Since the 2007 financial crisis, and in spite of difficult economic and market conditions, investment banks have invested significantly in improving their control environment. The market tremors from the Foreign Exchange (FX)-fixing scandal and subsequent probe — triggering a flurry of fines, litigation cases and prosecutions — have been a critical catalyst for such major changes.
So far, investment banks have achieved significant change across four dimensions:
- Changed control approaches to new types of risk (e.g., conflicts of interest)
- Clarified and defined new expectations related to culture and conduct
- Adapted policies and procedures to new regulation and client expectations
- Simplified business models and control environments by increasing the level of trading automation
In the last three years, mostly driven by regulators, investment banks have significantly improved their foreign exchange sales and trading control environment, focusing on implementing “low-hanging fruits” to show quick progress. Investment banks have made significant enhancements to their policies, procedures and guidance across the following five dimensions:
- Orders and pricing
- FX barrier options
- Personal account dealing
This change has had some impact on the FX business, including a significant increase in the cost of conduct and controls, and the formalization of control and risk management.
Client pressure has also been a critical driver of change
Due to client demand, investment banks have been focusing on improving their service offerings:
- More than 60% have been enhancing their electronic trading offering to enable the full and accurate execution of trades. Examples that we have seen in the market include:
- Automating execution of fixing and non-fixing orders (75%)
- Investing in innovating new aggregators and algorithms (57%)
- Offering agency execution capabilities (18%)
An increasing number of client demands for electronic trading and agency execution is resulting in limited trader discretion and manual intervention — or none at all — thus reducing human error and conflicts of interest.
- More than half of investment banks are working on building transparency through the following activities:
- Enhanced client disclosures in areas such as pre-hedging, determination of pricing components (e.g., trade execution charge, added value, markup and markdown) and how client orders are handled.
- Moving trading activity away from voice execution desks and on to electronic trading platforms
Investment banks are now expected to turn their focus to five key transformational areas:
- Formalizing progress by explicitly adopting the new FX Global Code
- Enhancing efficiencies across new control and risk management approaches
- Reinforcing the accountability of the front office and removing the unnecessary duplication across the three lines of defense
- Making certain that the new approach is implemented globally across all business units and principles are extended to asset classes (beyond FX)
- Systematically leveraging the use of information to improve the detection of abnormal situations and behaviors
While these specific changes to the control environment are crucial for investment banks in their quest to restore client and regulator confidence, they still have to make some tough choices around several dimensions:
- Radically changing the three lines of defense to make the control environment more efficient and effective
- Reducing the overall cost of control by 50% while improving effectiveness
- Increasing preventative controls to 50% of all controls