Nearly all liquidity is, to a degree, recycled, and always has been – a market cannot start without someone either posting interest or (often metaphorically) stating, “this is my price”. I get that, and my frequent and overwhelmingly negative comments on this recycling aspect of the FX market do take that into account – but this week I came across a release that highlighted the problem to me – one that highlights how the marketing is loose and retail clients are being dressed up as “institutional” to either make the firm look good or slide round regulations.
I have to be careful obviously so no names, but the release this week touted a partnership between two firms, one of which was becoming “a major liquidity provider” to the other’s “institutional clients”. The latest “LP” was joining “multiple” other LPs on the firm’s ecosystem, the other six “LPs” included two firms I had never heard of but upon further investigation turned out to be the same as the other four I had – prime-of-primes (PoPs).
I have absolutely no problem with the PoP model, credit is difficult for smaller funds to access sometimes and the model helps diffuse risk across the system – and yes, it could be argued that all we are talking about is another level of prime. That’s all well and good, but is a PoP a liquidity provider? Let me answer that one for you – absolutely not, and if it is, then it shouldn’t be. In the release itself the PoP highlights how it does not take market risk, so one firm is telling it the way it is – they’re a broker – while the other is drumming them up to be a rival to JP Morgan or XTX Markets.
I had a look at the firm proclaiming these “major LPs” and it has offices in Singapore, India, Dubai and, of course, Cyprus, home to many firms that like to proclaim their abilities as an LP but which are nothing of the kind. As an example, one “LP” website states on its homepage, “Bringing institutional trading benefits to the individual.” I don’t know about you, but last time I checked, “individual’ was a long way from institutional.
Another offers an “academy” to help traders learn to trade – again, you may wish to differ but I am not sure my definition of “institutional FX trader” includes the need for them to learn how to trade (although I do accept some buy side managers could be better at executing, but don’t get me started on the fix!).
What this release tells me is the story of a firm that is recycling the recyclers – many of which are just retail brokers and not an LP in any shape or form. Again, I need to stress the PoP model, in the right hands, serves an important credit function and in those cases the recycling is justified, although I do have a problem with those firms touting “unique” liquidity, for the only way their liquidity can be “unique” is if they are making prices themselves, which means taking risk, which means, in many parts of the world, breaking the rules.
It could, of course, also, as we have regrettably seen previously, mean there could be a link between a PoP and a market maker that gives the latter an unfair advantage – I fail to see any other way a firm can offer “unique” liquidity when its LPs are the same as most of their peers.
Likewise, what the firm at the end of this particular chain is doing is taking those septuplicated streams and then multiplying them by six. The end price is so far away from the original source it might as well be on the moon – can the LPs really know where their price is going and how it is being used? Should they care? Actually I think they should because in a world in which liquidity is more accurately valued, those original prices are the IP and the value of that IP is rising.
Of course, I didn’t write this just out of irritation at a PR firm overloading the hyperbole truck yet again (it was highly irritating to someone, like all you, who has been locked up for weeks, however), and I should stress there is no inference that anything is being done wrong here. It’s just the whole model and the marketing around it is muddying the waters and making it harder to pick out problems elsewhere. There are broader risks in this market model, not least the blurring of lines between retail and institutional and the smokescreen it can create for other firms to behave badly.
The end firm here is touting its “institutional FX business”, but while the two of the “LPs” (which appropriately and transparently stress they do not take market risk) servicing it have signed a Statement of Commitment to the FX Global Code, the other four do not appear to have done so. So here we have our own little “cluster” of firms that have formed the best part of a liquidity pool for “institutional” clients, that are using bank and major non-bank liquidity, but have made next to no commitment to follow the rest of the institutional market in signing up to a Code of best practice.
My concern is – and again I stress there is no suggestion of any wrongdoing in this particular liquidity pool – that this provides a back door in for firms to trade in the FX market and behave badly. We have seen instances of this before and the broader FX industry has, to an extent, been able to wash its hands of it because it happened in retail. It is difficult to sustain that line when more mechanisms such as I have described here are popping up (no pun intended).
In many ways this is the latest iteration of an old problem – how exactly do we define “institutional”? That line will always be pushed, especially in a leveraged world in which retail is highly regulated, but I do think we can do something about the use of the phrase “liquidity provider”. It would be nice if the major PoPs agreed to refuse to be party to a release, or a website – any promotional material in reality – that describes them as “liquidity providers”. At least then we would clear the air a little of the smokescreen. A liquidity provider should be a firm that provides a price with the intention of taking risk – and I don’t mean for as long as the onward connection to the real LP takes to execute the back-to-back trade.
I also think this type of problem is what happens when the industry condones last look in too generic terms. As much as I don’t like last look it should be operated in one of two places – the LPs themselves or the next connection down the chain. I suspect in the case illustrated here, there is last look in both those places and at the next level down. All this means is when the poor sap trying to trade at the bottom of the chain really needs to get the deal done, there is even less chance of it happening.
So it would be a good start if, following the current upheaval – which has also seen some major LPs found wanting – the FX industry could settle on a definition for LP, be able to define who exactly meets it, and find some way of identifying the recyclers better. It’s not hugely important in the big scheme of things, but it is about transparency and when it comes to the retail/institutional divide and the title “liquidity provider” I think the FX industry falls some way short of the desired standards.
And having purged myself of that, let me end on a completely different, and upbeat note. There is no need to reiterate the scale of the crisis facing the world, nor the efforts made by front line health workers. To celebrate its 10thanniversary in 2009 Profit & Loss established an FX Hall of Fame and its ranks have been swollen by so many people who have done great things in our industry.
The Hall of Fame celebrates those at the top of the business, who drive the creation of big business initiatives, as well as those “grunts” in the trenches, who do so much of the work and provide the glue that keeps our industry together. In that spirit I wanted to highlight two gestures made (there are others and I apologise for not naming them or knowing about their activities) made involving two of our Hall of Famers.
We published a story a couple of weeks ago about XTX Markets donating £20 million to charities fighting Covid-19 and I would like to congratulate everyone involved at that firm in the initiative, including co-CEO and FX Hall of Famer Zar Amrolia.
Equally, on a smaller, individual, but just as important scale, I want to congratulate Jack Linker of 360T, for the gesture of buying pizzas for front line medical staff at his local hospital. We take a lot into account when deciding on Hall of Fame nominees and character is one aspect. Here are two examples – many, many more exist in our industry I am sure – that warm the heart and make us proud of our colleagues in the FX world. Good on you gentlemen (and all others who go where you tread), we should all be proud of you – I know I am.