Following Monday’s column about the
responsibility of intermediaries to police behaviour in FX markets – and whilst
my sources say they don’t believe it to be the end game one has to applaud
FastMatch’s new order type, which effectively outsources last look – I think it
important to take a look at the responsibilities of market makers.
Before I start, some foundations need to be
laid down. Latency arbitrage is, in my opinion, bad behaviour that needs to be
stamped out, as indeed are all arbitrage strategies based upon the speed of
technology. Trading with several liquidity providers at the same time, i.e.
machine gunning the market, is bad behaviour if the client tells most or all of the LPs it is full amount.
There is little doubt in my mind that some
market makers need to better understand the nature of markets. Yes, market
making is not, as I have stated before, a charity, but it is a service – and as
such the service provider needs to behave just as responsibly and be as good a
citizen as other participants.
As someone who was a market maker for more
than 20 years I have a natural affinity with those playing the role in today’s
market, but feel that some perspective is needed.
The bottom line is, sometimes clients are
going to get the market or their timing right. This does not make them predatory, lucky maybe, skilful probably, but
predatory? Absolutely not. The market maker does not have the right to make money on every single trade and I am not
sure where this sense of entitlement grew from in FX but I truly wish it would
disappear from whence it came.
Listening to some, I have to stress not
all, market makers, one senses that they conveniently forget that clients have
best execution policies, as well as shareholders and investors to satisfy. It
is the client’s obligation to get the best possible outcome in their FX
Now if these clients do their analysis and
their best method results in hitting several LPs simultaneously, fair enough –
as long, as I stressed earlier, they do not try the old “full; only you” line.
If the LPs don’t like the flow they have the right not to quote the customer –
if the latter is anonymous, quote the venue wider or stop quoting to it full
So as is so often the case in the modern FX
market it is about transparency of action. Liquidity takers are not ATMs for
market makers to extract money from, nor are they entitled to a price if the
market maker doesn’t wish to make it – this is the epitome of a “consenting
It is well known that I am no fan of last
look but have accepted that it can help protect the market maker against
predatory behaviour – my real concern is that too many market makers hide
behind it and have become accustomed to only making money on quotes. They do
not only use it as a defence mechanism against certain clients, it can be used
against all clients, who are penalised for getting the market right.
Alongside orders and barrier options, last
look is easily the most emotive subject in FX circles, hence I was pleased to
read this morning about FastMatch’s initiative to create an order type that
outsources last look to the platform – an independent third party.
I am told that several banks encouraged the
platform to create the order type because they recognise it is a sensible,
possibly stop gap, solution to an increasingly complex problem. As someone who
has been calling for more than a year now for platforms to take some
responsibility I can do no more than praise the initiative, even though the
curmudgeon in me wants to ask why other platforms haven’t done it!
Either way, this type of initiative does
help throw the spotlight on potential bad behaviour by some LPs, because no
longer can they hide behind their own (flexible in some cases) take on last
look. If a trade is not rejected under the independent oversight where it would
have been under a different regime, or on a different venue, one could suggest
that the latter’s last look policy is too generous to market makers.
Of course, now that FastMatch has done
this, I do sincerely hope we do not get into a dogfight between venues over who
has the most generous last look terms for market makers – a race to the bottom
such as that which would ensue, does little good for anybody. Perhaps, and I
apologise to those already working long hours on it, this is yet another task
for the group developing the code of conduct as they switch their attention to
electronic markets? To develop fair and balanced last look thresholds for all venues.
Notwithstanding the step forward in dealing
with last look – and to return to the original theme of this column – I cannot
help but re-state a question I have asked of market makers before. If you are
not willing to buy or sell at the rate, then why publish it? More to the point,
why publish it across potentially dozens of venues?
I understand the argument that customers
demand it, but I thought we had moved beyond the era when the customer gets
everything they want and more? The new Code of Conduct stresses how the rules
are for every participant in FX,
including end users. Well I think alongside this needs to come a greater sense
of realism on the part of those end users. Liquidity is not, and should not, be
But market makers also need to understand
the subtle shift that has taken place in FX and they need to develop, in some
cases, a better sense of responsibility. If you make a price, stand behind it
unless there is an obvious case of market abuse taking place – and if there is
then stop quoting the client or the venue, natural selection will soon play its
If market makers are going to continue to
make multiple venues then accept you will be hit on multiple venues simultaneously.
If it is the same client, and this is a recurrent theme, price them wider, or
don’t price the venue.
I mentioned earlier that market makers do
not have the right to make money on every trade, but they also have another
right. They should not, collectively, have the right to paint a false picture
of available liquidity in the market and that is what has happened for too
A more realistic foreign exchange market
involves customers accepting they may pay more for a valuable service and
market makers accepting they may get hit if they are too careless with that
I stated on Monday that “responsibility is
a requirement of everyone in the industry” and I stand behind that. “Everyone”
includes those market makers who need to better understand that we operate in a
“no tears” environment.
If you can’t stand the heat, then if you
don’t get out, at least cook in less kitchens.