Circular 23/2017 — Modifies Circular 22/2017

Friday, December 22, 2017 OFFICIAL GAZETTE 1
BANCO DE MEXICO
CIRCULAR 23/2017 addressed to credit institutions, brokerage houses, exchange houses, and other intermediaries that are part of financial groups, regarding modifications to Circular 22/2017 (update of the text of the Global Code of Conduct).

A logo appears at the margin, stating: Bank of Mexico.

CIRCULAR 23/2017
TO CREDIT INSTITUTIONS, BROKERAGE HOUSES,
EXCHANGE HOUSES, AND OTHER INTERMEDIARIES THAT ARE PART OF FINANCIAL GROUPS:

SUBJECT: MODIFICATIONS TO CIRCULAR
22/2017 (UPDATE OF THE
TEXT OF THE GLOBAL CODE OF
CONDUCT)

The Bank of Mexico, in order to ensure the sound development of the foreign exchange market in Mexico, has determined to modify Annex 1 of the "Rules applicable to the report by participants to the Bank of Mexico regarding adherence to the Global Code of Conduct in the execution of foreign exchange transactions," contained in Circular 22/2017, with the objective that its text be adjusted in the same terms as the modifications to the Global Code of Conduct agreed upon by the Global Foreign Exchange Committee (GFXC, in English) in its session on November 14 of the current year.

For the above, based on Articles 28, paragraphs sixth and seventh, of the Political Constitution of the United Mexican States; 24 and 32, of the Bank of Mexico Law; 9, of the Organic Law of National Financial Institutions; 6, of the Organic Law of the Federal Mortgage Society; 9, of the Organic Law of the National Savings Bank and Financial Services; 9, of the Organic Law of the National Foreign Trade Bank; 10, of the Organic Law of the National Bank of Public Works and Services; 8, of the Organic Law of the National Bank of the Army, Air Force and Navy; 19, of the Organic Law of the National Financial Development Institution for Agriculture, Rural, Forestry and Fisheries; 22, of the Law for Transparency and Ordering of Financial Services; 4, first paragraph, 8, paragraphs fourth and seventh, 10, first paragraph, 12, first paragraph, in relation to 19 Bis, fraction V, and 14 Bis, first paragraph, in relation to 17, fraction I, of the Internal Regulations of the Bank of Mexico, which grant it the authority to issue provisions through the General Directorate of Central Bank Operations and the General Legal Directorate, respectively; as well as Second, fractions VI and X, of the Agreement on the Assignment of Administrative Units of the Bank of Mexico, it has resolved to modify the definition of Global Code of Conduct in section 2a.; the third paragraph of fraction I of the preamble, Principle 17, and the examples applicable to Principle 17 contained in "Annex 1 Examples," in Annex 1, of the "Rules applicable to the report by participants to the Bank of Mexico regarding adherence to the Global Code of Conduct in the execution of foreign exchange transactions" contained in Circular 22/2017, to read as follows:

RULES APPLICABLE TO THE REPORT BY PARTICIPANTS TO THE BANK OF MEXICO REGARDING ADHERENCE TO THE GLOBAL CODE OF CONDUCT IN THE EXECUTION OF FOREIGN EXCHANGE TRANSACTIONS

"2a. …

I. Global Code of Conduct:
the compilation of global principles of good practices in the wholesale foreign exchange market, whose Spanish translation is attached to these Rules as Annex 1, developed by the Foreign Exchange Working Group (FXWG, in English) of the Bank for International Settlements (BIS, in English), in the terms made public to the general public on May 25, 2017, as well as its subsequent modifications, with the aim of promoting a robust, fair, liquid, open, and adequately transparent foreign exchange market, in which the diversity of participants in that market, backed by resilient infrastructures, are able to conduct their business reliably and effectively at competitive prices that reflect available market information and in a manner consistent with acceptable standards of conduct. …"

ANNEX 1
GLOBAL CODE OF CONDUCT
…
I. …
"The Global Code of Conduct was developed with the collaboration of central banks and Market Participants from 16 jurisdictions around the world.

• On the part of central banks, in July 2015, the Foreign Exchange Working Group (FXWG) was established to facilitate the creation of the Global Code of Conduct and promote its adoption. This group operates under the auspices of the Markets Committee, composed of senior officials responsible for market operations in 21 central banks representing the largest monetary zones. The group was chaired by Guy Debelle (Deputy Governor, Reserve Bank of Australia).
• On the part of the private sector, the FXWG formed a Market Participants Group (MPG), chaired by David Puth, Chief Executive Officer of CLS Bank International, in order to coordinate through regional foreign exchange market committees (CMCs) and representatives of the Foreign Exchange Market in other regions, with the objective of involving a broad and diverse group of Market Participants in the process to develop and promote the Global Code of Conduct.
  …"

"PRINCIPLE 17
Market Participants that employ the last look practice shall be transparent in their use and provide relevant information to their Clients.
The last look practice is a practice used in Electronic Trading Activities in which a Market Participant that receives a trading request has a final opportunity to accept or reject the request at the quoted price. Market Participants that receive trading requests that use this last look window shall have governance structures and controls related to their design and use that are consistent with public terms. This practice may include appropriate management and compliance supervision. Market Participants shall be transparent in the use of last look practices so that the Client understands and is able to make informed decisions about how such practice will be applied to their trade. The Market Participant shall provide, at a minimum, explanations regarding how and in what manner changes in price in any direction can impact the decision to accept or reject the trade, the expected or usual period granted for making the decision, and, generally, the purpose for using the last look practice.

Friday, December 22, 2017 OFFICIAL GAZETTE 3
If used, the last look practice shall be a risk control mechanism used to verify validity and/or price. The verification of validity shall be with the intention of confirming that the details of the trade contained in the trade request are appropriate from an operational perspective and that sufficient credit is available to execute the trade contemplated in the trade request. The verification of price shall have the intention of confirming that the price at which the trade request was made continues to be consistent with the current price that would be available to the Client. In the context of the last look practice, the Market Participant has absolute discretion, based on the processes of verifying validity and price, to accept or not accept the Client's trade request, leaving the latter with the potential market risk in the event that the trade request is not accepted. In this way, and in accordance with the principles of the Global Code of Conduct:

• The last look practice shall not be used for the purpose of obtaining information without the intention of accepting the Client's trade request.
• Confidential Information is generated from the moment the Market Participant receives the trade request at the beginning of the last look window, and the use of this Confidential Information shall be consistent with Principles 19 and 20, regarding Information Exchange.
• Market Participants shall not execute trades using information derived from the Client's trade request during the last look window. Such trades include (1) any activity related to price determination on Electronic Trading Platforms that incorporates information from the trade request and (2) any hedging trade that incorporates information from the trade request. Such trades would carry the risk of sending a signal to other Market Participants about the Client's intentions to execute trades, which could move market prices to the detriment of the Client. In the event that the Client's trade requests are subsequently rejected, such trade could represent a disadvantage for the Client.
  This guideline does not apply to agreements that meet all of the following characteristics:

1. An explicit agreement that the Market Participant will fill the Client's trade requests, without assuming market risk related to the trade request, through the prior execution of trades in the opposite direction or that offset these trade requests in the market, and
2. The volume traded during the last look window will be transferred in its entirety to the Client, and
3. The agreement is appropriately documented and communicated to the Client.
   It is good practice for Market Participants to establish dialogues with their Clients to inform them of how their requests have been handled, including the treatment of information related to such trade requests. Such dialogue may include metrics to facilitate transparency in the manner of calculating price and executing the Client's trade requests and help the Client in evaluating the handling of their trade requests to determine if the execution methodology continues to meet their needs over time."

"ANNEX 1
Examples
…
Market Participants that employ the last look practice shall be transparent in their use and provide relevant information to their Clients. (PRINCIPLE 17)

4 OFFICIAL GAZETTE Friday, December 22, 2017
X A Market Participant sends a trade request to an anonymous liquidity provider to buy 1 million EUR/USD at a price of 13 through an Electronic Trading Platform while the displayed price is 12/13. It is understood that this trade request is subject to a last look window before being accepted and confirmed by the anonymous liquidity provider. During this window, the liquidity provider places buy orders at levels lower than the price of 13. If these orders are filled, the liquidity provider confirms and fills the Market Participant's trade request, but if the buy orders are not filled, it does not attend to the Market Participant's trade request. Market Participants shall only use the last look practice as a risk control mechanism to verify factors such as validity and price. In this example, the liquidity provider improperly uses the information contained in the Client's trade request to determine if it can obtain a profit and has no intention of filling the order unless it can obtain a profit. ✓ A Client sends various trade requests subject to a last look window and its liquidity provider has made known the purposes for which the last look practice may be used. The Client reviews information related to the average fill ratios for such trades. The information suggests that the average is lower than expected and the Client goes to its liquidity provider to discuss the reasons for this. Market Participants that employ the last look practice shall be transparent regarding their use and provide appropriate information to their Clients. It is also good practice to be able to engage in conversations with Clients about how their orders have been handled. In this example, the Market Participant's transparency has allowed the Client to make an informed decision about how their orders are handled and promotes dialogue between the two parties. X A Client requests to buy 25 million EUR/USD on an Electronic Trading Platform. During the last look window, the Market Participant, taking into consideration the Client's trade request, raises its prices on the Electronic Trading Platforms. Market Participants shall not use the information contained in a Client's trade request during the last look window. In this example, the Market Participant uses the information contained in the Client's trade request to change its prices on the Electronic Trading Platforms during the last look window. By doing this, the Market Participant could potentially signal to the market the Client's interests, who could be at a disadvantage if the Market Participant subsequently rejects the trade. ✓ A Client requests to buy 20 million USD/MXN from a Market Participant through an Electronic Trading Platform. During the last look window associated with that trade request, the Market Participant continues updating its prices in USD/MXN and other pairs on a number of platforms. The prices that the Market Participant displays on these platforms reflect normal sources of the Market Participant's
price determination algorithms, including movements in market prices and other trades completed by the Market Participant; notwithstanding the foregoing, it does not use the information from the Client's trade request as a source of such price changes during the last look window. Market Participants may update their prices while a last look window remains open if the update is completely independent of the relevant trade request, as doing so allows Market Participants to facilitate continuous price formation. Given the speed of electronic trading, Market Participants will need to make periodic updates to their prices while one or more last look windows remain open. In this example, the Market Participant does not take the trade request into account when updating prices during the last look window. …"

TRANSITIONAL PROVISION
SINGLE.- These modifications shall enter into force on the next banking business day following their publication in the Official Gazette of the Federation.

Mexico City, December 19, 2017.- The General Director of Central Bank Operations, Jaime José Cortina Morfín.- Signature.- The General Legal Director, Luis Urrutia Corral.- Signature.

For any inquiries regarding the content of this Circular, please contact the Department of Authorizations, Inquiries, and Legal Control, at the phone numbers (55) 5237-2308, (55) 5237-2317, or (55) 5237-2000 Ext. 3200.