The events of the last 18 months will, I believe, be seen by historians of the FX market as triggering a dramatic change in the market landscape. I have to say, though, that I feel one of the biggest changes is being overlooked – even though it is happening in front of our eyes.
So much of the focus is on the continuing investigations into allegations of bad behaviour, driven as it is by the media agenda, fuelled in turn by “wannabee” politicians seeking to kick-start a campaign. But underneath the surface of the market there is some serious introspection taking place – and it targets the customer base.
The capital available to bank FX businesses is already much reduced compared to a short time ago; the impact of the Fix fiasco is seeing more players pull back from proprietary risk taking and pushing more towards an agency model; the lessons of the SNB event are still being absorbed; and then we have the “hot” topic of last look being openly debated around FEMR and, possibly, by certain regulatory agencies.
All of this is likely to lead to several players doing what some institutions did years ago, and trim their customer bases.
Already I am told of banks telling certain reluctant clients that they must pay a fee for fixing services, or go elsewhere. Initially some customers did just that, but very quickly they are realising it is only a matter of time before everyone charges – and in case anyone is in any doubt about this, the FSB’s FX Benchmark Group seems to be making it pretty clear that it expects everyone to charge in some shape or form, or risk having charges imposed. Don’t misunderstand this – every bank will have to charge in some shape or form in the coming months.
So the first nail in the “customer is everything” ethos’ coffin is being banged in as I write. A second nail is how more players are shifting towards an agency model for all orders. Agency comes with what? That’s right, a fee.
A third issue is the growing understanding that while the Swiss event was a one-off, it is one that has highlighted the fragile nature of the FX market’s liquidity paradigm, the propensity of people to rush to legal recourse when things go wrong, and exactly how “strong” some liquidity relations are in the modern FX market (not strong at all if you’re wondering).
Finally into the mix we can throw the focus on last look. I am not sure whether the practice will be outlawed or not – it is well known I am not a fan of the practice, but less so that I think the answer is not in regulating the practice out of existence, rather via the imposition of a compliance framework that has a set process in the event of rejection rates rising above a certain threshold (I would like to set this at 1%, but 5% is probably more reasonable).
Defenders of last look stress that clients like the tighter pricing and that it allows the LPs to credit check as well as guard against latency. Fair enough. But if you are rejecting more than 5% of trades, surely this is telling you that your technology isn’t good enough – and should therefore be upgraded quickly – or you are quoting the wrong counterparties. The third option is the most dangerous – trades are being rejected because they “don’t suit” – and it is this practice that will lead to last look being banned, if indeed it is.
Either way, there is one school of thought that last look won’t be banned because the customers like it (some very much dislike it – as the FEMR responses highlight), and another that nothing will change if it is banned because banks will still want to quote all their customers on the multitude of venues on offer.
I am not sure on the first, as I have stated, but I feel the second argument is wrong.
I agree that one or two years ago banks would not have blinked at a ban on last look – they would merely have quoted everywhere a little wider. But ally this potential ban on what LPs (dubiously) consider protection for their quotes, with a higher capital charge, a riskier market environment and a desire to charge for FX execution services, and I wonder if the level of liquidity on offer will remain the same?
I don’t think it will, because while banks are “reassessing their client footprint”, a big part of this is the type of venue on which some “clients” are being met. There are “good”, or premium clients that the banks will meet on the venue(s) of the client’s choice, and there are “bad” clients that they will only meet on certain venues (typically with last look or a platform into which they only push proprietary, one-way interest).
The largest client footprint exists in a grey area, however, where it is borderline whether that client has any real value to the bank. Until now, banks have accepted the up and down relationship with these clients and met them on most venues, that is likely to change.
There will be an impact of a ban on last look for several platforms as well. For while there are some last look venues with a “good” client base, there is a multitude of venue providers that only get liquidity because they offer last look – in other words, the LP can deal on their terms.
If those terms have to change we will realise then that we are in a different environment in foreign exchange – one in which liquidity is no longer blindly provided to all, including potential competitors, but instead it is treated like the precious, valuable asset it is.
This realisation, which I believe will happen as a result of all the events described above, rather than one, will lead to a more realistic liquidity pattern in FX, and from that I suspect that a great number of clients, possibly even the majority, will have to reassess how they interact with the market.
Colin_lambert@profit-loss.com Twitter: @lamboPnL