Following on from Monday’s column about the futility of
blindly following your clients’ wishes – which I found rather soul cleansing I
have to say – it’s probably worth looking deeper at the liquidity
First up, we need to understand and accept – yes I am
talking to all you salespeople who deny it exists – that there is a natural
friction in the LP/client relationship. There always has been and it’s not just
limited to financial markets, I can’t count the number of times I have fumed
over a service provider but stuck with them.
In FX terms, it’s hard to find a dealer who is not;
the customer is not dealing full amount with them
said customer is intent on destroying his P&L
their own sales desk is in on the plan
That is the natural paranoia of the voice trader and all
that has really happened in recent years is the e-trading team have not only
inherited it, but have often got it much worse because of the fragmented nature
of orders and liquidity in the market.
But just as equally, it is hard to find a customer who is
the bank is ‘nicking a pip” on every order
the bank is “reading” them
the sales desk is in on the plan
Putting aside the sales desk’s position in this (for which,
as a former trader, I have absolutely no sympathy of course!) even in the most
transparent environment this friction will exist. Unless the market starts and
remains at a choice price for some time, one or other party will feel the other
has the upper hand.
I personally don’t see this as an issue, competitive tension
can be healthy and it does, generally speaking, keep both parties onside.
The problem is though, for some counterparties the world is
changing and this shift is likely to impact the broader market structure, part
of which I discussed on Monday.
Like it or not, the banks are going cold on all those major
hedge funds who are not their prime brokerage clients. The very nature of these
accounts having good timing in execution, as well as good market knowledge,
means that some banks – typically those head-in-the-sand merchants looking to
make money out of every single trade – have decided the business is more trouble
than it’s worth and are pulling back.
In normal circumstances the non-bank sector could be
expected to step in here as it collectively has in other areas, however these
firms too have a problem in that the business is just too toxic for them. And unlike
the banks who generally have a reasonable branch flow to sustain their FX
activities, too many non-banks (generally middle tier I would say – and isn’t
it great that we are tiering the non-banks? Anyone? Just me then?) do rely on making money out of most
trades. So they don’t want this flow either.
The bottom line for some of the smarter traders in the FX
world is that no-one really wants their business unless the PB fees cover the
cost or they happen to have a contrary interest at the time the smart trader
executes (and even then some LPs complain about “getting sniped”!)
The devil within wants to ask it if matters that we don’t
care about these alpha generators? And say that they should take their chances
with the rest of us. And if they get slippage etc., so what?
What concerns me a little is how some view other customer
segments in the same light. I had what I thought to be quite a disturbing
conversation with a couple of sales people in London recently, during which
they agreed that too many of their asset manager clients (the odd corporate was
mentioned as well) weren’t worth having because there was no money to made out
I casually mentioned the FX market’s role as a facilitator
of cross border trade and investment, as well as its obligation to help the
natural hedgers, and received a reaction that was part sympathy for my
obviously prehistoric views and part derision.
I have to confess I was a little confounded at first but it
soon became clear that some clients’ best execution policies are less than
beneficial for their liquidity providers. One noted how what was previously a
“very good” client (the definition of “very good” wasn’t made clear, so I just
jingled the change in my pocket in a symbolic show of defiance) had become much
harder because they had done some work on their execution policy and it was
more aggressive than previously was the case.
This is quite a tricky one at face value because the client
does apparently pay the institution some fees (not a lot I was told, but some)
and the sense was that “real money should not be last looked”.
I managed to stifle my urge to shout “no-one should be last
looked”, nodded sagely and agreed it was tricky, but surely the answer was to
reflect the client’s new execution policy by quoting them wider?
I am not sure what the response would have been if I had
suggested this person sell their children to me but I suspect it would not have
been too dissimilar. There is, it seems, still an unrealistic expectation on
the part of senior management at some banks for their institution to win
business and to maintain tight spreads to some customers. Sales people are
also, clearly, paid in volume credits at some institutions.
I don’t see how maintaining tight spreads is healthy,
because it not only makes it hard for the FX business to pay its bills but it
also heightens the threat of a flash move as multiple LPs seek to clear out a
large chunk of risk from one source. They know the others are getting some of
the order so want to get out of their piece as quickly as possible, thus it becomes
a race for the exit.
So in some areas it seems as though the focus on best
execution has made a lot of this mechanistic hedging business less rewarding for
I don’t think it helps that, in spite of this often being contrary
flow, which should always be valuable, too many continue to think of market
impact in terms of seconds (often milliseconds). Either way, though, it would
help if the see-saw that is the relationship in the FX market between provider
and consumer was rebalanced a little.
The friction will never go away, but by reflecting more
aggressive execution policies with slightly wider spreads, LPs – assuming they
have an open and frank conversation with their client – will be able to
maintain a good enough service.
If this is not possible, I do have some concerns over the
wider impact because without risk warehousers (risk takers even, who are
willing to hold for minutes) we will end up with an FX market where agency
rules and therefore no-one has responsibility beyond ticking a few boxes.
If we get to that stage, larger moves will become the norm
and that service that I do fundamentally believe lies at the heart of the FX
market – facilitating the real economy – will wither and die – and that isn’t a
good thing for anyone.