Circular 1/2019 — Modifies Circular 22/2017

Monday, January 14, 2019 OFFICIAL GAZETTE (First Section) 59 BANCO DE MEXICO CIRCULAR 1/2019 addressed to Credit Institutions, Brokerage Houses, Exchange Houses and other intermediaries that are part of Financial Groups, regarding the Modifications to Circular 22/2017 (update of the text of the Global Code of Conduct).

A logo appears at the margin, which says: Banco de Mexico.

CIRCULAR 1/2019
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)

Banco de 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 Banco de 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 aligns with the terms of the Global Code of Conduct updated by the Global Foreign Exchange Committee (GFXC, by its acronym in English) at its session on June 27, 2018.

Therefore, based on Articles 28, sixth and seventh paragraphs, of the Political Constitution of the United Mexican States, 24 and 32, of the Banco de 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 Institution for Agricultural, Rural, Forestry and Fisheries Development, 22 of the Law for Transparency and Ordering of Financial Services, 4, first paragraph, 8, fourth and seventh paragraphs, 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 Banco de Mexico, which grant it the authority to issue provisions through the General Directorate of Operations and Payment Systems and the General Legal Directorate, respectively, as well as Second, fractions VI and X, of the Agreement on the Attachment of Administrative Units of Banco de Mexico, has resolved to modify the examples applicable to Principle 11 contained in "Annex 1 Examples", in Annex 1, of the "Rules applicable to the report by participants to Banco de Mexico regarding adherence to the Global Code of Conduct in the execution of foreign exchange transactions" contained in Circular 22/2017, to remain in the following terms:

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

ANNEX 1
GLOBAL CODE OF CONDUCT
...

"ANNEX 1
Examples
...

The Market Participant shall only conduct Pre-Hedging when acting as Principal and shall do so in an equitable and transparent manner. (PRINCIPLE 11)

✓ A bank has revealed to a Client acting as Principal that it may conduct Pre-Hedging on the Client's orders. The bank has a Stop Loss Order for a large amount from the Client, which is expected to potentially be executed. The bank expects that there will be similar orders in the market at this important technical level and recognizes the risk of substantial slippage in the price during its execution. The bank decides to conduct a partial Pre-Hedging and begins to buy in advance without the intention of increasing the market price. However, the market reaches a maximum above the Stop Loss level, due to purchases by other Market Participants that are triggered when the market price reaches the technical level. The order is triggered but, as a result of the Pre-Hedging, the bank can provide an execution price close to the Stop Loss level.

Market Participants shall only conduct Pre-Hedging on Client orders when acting as Principal and when the practice is used with the intention of benefiting the Client. Stop Loss Orders are subject to the condition of breaking a specific execution level, and in many cases, orders are placed at significant levels in the market with the potential to generate substantial slippage when this level is reached. In this example, the bank has used Pre-Hedging to have an inventory in advance. The bank is better positioned than it would be if it had not conducted the Pre-Hedging, which allows it to protect its Client from substantial slippage in the price at the time of executing the order and, therefore, benefit it.

✓ A Market Participant has revealed to a Client acting as Principal that it may conduct Pre-Hedging on the anticipated orders of said Client. The Client requests the Market Participant for a buy position for a large amount of USD/CAD during a period of illiquidity during the day. Due to liquidity conditions and the size of the anticipated order, the Market Participant expects that it will have to quote a buy price significantly lower than what is shown on the Interbank Brokerage Service (IDB) screen. However, before determining its quote and, with the purpose of improving its price to the Client, the Market Participant tests market liquidity by selling a small amount through the Interbank Brokerage Service (IDB). The Market Participant quotes the Client a buy price for the total amount, taking into consideration, for the benefit of the Client, the amount already sold.

Market Participants shall only conduct Pre-Hedging to cover anticipated orders of their Client when acting as Principals and without the intention of creating a disadvantage for the Client. In this example, the Market Participant has conducted a Pre-Hedging of a part of the order to handle the potential risk associated with the anticipated order and to benefit the Client, specifically taking into consideration the benefit in the price of the amount covered through the Pre-Hedging for the Client.

X A Client requests a bank for a buy position for 75 million USD/JPY. The bank has revealed to its Client acting as Principal that it can conduct Pre-Hedging on the anticipated orders of said Client. The bank then sells 150 million USD/JPY in the market outside its ordinary operations and before attending to the requested buy position, with the intention of taking advantage of the information from the Client's request and benefiting from a potentially lower market price.

Pre-Hedging is intended to manage the risk associated with anticipated Client orders, designed to benefit the Client. Market Participants shall only conduct Pre-Hedging with Client orders when acting as Principal. In this example, the amount intentionally sold by the bank as part of the Pre-Hedging was not proportional to the risk inherent to the anticipated operation and was not designed to benefit the Client. The bank acted with the intention of taking advantage of the Client's operation request for its own benefit and potentially puts the Client at a disadvantage. A Market Participant must also consider the prevailing market conditions and the size and nature of the anticipated operation when evaluating whether it conducts a Pre-Hedging regarding said operation.

..."

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, January 7, 2019.- The General Director of Operations and Payment Systems, Jaime José Cortina Morfín.- Signature.- The General Legal Director, Luis Urrutia Corral.- Signature.

Monday, January 14, 2019 OFFICIAL GAZETTE (First Section) 61 For any inquiries regarding the content of this Circular, please contact the Central Banking Authorizations and Consultations Department, at the phones (55) 5237-2308, (55) 5237-2317 or (55) 5237-2000 Ext. 3200.