrity of the FX market. Here are two actions we all should take:

1. To those who have not yet signed up to the Code, I urge you to do so now. Upholding best market practice, and ensuring the market remains fair and effective, is not the sole responsibility of banks.
   To those who have signed up, I urge you to re-attest to the updated Code.
   You should be regularly reviewing how your practices align with the Code anyway, so re-attestation should not be an onerous task. Re-attesting is also an opportunity to educate new staff and refresh policies and procedures.
2. Review your FX settlement risk and adopt the best risk mitigation possible. In the past, this has been perceived as a sell-side issue but if we want to reduce FX settlement risk across the market then all participants need to act.

I will close by exhorting you to take action, with the words of Henry V:

‘I see you stand like greyhounds in the slips,
Straining upon the start. The game’s afoot’

Thank you.

I would like to thank Grigoria Christodoulou, Matthew Dove, Rand Fakhoury, Jon Fullwood, Gerardo Israel Garcia Lopez, Matthew Hartley, Shiv Khetia, Munalula Lisimba, Natalie Lovell, Arif Merali, Sita Mistry, James O’Connor, Tom Pattie, Victoria Saporta, Torsti Silvonen and Jack Worlidge for their help in the preparation of these remarks.