IOSCO launches consultation report on pre-hedging

The International Organisation of Securities Commissions (IOSCO) has launched its much anticipated consultation report on pre-hedging. The report assesses the potential conduct and market integrity issues associated with the practice of pre-hedging and sets out a definition of pre-hedging, along with a proposed set of recommendations to guide regulators in determining when and how pre-hedging practices may be acceptable. The consultation closes on 21 February 2025, with a final report expected in 2025.

Definition

Currently there is no globally agreed definition of pre-hedging. To facilitate international regulatory alignment, IOSCO proposes to define pre-hedging as “trading undertaken by a dealer, in compliance with applicable laws and rules, including those governing frontrunning, trading on material non-public information/insider dealing, and/or manipulative trading where: 

1. the dealer is dealing on its own account in a principal capacity; 
    
2. the trades are executed after the receipt of information about an anticipated client transaction and before the client (or an intermediary on the client’s behalf) has agreed on the terms of the transaction and/or irrevocably accepted an executable quote; and 
    
3. the trades are executed to manage the risk related to the anticipated client transaction.”

Recommendations

IOSCO proposes nine recommendations that should be considered as guidance. Once finalised, national regulators can consider how they wish to apply them to dealers in their jurisdictions, taking into account their relevant legal and regulatory framework. In particular, IOSCO seeks feedback on whether the proposed recommendations need to be adapted to specific circumstances, for example between bilateral non-electronic transactions and pre-hedging in the context of electronic trading, including competitive requests for quotes.

A. Cumulative recommendations for circumstances when pre-hedging is acceptable 

• Dealers should undertake pre-hedging only for a genuine risk management purpose.
   
• Dealers should (i) act fairly and honestly to clients, and (ii) undertake pre-hedging only with the intention to benefit the client.
   
• Dealers should (i) minimise market impact, and (ii) maintain market integrity when pre-hedging. 

B. Recommendations for managing conduct risk from pre-hedging

• The dealer should document and implement appropriate policies and procedures for pre-hedging. 
   
• The dealer should provide clear disclosure to clients of the dealer’s pre-hedging practices. 
   
• The dealer should obtain prior consent from the client. 
   
• The dealer should implement appropriate compliance and supervisory arrangements for pre-hedging including (i) supervisory systems and reviews, and (ii) trade and communications monitoring and surveillance. 
   
• Dealers should appropriately manage access to and prohibit misuse of confidential client information and adequately manage any conflicts of interest that may arise in relation to pre-hedging. Dealers should consider establishing, monitoring, and regularly reviewing appropriate physical and electronic information controls to align with changes to the dealer’s business risk profile. 
   
• The dealer should maintain adequate records of pre-hedging to facilitate supervisory oversight, monitoring and surveillance.

The ISOCO press release published on 21 November 2024 is available here.

Read our earlier note on the Financial Markets Standards Board (FMSB) Spotlight Review on pre-hedging published in July 2024.