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The world’s biggest sovereign wealth fund has urged banks to do more to restore investors’ confidence in the global foreign exchange market after a series of scandals.
The $5tn-a-day market for currency trading is dominated by global banks, and Norges Bank Investment Management has taken aim at the controversial practice of “last look”.
This type of activity enables a bank trader to reject a customer deal at the very last moment, even after a client has agreed to the price, should problems arise with credit checks or market prices move dramatically.
In a white paper published on Friday, Norway’s $1tn oil fund also said that the currency market needed to apply some practices from equities trading to a more opaque market where most decisions were concentrated in the hands of a few banks.
NBIM, which invests mainly in equities, fixed income and real estate, said that three market practices were “particularly problematic” for asset managers. These include a lack of adequate risk controls and liabilities for the algorithms that execute trades and a lack of transparency for prices paid.
While the sovereign wealth fund stopped short of calling for an end to “last look”, it does seek changes in market customs “which may make last look obsolete long-term”, said Yazid Sharaiha, global head of investment strategies at NBIM and co-author of the report.
Many large fund managers accept that the custom of ‘’last look’’ is a price worth paying for traders at banks to execute their deals, but many are wary that some could use advance knowledge of a deal to benefit its own books ahead of clients’ interests.
Regulators are undecided on the practice and some market participants, such as electronic traders Citadel Securities and DRW, have called for its demise.
“We think we need to take the FX market to the next step,” Mr Sharaiha said.
The fund, a frequent contributor to equity market structure debates, said it was building on the FX Global Code of Conduct, an industry code set up earlier this year to restore the public’s faith in a market.
Banks paid a total of $10bn in 2014 and 2015, largely to settle allegations that their traders shared too much supposedly confidential information about their clients’ activities.
NBIM said that dealers needed to share more information on their own risks before being offered to complete the full trade.
“We want to take on more of the execution risk. We want to be more explicit about the risk sharing between us and the dealer. The client is providing optionality for the dealer. We would like to rewarded for this option,” Mr Sharaiha said.
NBIM also said that the foreign exchange market could improve its controls around the algorithms that trade the overwhelming majority of deals on the market.
Although risk controls like “kill switches” are available to the broker, NBIM said it was not clear if they protected the client.
Nor was it clear who bears responsibility if an algorithm malfunctioned, it said. “Transparency in implementation leaves a lot to be desired,” Mr Sharaiha said.