Top of Book a Top Concern for Compliance Officers at Australian FX Brokers

This article was written by James O’Neill, a Director of ILQ Australia Pty Ltd.

ASIC-regulated brokers offering pricing feeds with top of book pricing should evaluate their procedures to ensure that they are compliant with Australian financial services law and consumer law. Top of book of book pricing refers to the highest bid and lowest ask offered in a prevalent market.

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Generally, top of book is an off-market price – more often than not, top of book is quoted by an investment bank or prime broker where that provider has overweight exposure to a certain currency. To entice market participants to take the opposite position, these providers will often quote a price better than the prevailing market.

For example, a provider may be overweight EURUSD. To sell off this position it may quote pips lower than the prevailing ask price. Conversely, another provider may be underweight EURUSD. To sell out this position, provider two will quote bid prices for EURUSD lower than other providers and the prevailing market. The bid-ask for these two providers will form the top of book price.

Erring on the side of caution

There is nothing inherently illegal about this practice, to the contrary, it forms these providers’ risk management system in line with s 912A(1)(h) of the Corporations Act 2001 (Cth). However, where brokers need to err on the side of caution is where they use top of book pricing without hedging the risk and quote these prices with limited depth.

Often brokers may do this to entice traders who will see tight spreads which they have limited prospects of hitting with any reasonable flow. Such practices will likely fall foul of the corporate regulator either under the s 12DA of the ASIC Act 2001 (Cth); s 35 of the Australian Consumer Law; or through the catch-all obligation under s 912A(1)(a) for AFS Licensees to act honestly, fairly and efficiently.

Section 12DA of the ASIC Act 2001 (Cth) provides that a person shall not ‘in trade or commerce, engage in conduct in relation to financial services that is misleading or deceptive or likely to mislead or deceive’.

While section 35 of the Australian Consumer Law relates to bait advertising asserting: “A person must not, in trade or commerce, advertise goods or services for supply at a specified priced if there are reasonable grounds for believing that the person will not be able to offer for supply those goods or services at that price for a period that is, and in quantities that are, reasonable, having regard to the nature of the market in which the person carries on business and the person is aware or ought reasonably to be aware of those grounds.”

Exercising care with consumer law provisions

As an example, ABC Brokers quotes top of book pricing on its majors including EURUSD and AUDUSD. ABC Brokers receives its price feeds from a prime broker but except in exceptional market conditions manages its own risk internally. ABC Brokers quote prices for the majors with prices good for 5 lots.

Once 5 lots are placed on any one pair, the next best price is substantially higher, but top of book is still quoted. ABC Brokers know or ought to know that the top of book price will be filled and that many clients will seek to execute at that price but will be slipped. In this scenario, the broker is likely to have contravened a number of financial services and consumer law provisions and have breached their obligations as holders of AFSLs.