Submitted Electronically

February 21, 2025

International Organization of Securities Commissions
C/ Oquendo 12
28006 Madrid
SPAIN

Re: Public Comment on Pre-Hedging Consultation Report (November 2024)

Dear Sir/Madam:

The Securities Industry and Financial Markets Association Asset Management Group (“SIFMA AMG”), American Council of Life Insurers (“ACLI”), and Investment Company Institute (“ICI”) (collectively, the “Associations”) are submitting this letter on behalf of our respective members (the “association members”) to address portions of the Pre-Hedging Consultation Report (the “Consultation Report”) of the International Organization of Securities Commissions (“IOSCO”).¹

The Consultation Report appears to start from the assumption that pre-hedging should be permissible in a wide variety of circumstances, despite acknowledging that pre-hedging gives rise to certain risks including misuse of information, lack of transparency, and lack of client consent and understanding.²  The Associations respectfully disagree with this assumption. Although we strongly support IOSCO’s goal of providing recommendations that will set the standard for pre-hedging globally, we urge the adoption of recommendations guiding regulators in establishing clear boundaries to limit the practice to minimize the harm that can arise from dealers trading before their clients.

Pre-hedging involves a dealer trading ahead of a client based on information regarding an anticipated trade received from its client and, therefore, a dealer may only trade on such information with the client’s express affirmative consent on a trade-by-trade basis following appropriate disclosure and only when it is designed to benefit the client. Trading without such express (and informed) consent allows a dealer in possession of such information to potentially negatively impact the execution of its client’s trade, to the dealer’s benefit, and indeed, allows the dealer to “hedge” a client transaction it may never engage in and a risk that it may never take on.

Although existing laws, regulations, and self-regulatory organization rules address market abuse and manipulation, including frontrunning, these regulatory regimes differ between jurisdictions. Pre-hedging must be specifically addressed by regulators. We believe, based on the key elements outlined above (appropriate disclosure, express consent and client benefit), pre-hedging is only appropriate in certain narrowly defined circumstances where the dealer takes on outsized risk in the anticipated transaction and the potential for harm to the client can be minimized (or at least, that it is knowingly consenting to any such harm and still wishes to proceed)—this would only include large, bespoke trades in over-the-counter (“OTC”) illiquid markets where there is active collaboration between the dealer and client to accomplish the trade. Even in those narrow circumstances, the client should be able to decide whether to permit pre-hedging.

Below we address some of the questions raised in the Consultation Report. Throughout these responses, we emphasize the principles discussed above.

I. Definition

1. Do you agree that this is the correct definition of pre-hedging? If not, how would you define pre-hedging? Does the definition of pre-hedging clearly differentiate it from inventory management and hedging?

We do not agree that this is the correct definition of pre-hedging because it conflates two concepts: (1) what pre-hedging is—a dealer trading ahead of a client’s transaction, based on information about the anticipated trade received from the client, for the dealer’s own benefit—and (2) when, if ever, such behavior should be permissible. Pre-hedging is simply trading undertaken by a dealer in a principal capacity where the trades are executed after the receipt of information about an anticipated client transaction and before the dealer and client have irrevocably agreed on the terms of the transaction. Jurisdictions have long recognized that behavior that meets this definition of pre-hedging could constitute market abuse, such as frontrunning. IOSCO should therefore distinguish between the concepts of “pre-hedging” and “permissible pre-hedging” as “permissible pre-hedging” would reflect a much smaller set of transactions and behaviors.

With respect to the IOSCO’s proposed definition, we agree that “pre-hedging” only occurs when the dealer is acting in a principal capacity (i.e., prong (i)). There is never a need to pre-hedge when a dealer is serving in an agency capacity because the dealer will not take on any risk from the anticipated transaction. We would revise prong (ii) of IOSCO’s definition to provide that pre-hedging occurs after the receipt of information about an
anticipated client transaction and before the dealer and client have irrevocably agreed on the terms of the transaction. This change would make clear that any trading taking place before parties irrevocably agree to the terms of the transaction is pre-hedging, regardless of whether the client or the dealer is the one who finally accepts the terms of the trade. For example, the Consultation Report’s definition does not account for situations where the dealer has a “last look.” In this scenario, the dealer has sole discretion over whether to accept the client’s trade and until such acceptance the client bears the market risk. A dealer that conducts any trading activity in the context of “last look” is pre-hedging because the dealer has not yet taken on any risk. Trading after the transaction has been irrevocably agreed to by both parties is, of course, actual hedging because it involves the off-loading of known risk held by an entity, here a dealer, in connection with its investments. In contrast, when a dealer “pre-hedges” it is reacting to a risk it does not bear but ostensibly believes it may or will. It may never actually receive or agree to the client transaction that it is pre-hedging and therefore may never take on the associated risk. A dealer trading before receiving information about a trade is mere pre-positioning and is generally acceptable as the dealer is not using the client’s information to obtain a better price for itself at the client’s expense.

Pre-hedging creates a conflict of interest between the dealer and the client and therefore entails certain risks and benefits that must be balanced in favor of the client. The primary risk is that the dealer’s pre-hedging will negatively affect the client’s price. The primary benefit of pre-hedging goes to the dealer who reduces the risk related to the potential client transaction, with little, if any, benefit to the client. Instead of pre-hedging, a dealer can always enter into a transaction with a client and then hedge the risk following execution. When a dealer pre-hedges instead, it ensures any price-slippage in the relevant market impacts the client’s transaction, not its own hedge.

To prevent dealers from taking advantage of this lopsided risk-reward structure, we propose that IOSCO provide a recommendation defining what is “permissible pre-hedging.”

First, pre-hedging must, of course, be in compliance with existing laws and regulations, including those regarding frontrunning. The Consultation Report acknowledges that “IOSCO has not analyzed when pre-hedging entails market abuse in different jurisdictions” but intends its recommendations to be “ancillary” to “existing regulations, including market abuse regulations.”³

Second, a dealer should only pre-hedge after a client has given explicit informed consent in the context of a particular trade. The client itself is best situated to determine whether the benefits of pre-hedging outweigh the risks in the context of a particular transaction, and therefore explicit client consent (and, importantly, not “deemed” or “negative” consent) should be required before a dealer is permitted to pre-hedge the transaction. Associated with this is the need for appropriate and fulsome disclosure (as more fully described below).

Third, a dealer should only pre-hedge when it is designed to benefit the client.⁴ This will help to increase the probability that pre-hedging results in a favorable risk-benefit outcome for the client. Further, there is typically not only one way to hedge a given transaction and a dealer often has flexibility in how it pre-hedges, so this requirement would help to ensure that a dealer always considers the impact on its client when choosing among its options. Ultimately, this would help to minimize any negative impact on the price a client ultimately pays for a trade.

1. IOSCO, Consultation Report: Pre-hedging (November 2024) available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD778.pdf. [↩]
2. Consultation Report at 10-11. The Consultation Report cites two recent examples involving enforcement actions by the Australian Securities and Investments Commission and the U.S. Financial Industry Regulatory Authority. See Consultation Report at 15-16. In addition, the U.S. Commodity Futures Trading Commission (“CFTC”) recently issued a consent order related to a swap dealer’s practice of “pre-hedging” foreign exchange forward transactions. See In the Matter of: Mizuho Capital Markets LLC, Respondent, CFTC Docket No. 23-24 (Apr. 25, 2023). The dealer failed to disclose to clients that it would trade in the minutes or seconds prior to providing the spot exchange rate and executing the transaction, potentially moving the spot exchange rate against the client. As a result, “the client at times likely obtained the currency it sought to acquire via the foreign exchange forward at a rate less favorable than may otherwise have been available, and [the dealer] may have been able to hedge its exposure vis-à-vis its clients at a rate more favorable than may otherwise have been available.” Id. at 1. [↩]
3. Consultation Report at 8. [↩]
4. The industry codes cited in the Consultation Report each include the concept of client benefit in their principles applicable to pre-hedging. See Global Foreign Exchange Committee, FX Global Code (rev’d Dec. 2024)  available at https://www.globalfxc.org/uploads/fx_global.pdf (including within the definition of pre-hedging that the trades are “designed to benefit the client”); FICC Market Standards Board, Standard for the execution of Large Trades in FICC Markets (May 6, 2021), available at https://fmsb.com/wp-content/uploads/2021/05/FMSB_Large_Trades_Standard_-FINAL-05.05.21.pdf (providing that pre-hedging should only be conducted when “it is designed to benefit the client and not executed in a manner that is meant to disadvantage the client”); London Bullion Market Association, Global Precious Metals Code (Dec. 2022), available at https://www.juliusbaer.com/fileadmin/legal/global-precious-metals-code.pdf (including within the definition of pre-hedging that the trades are “designed to benefit the Client”). Not all SIFMA AMG members have signed on to these codes. We mention them not as an endorsement, but to emphasize the necessity of including that pre-hedging is designed to benefit the client in any recommendation defining permissible pre-hedging. [↩]