It’s fairly obvious that, to use a buzzword of the moment,
the FX market has operated asymmetrically for most of its history – banks have
held sway and, until the advent of the non-bank high frequency market maker,
had little competition. It took that challenge, allied to a few conduct issues,
to redress the imbalance, but I am wondering if the pendulum – as happens so
often in this business – is swinging too far the other way? And if it is
swinging, what is driving it?

Regular readers will know I have long argued that foreign exchange
should be a “buyer beware” market, it’s one of the reasons I don’t like Last
Look. If you don’t want to buy or sell at a particular rate, why make, or hit,
that price? FX should be for “consenting adults”, you deal for whatever reason
you have and no matter what happens you accept the consequences.

Obviously when there was clear misconduct around the chat
rooms and use of last look something needed to be done, but last week I heard
that another bank – Goldman Sachs – has joined the growing list of institutions
providing automatic (you have to explicitly sign up before it goes into action)
price improvement in certain circumstances.

According to a document shown to me last week, the bank is
establishing thresholds for last look under which the rejection rules will
remain the same when the market moves against the bank, but will change if the
market moves in its favour. Counterparties via its bilateral API or over those
third party platforms that support price improvement, will receive a portion of
the price improvement equal to
the amount by which Goldman’s most recent internal price has moved in the
bank’s favour beyond its Symmetric Tolerance Band.

It’s hard
to escape the conclusion that, as has been the case with other banks who follow
the same path, this is another example of good client service and how the banks
have upped their game from the dark days of 2013-14.

Is it
necessary, however?

To go back
to my “consenting adults” theme, if the client didn’t want to buy or sell at
the rate why did they hit it? So their timing was a little off – do they care?
Should the market maker care?

It’s a
natural reaction on the part of the banks to the trauma of the past few years
that they want to do good things for customers but it does worry me a little if
they go too far.

Part of the
liquidity issue in foreign exchange markets at the moment is a reduction in the
number of true risk warehousers and those numbers are dwindling in part because
some institutions don’t believe they can make sufficient money from the

While I
fully accept that there was some bad behaviour from some participants that
meant clients were economically hit – and that this behaviour should be stamped
out and people punished – we should not forget that everyone has to earn a
decent living. Market making, liquidity provision, whatever you want to call
it, is not easy, it costs money, and is not/should not be, given away for free.

A fact of
market life is sometimes your execution is timely and good, and sometimes it is
sub-optimal. However, unless you can see into the future (in which case you
should be on your private Pacific island you bought with you profits from the
last 10 years) there is no guarantee that every time you hit the market it will
go your way.

This being
the case, why are banks effectively rewarding clients whose timing is slightly

understand this is just another way for me to write about how I don’t like Last
Look but I think there are deeper issues at play here – the events in Cable 10
days ago highlight the potential damage to the market from having too few
liquidity providers (and recyclers don’t count!) and part of that issue is the
squeeze on margins and then revenues.

There are
two aspects to this that interest me beyond whether we are being too kind to counterparties.
Firstly, in this highly litigious world, is there a risk that shareholders
bring an action against a bank for implementing a practice that explicitly
hurts the bottom line?

I would
like to think this was impossible but too many previously unthinkable things
have been happening in recent years!

as was suggested to me in conversation last week – is the price improvement
mechanism the banking industry’s answer to the challenge of the non-bank

Again, I am
unsure, although it was suggested to me that banks have more money to play with
and as such they can afford to give away a pip here or there to customers,
whereas several non-bank market makers still operate on razor thin margins and
the thought of giving something back is anathema – especially as they don’t
have specific client bases.

I find the
subject of price improvement a conflicting issue. I fully understand why some
institutions will want to do their best for certain clients, but in this day
and age treating clients differently is a no-no. Therefore they have to do it
for all counterparties and that must, surely, hit the bottom line.

I also
believe, however, that people need to be responsible for their actions. To my
mind the only time price improvement should be used is when the institution is
acting as an agent, i.e. executing a market (as opposed to limit) order. If
they receive an instruction to deal and the market moves in their favour by all
means improve because what you are showing there is your skill and window on the
market, which led to you improving the fill. That is radically different to
improving because of the vagaries of the market over a very short time horizon.

I can’t
help but feel that the foreign exchange industry would be better off if it
acted towards customers like good parents do with their children and their
homework. Be fair and help steer them in the right direction, but don’t do it
for them! Everyone has to learn responsibility at some stage.



Colin Lambert

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