Mike: Welcome to our new podcast series called FX Regulatory Rules Changes in 2023. I'm Mike Cahill, head of video and podcast content production for sales enablement at the London Stock Exchange Group. In this series, we'll be talking with Chris Leonard-Appleton, head of FX Risk and Regulation. In this first episode, we set the scene by discussing global regulatory developments in FX.
Mike: So to get started, you know, what new regulations can we expect to see in 2023 going into 2024?
Chris: Hey, Mike, and pleasure to be with you here today. So I think 2023, 2024, we can expect a pretty busy year and we sort of take this geographically for a minute. So if we look at the sort of probably the two key jurisdictions that the United Kingdom and the European Union, there's a lot of Brexit-led initiatives that are occurring.
Chris: So in the U.K., we've got the expiry of the temporary permission regime, which we were having to do a lot of work here at LSEG. We've got the revocation of the EU law bill that's going through Parliament at the moment and we've also got the UK Financial Services and Markets Act, that’s going through parliament at the moment as well.
Chris: So both of those are really driven by the after effects of Brexit. Across the channel in the European Union we've got a MiFID review going on. So those of us who live through MiFID to some of us even remember MiFID one back in 2007, but we will have scars MiFID2. Yeah, there's a lot of initiatives that are underway at the moment, but that we also have a lot of work around the Operational Resilience Program.
Chris: So the digital and operational resilience factor expecting to do a lot of work certainly in 2024 for that. And then if we look at Asia, which is increasingly becoming important, there's a lot of stuff going on over there as well. So Indonesia just recently passed a new law last September we had to react to. And in China, there's a new securities law that has just come into effect that, frankly speaking, we're still determining what we need to do with that.
Chris: So, yeah, 2023, 2024, busy year, busy couple of years, I suspect.
Mike: Is there any overriding theme to all these changes Chris?
Mike: You know what the goal of regulators is or is it does it vary per country, per region, what each country or group of countries is trying to accomplish?
Chris: Well, I think the regulatory objectives are normally quite clear. Right. I think regulators worried about increasing or decreasing conduct risk, increasing conduct regulation in their jurisdictions and that they're also wanting to mimic market structural reforms that are occurring in other jurisdictions. I think the general things that I would bundle are really the effects of those. So what we're seeing at the moment is increasing localization, which is a real struggle, frankly, for a global market like effects.
Chris: You know, I think some examples of that really are the the EU and the UK. So we've seen a severance of those two key jurisdictions where having to really double up all of the regulatory infrastructure that we put into both jurisdictions at the moment. We're seeing a lot of localization rules in Asia. So India, Indonesia, Malaysia to a lesser degree, Thailand are all jurisdictions where we've really had to go onshore in recent years, and that just really doubles up the amount of work that we have to do in what is quite a robust and increasingly important area of the globe.
Chris: And I think the other thing that we've seen are really around the prudential rules that these rules that affect banks capital requirements, but also things like unsafe margin rules. The last tranche of rules actually went live last September. And what we're seeing is really the continuing after effects of the financial crisis. You know, dare I say it, even all these years later, we're still seeing all of these reforms coming through and certainly the final stage of that.
Chris: And that's having some really material effects, which I think we're going to in a later episode on banks trading workflows and what it means for the small markets more generally. Conversely, market structural rules seem to be getting more appropriate. You know, if we look at what's coming through MiFID, we seem to be seeing a lot more pragmatism emerging with things like pre trade transparency requirements in non-equity, some of the proposals to remove requirements for execution, quality reporting by venues.
Chris: Yeah, I think a lot of those developments are really quite promising. So I'd sort of conclude by saying there's probably three general themes and all of them are quite, quite a mixed bag really.
Mike: Any direct impact on actual trading and by these rules changes that are coming?
Chris: Yeah, absolutely. So I think certainly the local localization rules are causing a degree of Balkanization and liquidity globally. So the minute you have to onshore in a different jurisdiction, you then have to go through the process of figuring out who or who cannot trade on each of those different venues. That naturally leads to fragmentation. And obviously that has a ripple effect ultimately through to end users finance costs, funding costs and cost of capital.
Chris: I think obviously in the Prudential space where we've had particularly things like Saccos, which has sort of been implemented in staggered ways globally, you know, we've seen a lot of big market makers, particularly in the forward space, really pull back from certain liquidity profiles in those instruments because the capital costs are becoming quite prohibitive for them. So yeah, anecdotally, we're hearing about drops in liquidity as a result of that and certainly we are seeing some market makers pulling back and reducing the amount that they trade and provide liquidity to the buy side forum now.
Chris: So yeah, I think I think when you start to fragment liquidity and then you start to reduce liquidity, which respectively the localization rules and the prudential rules are achieving, then obviously that has a real effect on first of all, the liquidity buy side can get hold of. And also on workflow as well. Maybe things like clearing coming onto the agenda in a big way.
Mike: Are you seeing banks respond already to some of these changes or proposed changes that are in the pipeline?
Chris: Yeah, absolutely. I mean, as I say, we're seeing several large market makers pull back in certain asset classes really in the last few months. So, yeah, we're already seeing a material effect as a result of these rule changes.
Chris: Now we've got some regulatory authorities who are publishing papers on the definition of a trading venue. How does that impact technology vendors in the markets, Chris?
Chris: Yeah. So if we look at what's been published, so the CFTC was really first out the gate with their paper, 2119. They've got exciting names for their papers. That was over a year ago now as just published, their final opinion actually in the last week or so. And we anticipate the FCA in the UK will follow suit quite quickly.
Chris: The net effect of this really is to ensure that technology vendors that if I can put it this way, look and feel like trading venues should be appropriately regulated as such. For example, the fixed business at London Stock Exchange, we operate in MTF in Ireland, which we will shortly have on in the U.K. we have the SEC in the United States, we have an RMO in Singapore, in ETP.
Chris: You know, we've got venues all over the place globally. There's a lot of vendors who operate business models that are potentially similar to ours who on the face of it, don't seem to have the same sort of regulatory status as us. So we're very supportive of the opinions that have been promulgated by these authorities. I think there are some risks, though.
Chris: So, yeah, we're supportive. We're not fully supportive. And I think there's probably two key risks that I would call out. The first is the FX market is vast, diverse and global, and as a result of that, we've had a lot of different trading paradigms that have emerged over the years to really make the markets more efficient. And this is particularly pertinent to emerging markets.
Chris: Now, if you look at UK banks, EU banks or US banks, we want to trade with emerging market banks, particularly local currencies. There are certain trading protocols that have emerged to make trading in those jurisdictions far more efficient than picking up the phone. It's not clear that the opinions should apply in full to those trading protocols. So I think what will be necessary is a very, very thoughtful case by case assessment of each product by regulatory authorities in those jurisdictions to assess whether the opinion should apply or not.
Chris: So I think that's the first point. We just need to be wary of unintended consequences with the application of these papers. I think the second set of risks are we are seeing slight divergences occurring between the different opinions. So I think in general as the CFTC and the FCA have attempted to align, but the devil's always in the detail, if I can use a cliche, and I think risk of that is you see regulatory jurisdictional arbitrage occur between those jurisdictions.
Chris: So I think what I would urge they would listen to me, but what I would urge those authorities to do is try to converge on the most pragmatic set of opinions, which I know will take time. The authorities have already issued their papers. They're not going to change them like now. But as time goes by, I think convergence rather than divergence, particularly in global market like effects, would be preferable.
Mike: So one final question for this episode, Chris, and it concerns what are we seeing in terms of cross-border trading and and how that's being affected in particular for FX in general?
Chris: Yeah, well, I've sort of touched on this. I mean, with we're seeing localization occurring in the global market and the thing it's quite idiosyncratic to FX. FX is an inherently global market. If you trade Eurodollar, you're, you're immediately touching two of the major jurisdictions in the EU and the US. You can't get away from the fact that affects is a is a cross-border global market in the way that transferable securities, equities, fixed income and even rates and credit isn't.
Chris: You can draw sovereign borders around those markets a bit more effectively than you can with FX. So, you know, the upshot of localization is that we will see liquidity fragmentation in the global market. That's just something that we're having to deal with at the moment. The fact of the matter is, we need more deference by regulatory authorities to home state regulators.
Chris: And yeah, this is an argument that was made during Brexit. It's an argument that will continue to make. And I think a lot of jurisdictions such as the US, Switzerland, the Canadian provinces actually do this pretty well. But unfortunately jurisdictions like the UK, the EU and others are probably doing it less well. So really, I know that we're probably drilling into the cross-border details of what I'm alluding to here.
Chris: This is sort of macro picture, but the trend to localization is problematic. It's something that we spend an awful lot of time thinking about here at LSEG and a lot of the developments that we can be doing over the next couple of years are geared to responding to those developments.
Mike: Our thanks to Chris Leonard-Appleton, head of risk and regulation at the London Stock Exchange Group. I'm Mike Cahill, and thank you all for listening.
