I had an interesting conversation with someone this week about competition in FX markets, specifically how in May, pricing in spot markets on aggregators and multi-dealer platforms become much more competitive. In many circles this is seen as liquidity “normalising” meaning spreads inevitably come in, but I think it also shows something else – the return of the liquidity recyclers.
My conversant noted that a lot of the most competitive pricing came from sources that had disappeared in March and were only sporadically on the radar during April – and that this indicated that clients had reverted to type and forgotten who stood by them during the most turbulent times. Without doubt, in this age of entitlement, some clients will conveniently ignore those providers who saw them through the worst (hopefully) of the crisis in favour of a recycler with a slightly tighter price and, probably, greater market impact.
As more data and analytical tools become available, however, my sense is that other clients are willing to – within reason – stick with those who stood up in March. Of course, the pricing can’t be significantly worse, but there seems to be an understanding, finally I might add, that some LPs are simply better than others, and that the criteria for making this judgement is about a lot more than being top of book in one million or less.
I was talking to someone else this week, who was, to put it politely, in an agitated state, something that apparently happens when you try to use your aggregator to buy EUR/USD in a spike and get rejected around 30% of the time. I should add, this second conversant is in no way seen as a predatory trader, if they were the weaker LPs would probably have nothing to do with them, but this didn’t stop them struggling to get the euros in when they most needed them.
And that, in a nutshell, is what I think the criteria for being a good LP should be judged on – how well does an LP perform when you are trying to trade “with the wind” or in tough market conditions? Anyone can provide a great bid in a rising market, but does that make them a quality LP? It shouldn’t.
It does bother me that some clients have such short-term memories, because the same participants will bang on until they are blue in the face about the value of relationships, but they don’t feel the need to practice what they preach. If an LP stands in during the really rough times, why diminish their role during the good? Of course, this would not be a problem if the very small group of LPs did more to manage where their price went (some do I have to stress) and how it is used. More pertinently it would be helpful if they actually played a long game and actually stopped pricing the client so aggressively – effectively turn the tables on the recyclers by making them top of book for the client and ensuring that the genuine LP only gets hit at a time and a level, that suits them.
Previously there has been a lot of emotion around the relationship and what the client and LP was doing, but better data and analytics does allow us to have more rational discussions and I think an LP has a perfect right to ask a client why they are suddenly allowing fair-weather LPs into the pool? That client has the right to do what it wants of course, but would maybe consider matters more circumspectly if they thought the backbone of their liquidity pool was going to be weakened?
My second conversant in this tale tells me they have learned a lesson and will refocus their business on a smaller group of LPs once again, and I suspect that as we see more of these 30-50 point blips in the market, the weaker LPs will be found out and, having “previous” for disappearing, will be shown the door permanently.
The fear as far as the first conversant is concerned is equally genuine, however – what happens if volatility returns to the historic lows seen 18 months ago? One would hope that this would not matter but it undoubtedly will and in that instance I think there is nothing for it but for the LP to adjust its horizons and expectations and consider cutting the client tale.
There is, I sense, a relatively new found and growing respect for genuine liquidity in FX markets. It would be a real shame if that was reversed thanks to a bunch of LPs hiding behind last look and/or their ability to cherry pick the flow. The clients need to wake up even more to how their LPs are treating them and while some undoubtedly are, there is, equally undoubtedly, a long way to go.