Monday’s column touched a raw nerve and triggered quite a
response and it seems that market making or liquidity provision is just as
susceptible to marketing overkill as any other service.
I had little idea that the extent to which people widen out
was so large, so regularly, but several people got in touch, highlighting how
often a price will go two or three big figures wide – even though the day’s
range was 150 points!
It seems that too many participants in the FX market are
wary of being seen to step out of the market. In part this may be because of
the flak some took after SNB Day, it could also be because they don’t want to
be seen to be inferior to their peers.
Either way, what it comes down to is someone can sit on a
stage, or be quoted in the media as saying that “We at [fill in name of
participant] were in the market for our clients throughout.”
It is very clear to me having heard from some of these
“clients” that they do not consider multiple spreads on a day’s range to be “in
the market throughout” – in fact it is interesting that some clients are
telling me they actually consider it a worse act to quote 30 or even 50 big
figures wide (as I described on Monday) than it is to say, “we’re out”.
This is logical because if such an event does happen, the
chances are by pulling out of the market there is less opportunity for people
to hit the wrong price, and then go through the re-papering process. Of course,
what is illogical and what I have to question, is what sort of participant is
dumb enough to hit a price in, for example, Cable, at 0.75 or thereabouts, when
the last trade was at 1.10?
Yes I find it reprehensible that the so-called liquidity
provider is quoting this wide, but how good are the counterparty’s risk
controls? Answer: not very! Clearly both sides of the industry need to up their
In some ways this brings the conversation back to the
subject of circuit breakers in the market, which is a tricky one. I personally
do not agree with circuit breakers because if we have such a thing around a
genuine event then people are unable to exit risk at a reasonable level.
Yes, the SNB stuffed it badly in January 15, but we can’t
ignore the fact that on some venues, people were unable to trade because the
circuit breaker cut it at 1.14, 1.15 or even 1.16. In that event, bidding at
1.10 and even 1.05 was probably acceptable because clearly there was a massive
order imbalance, and most of those participants would have been grateful to
trade there. As it was they either got lucky(ish) because by the time their
platform re-booted the market had bounced back to 1.00-1.05, or they were
properly stuffed (technical market term) because their platform came back on at
0.85-0.90 – and they paid away another 10 or 20 big figures because of the
That said, if so-called LPs are going to go 50 big figures
wide, we are going to have just as many problems with arguments over
re-papering – some of which could end up in the last place the foreign exchange
industry wants or needs to be, a court of law.
Part of this problem is the structure of banks in particular
since the Cartel scandal. Voice desks, that would step in and ease matters in
these events, have been emaciated (sometimes correctly so), and even those
remaining have been, as I have argued repeatedly, handcuffed by the fear
On the latter note, a friend got in touch following Monday’s
column and made the point, “how are we going to effectively train the next
generation of traders, LPs and risk managers if they cannot experience these
The fact is, my friend pointed out, too many managers in the
banking business especially focus on the negative – they are too busy stressing
how a staff member cannot do something to have time to actually look at what,
in this case a trader, could be
doing, i.e. helping to make markets better and, into the bargain, helping that
Something else worries me as well, and this was brought up
by another friend who got in contact. What happens if – and I accept this is
unlikely because the technology is too robust, but humour me – two or three of
the primary venues go down at the same time? Are we facing the threat of a
flash move because the electronic market makers will have no data to speak of
and their defence mechanism is to widen out to ridiculous levels?
It sounds far-fetched but too much has happened in this
world over the past couple of years for me to dismiss it entirely. If the
principal sources of data go missing, do the firms pull out or go extremely
wide? Either way trouble will result.
Thankfully I am optimistic that the industry can weed out
the worst offenders by taking up one of the seemingly many execution quality
analytics tools being rolled out.
It may take a bit of naming and shaming, which will not be
to everyone’s taste, but quite honestly I don’t care, and nor should anyone
It is just as detrimental to markets to quote these
ridiculous spreads as it is to pull out of market making the minute things get
tricky, so if certain participants are undermining the market structure with
their structure and behaviour, then why shouldn’t people know? Especially if it
can be empirically shown by one of these execution quality tools that they are
behaving is such a fashion?
Customers can vote with their business, but sadly this
doesn’t stop the aforementioned marketing blitz by a participant that will suck
in other, newer clients. Only by actually highlighting this poor behaviour can
we truly eradicate it.