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'FX' takes a regulatory hit.

Byline: By Natsuko Waki pecial correspondent

New European financial market regulations taking effect in November could stifle the global foreign exchange market, which has largely escaped regulatory control.

Financial institutions either operating in the 25-nation European Union or with EU-based clients must complete a costly process to comply with the Markets in Financial Instruments Directive (MiFID).

MiFID demands firms ensure transparency, management of conflicts of interest and the best execution in transactions. Firms will have to review policy on how and where they conduct FX transactions, and document and demonstrate why it is best policy. It is expected to cost UK firms pounds 1 billion pounds, according to the UK Financial Services Authority.

MiFID aims for a single market in European financial services so firms can operate in any member state. Firms not complying could face fines.

"It's unfortunate the rules and regulations are coming in effectively strangling the market. They are trying to regulate something self-regulating," said Alan Atwood, UK president of the Financial Market Association (ACI), an umbrella body for global FX traders.

"FX customers are as professional as banks. (With or without regulation), people won't go to banks that don't give them good price or good execution."

The FX market is self-regulating, with the ACI and central bank-led industry forums drawing up voluntary codes.

Trading is over-the-counter and does not take place in one location, unlike stocks or bonds. Money moves across borders and around the globe 24 hours a day, with daily turnover a whopping $2 trillion to $3 trillion.

Not all FX transactions will fall under MiFID, designed to cover investment transactions, embracing most FX derivatives. However, it might catch some forwards and spot transactions if they are provided to clients in conjunction with an investment service, like buying equities abroad and repatriating profits.

Banks, which bundle commercial and investment FX transactions, say unbundling them to meet MiFID is unrealistic.

It will replace the existing Investment Services Directive, designed for the equities market. The ISD has already drawn heavy opposition from the FX industry.

One of the pillars of MiFID relates to best execution of dealing and the "to do" list is long.

A firm must draw up an "execution policy" which takes into account price, costs and speed. The firm must detail which dealing channels will be used, assess them annually and inform clients and obtain consent.

"(MiFID) changes business process fundamentally and it has a global impact. Best execution is the heart of it... We see FX is one of the major business areas. Firms need FX in a way they never needed before," Chris Pickles, chair of the industry-led MiFID Joint Working Group told an ACI seminar.

Regulators stress best execution is not just about prices.

"If you can document why you do what you do, if you can make that into documentation or policy, in our opinion that gives clients best execution," Tim Rowe, associate at markets policy at the UK FSA said.

With less than a year, regulators are still debating how to treat non-deliverable forward contracts (NDFs) and specific active management of currency risks - FX overlay.

NDFs are forwards on a currency traded entirely offshore and exist for currencies with tight controls and restrictions on capital flows, like the Chinese yuan. Since NDFs can be used for speculation and hedging, regulators have yet to conclude whether they come under MiFID. "Hopefully we can sort out soon (on NDFs). It's certainly one of the areas the FSA is looking for help," the FSA's Rowe said.

Large firms will be better able to afford the sums needed for the technology required to meet MiFID rules but smaller players could find it costly.

Consolidation is concentrating liquidity into fewer, bigger banks. Smaller banks have focused on regional strength and outsource business in other currencies to bigger bank
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Title Annotation:Business
Publication:The Birmingham Post (England)
Date:Dec 9, 2006
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