I have been quite vocal in recent weeks about the need for responsibility in financial markets generally and in particular have expressed the opinion (which has not gone down that well I will confess) that unless there are specific circumstances, for example, a bilateral trade on a private venue where both parties agree it was wrong, we should never consider re-papering trades. It is now time to take a different perspective on this, although I hasten to add I have not changed my mind – “always certain”!
My position remains that by allowing a mass re-papering of trades, such as happened in the SNB event and, to a lesser degree, the sterling flash crash, we are effectively rewarding poor operational practice. As always, however, there are complexities around the issue that my rather straightforward approach need to take into account – specifically spreads.
It is impossible to know if this is true, however it has enough authenticity to share, but I was told by one trading source that they hit a “silly bid” during the SNB event but did so because the market changed, and widened out. Effectively, my source told me, they tried to hit a bid at 0.70 (which still would have been re-papered of course, much to my chagrin) but in the millisecond they (manually) clicked to trade the market price on the platform concerned went from 0.70-0.80 to 0.30-0.80.
I have some sympathy for this situation, especially one where panic has set in and the market is still just about at what might (very) loosely be termed rational levels – although I have to point out of course that EUR/CHF hasn’t traded under parity since that day. For the manual trader operating on platforms in fast markets it is clearly difficult, but this was a relatively isolated instance, I think most manual traders were on the bid during both events and making some very nice money (less money than it should have been thanks to the trades being re-papered).
That latter is actually a factor that I believe is under-appreciated – traders are expected to hit P&L targets and by repapering a EUR 1 million trade from 0.70 to 0.85 costs them CHF 150,000 and several traders I spoke to in the aftermath of the event had a lot more than one million on. By re-papering you are also inhibiting a trader’s ability to hit their target – and this is something, sadly, that they have become more used to in the intervening period.
To the main point of this column, though and that is spreads during flash events. I have written before that after the sterling event someone showed me a screen grab where a reputable firm was showing 0.70-1.30 in Cable. To give this context, the spread was wider than the entire range for that pair during the last eight or nine years – a period that included Brexit.
I find this reprehensible and the cynic in me sees it as an LP pushing unrealistic prices to the market in order they can trumpet after the event “we stayed in and priced the market throughout”. If that is the case there is a simple response to such a statement – no you didn’t. You threw out totally unrealistic prices knowing that you would only be hit in error and would probably have to re-paper the trades. This is equally poor operational practice in my mind because it is not showing reasonable prices, it is an abdication of responsibility to clients and the broader market to help them in times of strife.
I am not, I want to stress, arguing that we should insist on market makers being limited to 50 point spreads or something like that – although I would note that generally in the voice days when there was an event like this (yes it was slower but the markets moved just as far) most people managed to quote 100 points wide. Perhaps we need some guidelines around what responsible, and therefore acceptable spreads are, maybe the maximum spread as a percentage of the previous minute’s range? I am sure there is something that can be worked out and it should be because just as it galls me that someone is stupid enough to either hit, or have an algo that hits, 0.30 in EUR/CHF, so too does the thought that someone could make a bundle of money on a spread larger than the pair’s historical range.
I keep on hearing in the wake of the latest market event in January that the important thing for the e-FX business is “adult supervision” as one banker put it recently. This should be extended to return the FX market to what it was previously, a “consenting adults” market. If you have an out of control algos hitting prices at silly levels, or make a wrong price, wear the consequences – if nothing else it will trigger a much-needed tightening in operational risk controls.
Just as equally, however, market makers should be just that – they should price reasonably to the conditions, not to the laws of Toytown (and I think Noddy would probably price tighter than some of the examples I have heard!)
This is probably something for the Global FX Committee to discuss and if it does get to the agenda then hopefully rational sensible discussion will lead to some sort of guidance around what is unacceptable. I understand there remains a fear factor in FX markets around conduct and behaviour, therefore it needs senior officials to lead the way by making the statement that it’s OK to lose money occasionally.
Things do go wrong in markets and when they do customers – the people that are apparently at the centre of everything we do – need help. I would argue by pricing in a cowardly (and I use that word advisedly) and irresponsible way, some market makers are showing themselves for what they are – firms who see their customers as a source of easy revenue and nothing else.