As part of the public service duty of this column (and
especially as a warning to any stag parties thinking of going there dressed as
Robin Hood and his Merry Men), I feel the need to point out that a law exists
in York, England, that says it is legal to murder a Scotsman within the ancient
city walls, but only if said Scot is carrying a bow and arrow.

Clearly this is a law that has no basis in reality and is
backward looking – however it is only slightly
worse than MiFID2 when viewed through the prism of the FX market.

It is hard to find anyone in the industry who can say a good
word about MiFID2, several institutions are spending hand over fist to be
compliant in time (others feel more comfortable it has to be said) and it
clearly, as a regulation, does not easily fit the FX paradigm.

I suspect, however, that MiFID2 has already had one positive
impact in FX (and yes, it is likely to be to the only positive!)

As someone who has long argued that signalling risk and
market impact are viewed as irrelevant by too many on the buy side, it is
pleasing to hear more and more that this market segment is looking at the
issue.

Best execution is, I think most agree, a misnomer, because
it is a box-ticking exercise that has little or nothing to do with execution
quality – which is what we really should be monitoring. As I have noted before,
on October 7 I could have hit every price point from 1.2000 to 1.1500 in Cable
and produced a best execution report that highlighted how I hit every top of
book bid and thus fulfilled my best execution obligation. But was it a good
execution? Not if it was my business that shifted the market five big figures
it wasn’t.

By taking into account market impact we can gauge the
execution quality that much better and it strikes me that more people are
(finally) actually paying attention to this crucial element of the execution
process. I say this because more people are talking to me about the benefits of
“full – only you” execution for certain trades.

I must confess I did not expect to hear this again given the
changing market structure, but clearly a couple of years of slippage has
trained a few minds and got people thinking – which is good.

Better quality analysis, provided by banks and third
parties, has clearly helped people understand the issue a little better, with
the growing range of pre-trade TCA tools paramount in this trend. I also think
that the opening of minds to the potential of algorithmic execution is helping
– the take up is still on the slow side but there are definitely beacons of
light out there for those tasked with growing and selling a suite of algo
tools.

As more people become concerned about market impact they
inevitably look at the algos and this, along with the better analysis, allows a
much better comparison regarding projected (not guaranteed of course) execution
quality. It also helps that some larger LPs are seeing the potential benefit of
picking up this business and are showing a tighter arrival price as part of
their pre-trade TCA. Yes, they are saying, by all means use the algos (at a
price), but here is a competitive price to rid yourself of the burden immediately.

Over time I suspect more people will use the algos than
actually go “full – only you”, but in the shorter term – with event risk off
the scale (especially around 4-6am Washington DC time!) – the latter is
probably a smart option.

One of the problems with modern regulation is that it
assumes the end user has a certain degree of expertise, which is not always the
case, and it also places more of the onus for execution quality on relatively
unsophisticated players. I am not sure either was intended, but that is not a
new story when it comes to regulation. At least by looking to execute “full –
only you” these customers are recognising that and acting accordingly.

Late last year a
BIS paper saw the return of relationship trading
in FX market, and while
that paper highlighted dealers’ eagerness to retain valuable flow by pricing
tighter for that business, I suspect clients’ collective greater understanding
of market impact also played a role.

It does seem sensible for non-professional traders to hand
off the risk to professional counterparties rather than navigate the
potentially tricky world of FX liquidity and the fact that a growing number of
firms and tools are available to ensure no liberties are taken with the flow
means they should be able to do so with confidence.

So, here’s to you, MiFID2, you may be a contender for the
worst financial regulation of all time, but at least you played a role in
changing one important aspect of the FX world.

Colin_lambert@profit-loss.com

Twitter @lamboPnL

Twitter @Profit_and_Loss

Colin Lambert

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