Confirmation, to me at least, that we need to talk about market participants in more nuanced terms comes in the form of recent news and that perennial source of good gossip – the rumour mill.
I have banged on enough about the need to get away from the “bank/non-bank” divide because quite frankly it doesn’t exist anymore. I have also argued before about re-thinking how we bucket providers in this business and I strongly believe that the greater transparency that will come with better explanations of risk management policies will drive such a change.
Put simply, while I don’t think we should have a ‘bank’ and ‘non-bank’ bracket, we should be more nuanced about how we look at players in both segments and then bucket those firms together.
So, looking just at the non-bank space, I believe some players act like regional or second tier banks – they are in FX when they want to be and where they want to be, they cherry pick to a degree. Admittedly, when it comes to the banks they have local customers they need to service in FX, but they often choose to back-to-back one side of the trade out immediately. Equally, some smaller or single product non-bank firms have venues on which they make a good return thanks mainly to last look and a risk management policy that operates in the millseconds.
Conversely, at the larger end of town, we have some non-bank firms acting like banks by quoting across a much broader set of asset classes, and not only using correlations to actively hedge out of risk, but to internalise flow as well. Again, the capital structure of the firm – whether it is a bank or not is irrelevant – more it is about their risk appetite. Of course the non-bank firms are held to different standards than the banks when it comes to things such as capital adequacy, but my point still holds up I believe.
So the fact that Lucid has closed its doors, at the same time that firms like Citadel Securities and XTX Markets thrive is pertinent – even though Lucid was still making good money. It’s model worked in FX but I feel that success in this space – which is driven by scale – comes with having more strings to one’s bow because FX margins are thin and costs can mount up.
So to me, we need to better delineate practitioners – no player is going to give up too many details of their risk management policies, but the execution analysis tools available can provide ammunition for clients to root out the churn and burn brigade – if indeed that’s what they want to do (if they don’t, of course, then I think people have to ask tricky questions about the firm’s motivation in being in markets in the first place).
My barometer for the level of commitment to the FX market tends to be whether a firm quotes those awkward ‘customers’ – we all know them – the ones that have the nasty habit of getting the market right and being clever with their execution! A relationship with these firms signifies a true liquidity provider/market maker/risk warehouse is committed because they are not, as many firms are nowadays, cherry picking the business. Likewise a firm that loses money two or three days a year is not really holding risk as their main business model – they are nicking points here and there.
The last week has seen rumours of a potential buyer of a market making firm, XTX, however the firm itself is adamant no such deal is in the pipeline. To me though, true or not, the very fact the rumour is out there and people believe it, at the same time as another firm shuts its doors, indicates to me that their stories are very different. The problem is, to too many people in the industry, they are one and the same.