There is a paradox in the FX industry that is highlighted in the top two stories in Squawkbox this week – on one hand we have an initiative aimed at making the market a better, fairer and more transparent place and on the other we have direct evidence of poor practice.
The industry needs to be wary, not least after last week’s report on the WMR fixing, because the knives are out, therefore it is a good time for EBS to propose best practices for aggregation.
Aggregation has been one of the bigger trends of the past decade, a trend that has accelerated over the past two or three years as best execution has grown in importance, but as always with growth and success comes the shadier side – in this case in the form of stories (none proved I should stress) of some aggregation venues taking the “inverse spread” for themselves, directing trades to preferred liquidity providers or adjusting VWAP or TWAP executions to capture price improvements.
I normally try to avoid praising firms too highly in this column, it’s bad for the reputation(!), but in this case I think EBS deserves the highest praise for highlighting a growing issue and trying to do something about it. And the key there is “doing something about it”. That, in a nutshell, is the definition of industry leadership that EBS once had, and aspires to reclaim.
Of course, this being me, there have to be a couple of nagging doubts, and in this case, as inferred by EBS CEO Gil Mandelzis in our top story, my main concern is whether they go far enough? The idea of having aggregation providers sign up to best practices is sound and should be supported by everyone with the industry’s best interests at heart, but should we not take this further?
Specifically, what about the prime brokers that provide central counterparty services to some aggregation venues? They have a responsibility beyond just earning brokerage – or at least they should do if they truly have the end users’ interests at heart. It should not be that much of a problem, because these CCPs already adhere to best practices, they will merely be helping to enforce these best practices further down the chain.
I also think the retail FX industry could do with best practices similar to these, after all aggregation is a big thing in the retail sector, but accusations of blurred lines between agency and principal trading are legion.
The fact is though, this type of initiative has to start somewhere and EBS has planted its flag in the institutional ground and should be congratulated for doing so. From here, it would be nice to hear of legions of aggregation providers agreeing to the practices and, perhaps more pertinently, of other liquidity providers or facilitators agreeing to enforce them. After all, if 10 specific banks and three or four key venues insisted that aggregators adhere to these practices or they will not have access to their markets, then any instances of poor practice would soon be severely reduced.
As a digression, if that did happen of course, we would hopefully and finally have the answer to the question of the liquidity mirage. If aggregators did not sign up and were marginalised, but still had plenty of pricing, then the mirage is not as big as some think – if they withered and died, the opposite would, of course, be true.
I would like to see two things happen from here, aside from everyone signing up. Firstly, and with no disrespect to EBS at all, I think it would be good if one of the world’s FX committees took over this process. One potential hindrance to this initiative’s progress could be commercial rivalries – it shouldn’t be, but it may be. If an FX committee adopted the practices that obstacle would be overcome.
Secondly, I hope that customers of any aggregators that do not sign up start to ask some very pointed questions. EBS says it understands that some customers have spent money integrating to aggregation providers and as such it does not want to dictate to them whether they can access EBS liquidity or not (the grandfathering solution referred to in our top story). There may be good reasons for this, which hopefully will emerge in the ongoing consultation process and be accounted for, but all I can say is that at face value EBS is nicer than me!
As always I am open to explanations of why this process may not work for certain providers, but I can’t, initially at least, see anything obvious. The smart thing in the proposed practices, especially if they are adopted by a neutral body like an FX committee, is the moral pressure they apply. I would expect customers of aggregation venues to ask the question – why won’t you sign up?
After all, if there is one thing obvious from events elsewhere in the industry over the past week it is that FX needs a good news story, where it demonstrates how well it self-regulates. It is all very well for some aggregation providers to baulk at best practices, but if the result is more stringent oversight of the industry by people that don’t understand it, that in turn could lead to lower overall volumes, then they would be quick to complain.