A Large Fix Order, Pre-Hedging and Last Look

Buying USD 30m ahead of a USD 150m fix order is pre-hedging: trading in anticipation of a client order that the firm knows is coming. Under the FX Global Code, pre-hedging is not automatically prohibited, but it must be conducted in the client's best interest, disclosed appropriately, and not used as a vehicle for front-running or for the firm's proprietary benefit.

The problems here are:

• No client disclosure. The client has not been told that the bank may trade ahead of its order. A generic statement that the bank 'may pre-hedge' without describing when, how much or with what controls is not adequate transparency.
• Size and direction. The trader bought USD 30m, 20% of the order, in the same direction as the expected client flow. That is precisely the activity that can move the fix against the client. The bank must be able to show that the purchase was a risk-management hedge for the client's order, not a proprietary position.
• Information handling. The salesperson disclosed the client's price sensitivity and purpose. That information should be shared only on a need-to-know basis, and the proprietary desk should not see it.

Required controls: a written pre-hedging policy with a defined client-consent or disclosure framework; a pre-hedge limit as a percentage of the order; a prohibition on pre-hedging where the firm cannot demonstrate client benefit; segregation of client order information from proprietary trading; and surveillance of pre-fix trading. The trader should be able to show a contemporaneous record of why 30m was bought, how it was allocated and why it was in the client's interest.

Last look is the practice of giving a liquidity provider a final window to accept or reject a trade after receiving a client order. The Code permits it only with proper disclosure and only where it is used to manage settlement and credit risk, not to exploit information about the client's order.

The 10-pip spread check is the main problem. It rejects fills whenever the market moves more than 10 pips in the 40-millisecond window, which means the bank systematically avoids fills that have moved in the client's favour while keeping fills that have moved in the bank's favour. That asymmetry transfers market risk to the client and can amount to using last look as a free option. The 40-millisecond window itself is not the issue; the rejection rule is.

Changes required:

1. Disclose the last look in the client's terms, including the window, the spread check and the rejection rate, in plain language.
2. Make the check symmetric or remove it. If a spread check is retained, it should reject on both favourable and unfavourable moves, and the firm should publish or provide rejection statistics.
3. Monitor and cap rejection rates by client and by currency pair, and escalate outliers.
4. Do not apply last look to fix orders where the bank has already pre-hedged, because the combination allows the bank to trade ahead of the client and then reject the client's fill.
5. Obtain client consent where required by the client's jurisdiction or by the bank's own policy, and record it.

The bank should treat this as a large, information-sensitive fix order and separate execution from proprietary risk-taking.

Execution options:

• Agency fix execution: pass the order to a fix execution algorithm or an agency desk that works the order around the fix without taking proprietary positions.
• TWAP or interval execution: if the client will accept an average price rather than the fix, execute over a defined window to reduce market impact.
• Disclosed pre-hedging: if the client wants a fixed price and the bank needs to pre-hedge, agree in writing the maximum pre-hedge size, the permitted instruments and the disclosure that the bank may trade ahead of the order.

Documentation:

1. Record the client's instruction, including the benchmark, the size, the value date and any price tolerance.
2. Record the pre-hedge decision: size, timing, rationale, who approved it and how it was in the client's interest.
3. Record the execution venues and timestamps, and the fix level compared with the 3:55pm mid.
4. Record the last-look outcome: whether any fill was rejected, why, and whether the client was informed.
5. Escalate the salesperson's disclosure of the client's price sensitivity to compliance, and confirm that the proprietary desk did not receive the order information.

Given that the fix printed 20 pips above the 3:55pm mid after the trader bought 30m, the bank should also review whether the pre-hedge contributed to the move and whether the client's fill should be adjusted or explained. A clear written explanation to the client is preferable to leaving the client to infer that the bank traded ahead of it.