As I am making predictions this week, and for once it seems to have gone OK (still time, I know), let’s maintain the momentum. When the world comes out of this crisis, financial markets will look different, but very familiar to some.
I was talking to a friend who runs a fintech business in our space the other day and while they weren’t gloomy as such, they did see their world on hold, mainly because the decision making process at their customers – mostly banks – is solely focused on business continuity, not on developing new ideas or business lines. “I feel confident in my financial position for various reasons,” my friend observed. “But I don’t think many in the small business game can say the same.”
There is little doubt that the crisis management in place at most fintech customer firms does not include increased investment in anything other than existing, critical business segments and is more about survival than it is expansion. It will not stay that way forever, of course, and some governments seem more eager to help businesses than others, which means geographical location may be more important to a firm’s survival than its business model.
I find the online debate – is there any other these days? – about the shadow banking organisations interesting, these firms undoubtedly have the technology infrastructure to work on a dispersed basis, but as most crises show, cash is king – even the best business models can go under without it. Withstanding a financial shock is what picks the winners from the losers and as such one has to think that the capital requirements imposed on the banks – to much criticism from certain circles (me included on occasion) – will enable those institutions to cope better.
I suspect the same will happen in FX markets and we will see several firms that have built their model on liquidity recycling simply disappear. I am already being told by countless liquidity consumers that the liquidity providers that have stood up in this crisis, can be counted on one hand. I should stress that it is not the same four or five – relationships are helping a lot – but it is clear that the overall number is less than 10. Equally, it needs to be highlighted that the spreads being quoted are like nothing many customers would have seen on a sustainable basis unless they have been in the business more than a decade, and I should add the odd currency or regional specialist to this of course. Whichever way you look at it, however, this crisis is highlighting those firms willing and able to stay in tough markets for their customers, and those that either cannot or will not. No longer will firms be able to get away, I hope, with the moniker “liquidity provider” unless they genuinely are.
The key to whether I am right or wrong will be those consumers’ memories – do they stick with those firms that looked after them when the smelly stuff was flying about, or do they re-introduce providers that didn’t? If it is the latter then I for one would not blame the LPs for abandoning them to their fate – for such a decision would underline the hypocrisy of certain clients who believe the “relationship” only exists one way.
My sense is that many customers are appreciating the service they are getting, they also are gaining a better understanding of what real internalisation means and the benefits it provides when using an algo strategy. If I am right then a return to “normal” will not see the liquidity recyclers regain a footing in the market, the customer will not go to them direct and the major LPs will look closely at the real value delivered by the channel.
This will also provide a challenge for some multi-dealer platforms who are stacked with such customers – I also wonder if the emergence of a group of 10 stand out LPs will mean that those institutions become the quasi-exchange for customers? After all, what is an internalisation pool if it is not a private exchange in some shape or form?
I should stress that what I am writing about is not the start of a new paradigm – these changes were already underway in some shape or form. What I think will happen is that the move to trim the number of connections on the part of LPs will be accelerated by this crisis, just as the value of a robust, reasonably priced, liquidity stream will soar – and be recognised.
As it is in everyday life, my sense is that fundamental changes in how we operate in the FX market will emerge during this crisis – and I don’t think many of them will be reversed. A more realistic liquidity landscape could be one facet of it, however, and that model will look familiar to many of certain generation.