Best practice of Foreign Exchange

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Ever-rising volumes in the FX market have inevitably been accompanied by increasing
commoditization in the major currency pairs, which account for the lion’s share of daily
volumes. More than any other sector within the global financial market, that process
has made the FX business one that is characterized by very high volumes and tight
spreads. As an inevitable consequence, the FX space is one in which market
participants are increasingly demanding improvements in execution; in the high speed
world of FX, the difference between good and best execution is measured in
milliseconds.
Ensuring that technological progress is able to keep pace with the exacting demands
of participants in today’s FX market has become an even greater priority in light of the
increasing influence in the market of algorithmic traders or autodealers. But speed of execution is only one of a host of objectives that are commonly known as best
practices. In 1995, the FXC identified the need for a check-list of these best practices
that could “aid industry leaders as they develop internal guidelines and procedures to
foster improvement in the quality of risk management”. Observing those best
practices, added the FXC at the time, would also help to reduce risk across the FX
industry as a whole and to keep operational costs down. In November 2004 the FXC
published a list of 60 best practices in the management of operational risk in FX, subdivided
into pre-trade preparation, trade capture, confirmation, netting, settlement,
nostro reconciliation and accounting/financial control processes.
The FXC is by no means the only organization that has channelled considerable
resources into defining and promoting best practice in the FX market in recent years.
In the UK, the Bank of England’s Foreign Exchange Standing Committee (FX JSC) and
the Financial Services Authority (FSA) have also made key contributions to the
industry’s pursuit of a code of practice designed to minimize risks and maximize
efficiencies in today’s FX market.
At a European Union (EU) level, meanwhile, the Markets in Financial Instruments
Directive (MiFID), which is due to come into force at the start of November 2007, is
recognized as one of the most extensive and significant of the European
Commission’s financial services directives. MiFID, which replaced the EU’s
Investment Services Directive (ISD), requires companies to implement – and to
provide demonstrable evidence of – best execution for their clients in terms of
price, venue, speed and cost across a broad range of financial instruments.

Although few of the principles championed by MiFID apply directly to the FX
market, their indirect long-term impact is likely to be significant. After all, much of
what MiFID insists on represents no more than sound, strategic common sense as it
aims to establish and maintain high standards of service and integrity across the
board – standards which every bank with demanding customers and shareholders
should be constantly striving to achieve, MiFID or no MiFID.