Derivatives and securities dealers and some of their market users are locked in a potentially consequential debate over what legal standards should be adopted to govern pre-hedging (also called "pre-positioning" or "anticipatory hedging"). Pre-hedging is the practice of dealers establishing market positions to hedge their own risk from client-requested trades prior to accepting and executing the clients' trades. Pre-hedging is a common practice, but its benefits and the type and timing of dealer disclosures and client consent required to permit it are not settled. The debate is occurring in the context of the effort of the International Organization of Securities Commissions (IOSCO), the international body comprised of the world's securities and derivatives regulators, to adopt model legal standards governing it. IOSCO's aim since publishing its 2024 Consultative Report on Pre-hedging (Report)1 is to adopt consistent international standards that IOSCO's member regulators can implement in enforceable rules in their respective jurisdictions.
Dealer Conflict of Interest Concerns
Pre-hedging is controversial because it involves (1) the dealer is using the non-public information of a client's impending order for the dealer's own benefit, when (2) the dealer's trade potentially can move market prices adversely to the client's interests. Some market participants also worry that the practice opens the door for client abuse by giving cover for a dealer, in the guise of "pre-hedging," to front run a client order by "pre-hedging" but then backing away from executing the client's order.
The Pros and Cons of Pre-hedging
IOSCO's Report acknowledges that by reducing a dealer's risk of financial loss pre-hedging can benefit all market participants by improving liquidity, allowing for better pricing, increasing the speed of execution, providing for a larger trade size, and reducing market impact from the anticipated trade. Dealers view the risk protection provided by pre-hedging to be a necessary predicate for them to offer the desired liquidity in volatile and illiquid commodity and securities markets and for large trades. Some buy-side firms oppose the practice and argue pre-hedging should be limited to large transactions in less liquid markets where the parties negotiate the terms for the pre-hedging in advance and better understand the potential market price impact from it. The Report contends that the potential for abuse is aggravated by a lack of transparency into the effects from a pre-hedge transaction such that clients or counterparties may not be able to monitor and assess whether a dealer's pre-hedging provided benefits or, instead, harmed the client's or counterparty's interests.
The Current Array of Different Standards
There are no consistent international standards for pre-hedging. The CME Group (CME) and ICE Futures U.S. (IFUS) impose specific requirements for pre-hedging of block trades, and certain industry trading codes, such as the FX Global Code adopted by the Global Foreign Exchange Committee for wholesale forex transactions, delineate standards for pre-hedging in their particular markets.
The CME and IFUS rules require that (1) the pre-hedging party must have a good faith belief that the anticipated block trade will be executed; (2) each party to the anticipated trade must act in a principal capacity and not in an agency capacity; (3) the pre-hedging party must make clear to its counterparty that it is acting as a principal; (4) brokers may not pre-hedge; and (5) front-running is prohibited.
Principle 11 in the FX Global Code, and its accompanying Commentary, focuses on the dealer's intent and disclosure, requiring that (1) pre-hedging should be for the management of the risk associated with one or more anticipated counterparty orders; (2) pre-hedging must be designed and intended to benefit a counterparty; (3) the pre-hedger must be acting as a principal; (4) the pre-hedger must reasonably anticipate in good faith that it will execute the counterparty's order; (5) the pre-hedger should limit pre-hedging to circumstances where there is a need for risk management; and (6) pre-hedgers should act fairly and with transparency, such that dealers should communicate their pre‐hedging practices to their counterparties in a manner that allows a counterparty to fully understand the potential impact on the execution of its order.
The U.S. Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) do not have rules specifically governing pre-hedging, but the CFTC has construed certain of its swap dealer disclosure and business conduct rules to apply to pre-hedging. In a 2023 consent settlement the CFTC made non-adjudicated findings that the respondent swap dealer's disclosures of its pre-hedging practices were inadequate and its pre-hedging violated Commodity Exchange Act Section 4sand CFTC swap dealer regulations 17 C.F.R. §§ 23.431(a)(3)(ii) and §23.433.2 The order recounted allegations that the respondent had pre-hedged customer transactions minutes or seconds before they occurred and that caused worse pricing for the customer. The order effectively found that the swap dealer's disclosures to its client that it "may" seek to pre-hedge transactions, and that pre-hedging "may" affect the price of the underlying asset, were inadequate. The order suggests that the swap dealer in that context was required to disclose the more specific information that pre-hedging may occur in seconds or minutes before the customer's trade and that it may negatively affect the price of the customer's trade.
A recent decision of the U.S. Court of Appeals for the Second Circuit in Johnson v. United States,3 however, raises significant questions about whether and when a dealer is in a fiduciary relationship with an institutional counterparty and when the dealer's use of a counterparty's non-public information about an impending trade to pre-hedge the dealer's financial risk constitutes misappropriation. In July 2025, the Second Circuit reversed a 2017 criminal conviction of the head of an international bank's foreign exchange trading desk for wire fraud and conspiracy arising out of a pre-hedging transaction. The government's case charged, among other things, that the pre-hedging of the bank's 2011 conversion of U.S. dollars into 2.25 billion British Pounds for a client constituted a misappropriation of material non-public information about the client's anticipated transaction.
The court reversed in part based on its finding that it is unlikely a reasonable jury being properly instructed would have reached unanimous agreement that a fiduciary duty existed where the transactional documentation disclaimed that a fiduciary duty existed and to form a de facto fiduciary relationship requires "quite strong" evidence which the court did not find existed in that case. The court opined that a fiduciary duty cannot be "lightly implied" and a customer's placing "great confidence and trust" in its dealer "is insufficient". Rather, the court held that a fiduciary duty requires "de facto control and dominance" over the principal's affairs.
The court also held that the proof of a misappropriation of information was insufficient. The court explained that misappropriation requires proof that the defendant used the information in a way that was not permitted, and the use was for the defendant's own benefit and to the detriment of the other. The court found that the evidence showed that the trading desk in executing the pre-hedge acted as it "normally" would and this undermined the government's argument that the defendant used confidential information in "an abnormal or knowingly impermissible way."
Important Legal Issues for Dealers and Clients
Scope of the Terms "Dealer" and "Client"
The IOSCO Report's definition of pre-hedging is framed only as to "dealers" and "clients," but does not define those terms.4 Yet, it seems to contemplate only professional dealers by differentiating "dealers" from "issuers, brokers, investors and other wholesale market participants." This characterization would appear to exclude commercial end users who engage in transactions that from time-to-time might function as dealing, but who do not hold themselves out to the marketplace as a dealer and do not engage in the activity as a regular business.5 Framing a dealer's duties as those owed to clients also suggests the Report's recommendations are aimed at the activities of professional dealers in the business of serving clientele.
The Report does not define the term "client." Traditionally, the term can imply a relationship in which a party is hired to serve the interests of the "client" and assume a range of duties to a client, such as duties of loyalty, disclosure of material facts, and best execution. However, there can be circumstances in which the counterparty to a dealer has no special relationship with the dealer but is simply a counterparty. The Second Circuit's decision in Johnson would seem to illustrate that. The CFTC's rules for swap dealers use the more neutral term "counterparty," whereas its rules for commodity trading advisors use the word "client," which comports with the language of Section 4o of the Commodity Exchange Act and the traditional relationship between commodity trading advisors and the persons who hire them. Given these distinctions, the final IOSCO standard might be crafted to refer to counterparties or at least clarify that the term client is not intended to assume or denote a particular legal relationship between the transacting parties.
Limiting Pre-Hedging Restrictions to the Receipt of Material Information
IOSCO's proposed definition of pre-hedging covers trading "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." Some commenters have argued that pre-hedging restrictions should be triggered only upon receipt of material information about a counterparty's potential interest in entering a specific order to trade. In this regard, dealers can receive all sorts of information throughout a trading day relating to potential transactions, much of which may be immaterial. Limiting the definition to material information would be consistent with the Report's focus on dealer restrictions upon receipt of a specific trade request.
The Scope and Timing of Dealer Disclosures to Clients
One of the most potentially consequential standards in IOSCO's recommendations is that of delineating a dealer's disclosure requirements. The scope of disclosure requirements implicates significant issues of cost, feasibility, and legal exposure. IOSCO's Recommendation B2 set forth in its Report states that a dealer should provide clear disclosure to clients of the dealer's pre-hedging practices but leaves open for further consideration how disclosure should occur, when it should occur, and the specific information that must be disclosed. In this connection, the Report raises the issue of whether disclosure should be (1) trade-by-trade, (2) generic as part of on-boarding documentation, and/or (3) post-trade.
The dealer community has argued that disclosure obligations should be flexible and bespoke based on the client and the nature of the transaction. For example, it has argued that trade-by-trade disclosure would be problematic for competitive Requests for Quotes sent on electronic trading platforms since they are largely executed by automated trading algorithms, and dealers may not have a direct relationship with clients. Bespoke disclosures to clients typically occur when the anticipated transaction is large and/or complex and the scope of pre-hedging is specifically negotiated with the client or counterparty. The Report explained that large and/or complex transactions generally are negotiated bilaterally and involve a longer lead time, allowing the dealer and client more opportunity to discuss terms for pre-hedging.
Client Consent
The Report recommends that client consent to pre-hedging should be required. The Report does not specify what type of consent is required, i.e., trade-by-trade, affirmative general consent, or implied negative consent following disclosure. As with disclosures, dealers argue that trade-by-trade consent is infeasible in fast-moving or electronic markets.
Compliance and Supervisory Controls
The Report recommends that dealers should implement appropriate compliance and supervisory arrangements for pre-hedging including: (1) supervisory systems and reviews, and (2) trade and communications monitoring and surveillance. This raises the question whether surveillance programs specifically targeting pre-hedging should be required. Some dealers already have risk-based surveillance for front-running and fair pricing reviews, and other surveillance to comply with established industry codes. They argue that the efficacy of requiring even more granular surveillance for pre-hedging is not warranted, especially when weighed against its cost and difficulty.
Conclusion
IOSCO is expected to adopt legal standards for pre-hedging in the not-too-distant future that member countries eventually may include in formal regulations. Those standards could (1) significantly impact dealer legal exposure and the scope of compliance controls and (2) impose additional costs for dealers. For buy-side firms, the standards could provide increased legal rights and protection, but also conceivably less attractive quotes and liquidity if dealers need to price in the higher market risks and costs to them if pre-hedging is not available.
Footnotes
1 https://www.iosco.org/library/pubdocs/pdf/IOSCOPD778.pdf.
2 In re Mizuho Capital Markets LLC, CFTC No. 23-24 (Apr. 25, 2023).
3 Johnson v. United States, 2025 WL 1966390, No. 24-1221 (2d Cir., July 17, 2025).
4 The FX Global Code also uses the term "client" in its directives.
5 The SEC and CFTC in various releases have generally described the attributes of "dealers" as entities that act in a principal capacity as part of a regular business to provide liquidity to a market by both standing to buy and sell within an offered bid/ask spread of prices with the objective to profit from the spread and not hold a market risk position. E.g., CFTC and SEC Joint Release: Further Definition of ''Swap Dealer,'' ''Security-Based Swap Dealer,'' ''Major Swap Participant,'' ''Major Security-Based Swap Participant'' and ''Eligible Contract Participant,'' 77 Fed. Reg. 30596, 30607-30614 (May 23, 2012). The SEC's more recent effort to expand its definition was rejected by the courts and abandoned. Nat'l Ass'n of Private Fund Managers et al. v. Securities & Exchange Comm'n, No. 4:24-cv-00250 (N.D. Tex. Nov. 21, 2024); Crypto Freedom All. of Texas et al. v. Securities & Exchange Comm'n, No. 4:24-cv00361 (N.D. Tex. Nov. 21, 2024).
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