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And Another Thing…

If this column sounds angry – it should do!

So here we go again – vague accusations of collusion around a process that has proven time and again to be broken and only serves to highlight a lack of professionalism amongst the asset management community that continues to take the breath away.

That a cynical enough start? Hopefully it is because when I read the latest allegations published by Bloomberg News I just sighed. Apparently the 4PM London WMR Fix saw some volatility in recent weeks and this is enough to bring the conspiracy theorists out of the woodwork once again.

I have news for these people – the 4PM Fix has been broken for a decade and price moves like those reported have been happening for longer than that and every time they do they highlight why so-called “professional” money managers need to understand the meaning of that word.

The problem is tracking error – managers are scared stiff of it, even if – ridiculously – it means they make less money than they could. They follow each other like sheep, making sure they adhere to the market average and that leads to a lot of similar positions. So what happens when they need to hedge or roll those positions? They are all the same way and they all want to get the same deal done in the same minute as each other because – please no, don’t make it so – they might trade at a point or two better than everyone else.

Price action and volume in the market has always been silly around 4PM London – and whilst we are on it – there are accusations out there now of dealers “banging the close”. These people might want to know that the FX market doesn’t close – it’s open from 5AM Sydney on Monday to 5PM New York on Friday. And try banging that close – you might get $5 million done!

It would be interesting to see how those that believe this is collusion would react if the trades went through other markets. For example, if a group of sheep – sorry asset managers – go long Australian equities they probably do so over the course of a couple of hours. That way they don’t scare the market – they get as much done as they can in block trades and dark pools – and things remain tranquil.

Imagine what would happen if, say, five managers all tried to buy their $2 billion worth of equities in the same minute?

On the serious subject of collusion, and as I did last time I discussed this issue, I want to make it clear that Bloomberg is right to report these accusations and the authorities should investigate them, I am struggling to see how it would happen. The point is made that four banks handle 50% of FX volumes and thus it is easy to “collude”. I know traders at many of those banks and they are not allowed, since the Libor fiasco, to talk to other dealers during working hours. That does not mean they don’t I suppose, but the investigation should clear that up. My information from banking sources is that talking to other dealers remains a no-no.

If there are accusations to be thrown at the banks it should be for failing to adequately look after their clients by explaining to them the folly of relying upon one minute in the day. I know several have tried and failed because it was too much work for the client or was knocked back by fiduciary overseers, so not even that accusation really sticks.

Either way, there is an easy fix to this issue (no pun intended – I’m not in the mood) and that is for those asset managers still relying upon this mechanism to drag themselves into the 21st Century. Older members of our industry will remember the days of the Bundesbank Fix at 1PM in Germany – quite often the market would do silly things for a few minutes before the fixing rate was announced. That was operated and managed by what was at the time probably the most respected central bank in the world.

The fix to this issue is in the use of basic algorithmic strategies. Use a VWAP or TWAP to execute your risk at the appropriate time. I stress those last words because bizarrely some managers are still trying to hedge Asian-denominated risk at 4PM London – how is that working out guys? By all means build your own strategy (if a blindfolded monkey can beat the market one could certainly program you a VWAP) or use an off-the-shelf product, but either way get more professional about it.

The Bloomberg story cites many instances of price volatility and quotes from research that tends to highlight how the mechanism doesn’t work, but doesn’t have any real depth to accusations of collusion. I was very much taken by the last paragraph which, after all the speculation, nailed the issue. So, with full recognition of the source at Bloomberg News, here it is.

“Where possible, I would always advise clients not to trade at the fix – but minimising tracking error is so important to them. That doesn’t seem to be the right attitude to take when you have a fiduciary duty to seek the best execution for pension holders.”

Enough said.

Profit & Loss

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