OTC versus the exchange. It’s a debate in foreign exchange that is almost as old as this oldest of markets. You’ve read the arguments and listened to the debates where the argument is driven by people passionate about their preferred mechanism, and still you can’t make up your mind who makes the most sense.

So what should be the important drivers of this debate? What should our end goals be? Profit & Loss’s deputy editor Galen Stops may have found the answer…in Cuba.

off the plane in Cuba the first thing that tourists need to do, obviously, is
exchange their fiat money into Cuban pesos. So upon arrival in Havana I dutifully
took my place at the back of a long queue of foreigners waiting to trade their
money at the official currency exchange booth at the airport.

Cuba actually has a dual currency, with both the Cuban peso (CUP) and the Cuban
convertible peso (CUC) functioning as legal tender. Essentially, CUP is the
currency for locals while CUC is the currency for tourists, the latter being
pegged to US dollar and being worth 25 times more than the former.

I had
previously been warned that euros or British pounds would get a more favourable
exchange rate than US dollars, but I only had dollars with me and therefore –
with the 3% fee at currency exchange booth – I could expect 0.97 CUC for every
$1 in my possession.

English I enjoy a good long orderly queue as much as anyone, but the pace at
which this line was inching forward was truly pitiful.

“Usually they have four
people working in the currency booth, but today they have only two,” was what I
understood in half-Spanish, half-English from the man in front of me, who was
clearly a local. 
He added:
“Cuba is not capitalist, this is what happens in a communist country, you have
this” – he indicated the line – “and two people leave to go home. In capitalist
country you would have four people there, all the time.”

As someone
who grew up in London and lives in New York and has therefore spent what is
probably a not insignificant chunk of my life queuing, I thought that this was
probably a somewhat optimistic view of capitalism, but I had neither the
inclination or the Spanish vocabulary to dispute his assertion.

However, my
queue companion, let’s call him Robert, continued to talk and he gave me the
lay of the land vis-à-vis currency trading in Cuba.

Once you
land in Cuba, I discovered, you essentially have three options.

One, you
can wait in line at the official currency exchange booth. Two, you can go
upstairs to the information booths and they often have currency they can trade
there, but often they can only do USD/CUC. And three, you can trade with people
in the city of Havana where, Robert assured me, you could get a better price.

And, would
you believe it, my new friend just happened to run such an operation.

basically, I could trade on a “lit” exchange, with the advantage that I could
physically see the agreed upon price before execution. In addition, the
transaction is standardised; I have an audit of sorts in form of a receipt and
I feel less likely to get ripped off trading in such a public forum that (in
theory) has clear rules that apply to it.

upstairs was the same deal in terms of price, but what I improve in latency
(not having to queue) I lose in terms of auditability (no receipt) and it
certainly feels less subject to the rules of the lit exchange.

The third
option improves my price, but I don’t know Robert well and therefore have counterparty
risk, because he could try to rip me off; and potentially settlement risk if we
think that we have agreed on a price only to find out when it is time to
exchange funds that there has been a miscommunication of sorts.

At this
stage, option one felt like my best bet as it felt like the safest option. But
as the queue slowly, slowly, slowly progressed I continued talking to my new
would-be counterparty.

If he could
trade upstairs quicker, why was he waiting in line with the foreigners?

It turns
out Robert was picking up two clients who were staying at his casa who only had
euros, which he didn’t have at his home. And sure enough two young students,
from South Korea and Singapore originally but studying in Connecticut, appeared
shortly thereafter to say that they were out of euros at the upstairs tourist

So what
sort of price was Robert offering?

He said
0.90 CUC per $1, which of course prompted me to point out that this was, in
fact, worse than the rate being offered at the official exchange booth.

responded by pointing out that there is a 10% tax on all USD transactions, so
that the real rate being offered by the currency booth was in fact 0.87 per $1.
Sure enough, as I got close enough to see the prices at the exchange booth I
noticed the small print at the bottom of the board indicating this 10% tax on
USD transactions.

At this
point I was developing a rapport with Robert but was still on the fence with
regards to trading with him. He continued talking and I discovered that he
lived in the same area where I was staying and he said that if I wanted I could
get a (paid for) ride into town with his clients, change the money within two
minutes at his casa and then be dropped off at the one I was staying at.

I’d been
previously informed by the person hosting me in Havana that I should pay 25CUC
to get a taxi from the airport to where I was staying, and told to be careful
as the taxi drivers would often take me the long route and ask for more money
or try to take me to their friends’ casa instead.

Seeing that
Robert was going in the same direction as me, I offered to pay him 20 CUC for
the ride and said that I’d do my FX transaction with him at USD/CUC 0.90. Done.

So we
hopped in his 42-year-old Lada, rattled down the highway, dropped the students
off, traded our currency, and proceeded to the casa that I was staying at.

this back to the FX market that we know once more, why did I decide to do an
OTC transaction rather than going to the exchange? After all, I was almost at
the front of the queue by the time this was agreed, and I still had to wait for
the students to trade anyway.

because I’m a journalist and so I’m very price sensitive. I was only trading
USD300 and therefore only saving 9 CUC at the new price. But, 9 CUC in Cuba can
get you six beers in Havana, which is not to be sniffed at. Plus, who doesn’t
like a deal?

And in
addition, I’d developed a good relationship with Robert, I had reached a stage
where I was comfortable with him as a counterparty and would rather give him my
business than someone who would punitively charge me 10% for my FX trade.

Also, I
saved myself haggling with a taxi driver in a foreign language, got a cheaper
price on my transport than I could expect otherwise (another three-and-a-half
beers), and thus developed a slightly more holistic relationship with Robert
that was broader than just an FX trading. And the speed became a negligible
issue because what was two more minutes after I’d already waited an hour in
this queue?

relationship, ease of transaction and speed. The drivers at the retail level
for me trading in FX in Cuba were some of the same (but obviously not all) of
the factors that also determine where firms trade at the wholesale level. It
also provides an example of why some people opt for trading OTC over lit
exchanges, but also why the reverse might be true. Had the pricing on the
exchange been better I would have traded there, because of the perceived added
security. Had the line been quicker I wouldn’t have had time to build a
relationship with Robert.

Of course,
the parallels don’t work entirely. For example, the OTC market in this instance
only offered a product that was widely traded, USD/CUC, and where there were
plenty of pockets of liquidity, whereas the lit exchange could provide
liquidity in more exotic currencies. And the rule book and legal standing of a
lit exchange in wholesale markets is very different to trading at a Cuban
currency exchange, as is swapping currency outside some guy’s house versus
trading with a counterparty that has signed an ISDA and other legal documents.

But still,
nine and a half beers………




Colin Lambert

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