My colleague Galen Stops and I were recording some material
for our podcast series “In the FICC of It” late last week and during this hour
or so we made the observation that one of the buzz phrases that seems to be
used more and more in the industry (and that we dislike intensely) is “unique
liquidity”.

The temptation whenever a buzz word or phrase gets over-used
is to dismiss it as yet another ruse thought up by marketing people to sell the
same service – as I have noted before, I have the odd issue with firms
following their clients (which would destroy their business in a matter of
months) rather than leading them, I also tend to be a little sceptical of the
“client-centric” organisation that makes billions of dollars in profits every
year.

So am I sceptical of “unique liquidity”? You betcha!

This is not to say it doesn’t exist – one of the big
differentiators of the FX market is that is does
have flow that is unique to a currency pair, and only in the market on specific
occasions, rather than being ubiquitous. Every time a corporate hedges
exposures with a market participant it is introducing new flow to the market
and it can, therefore, in those seconds or minutes it takes to execute the
risk, be seen as “unique liquidity”. The same goes, obviously, to any
transaction executed for hedging purposes – the customer is not going to buy or
sell the position back – but I feel this is “unique flow” rather than “unique
liquidity.

It would be helpful to clear up a few semantics over what is
“unique liquidity” exactly. I have to say I don’t believe that someone
executing over an RFS is actually supplying liquidity to that platform. The
“request for” element kind of gives it away for what they are actually doing is
offering to trade with a limited number of counterparties on that venue – the
wider market doesn’t know of, or see, the flow, especially if 70% of it is
internalised.

My aforementioned scepticism is very much driven by so many
people talking about “unique liquidity” who are not referring to the above
example. Rather they are – and I accept this is a little direct – deluding
themselves and trying to dupe us by claiming their market makers stream only to
them.

Let’s be frank – the single-most significant change in the
FX market structure over the past 15 years has been fragmentation and greater
inter-connectivity of trading venues.

The advent of the non-bank market maker to FX markets has
driven a sea change in how liquidity is distributed and how risk is managed –
initially the swing was towards the high-speed, short duration, non-bank model,
this has recently been arrested to a degree as some of these firms start to
hold risk for slightly longer durations.

They still make markets across dozens of venues, however,
as, of course, do their banking competitors and I have to confess I struggle to
see how several of these non-bank (and bank, especially those that have
outsourced their pricing and risk management) strategies can survive if they
were pricing to just one venue.

It simply doesn’t happen – even those that hold risk are
doing so for internalisation purposes and if you are going to be an
internaliser you need to have pricing out to multiple venues.

In other words, there is nothing unique about this
liquidity.

I met up with someone at one of the platforms this weekend
and had just this discussion. And I know it will come as a surprise to those of
you who know me, when my friend insisted that their platform had “unique
liquidity” I did become a little belligerent! And, I am happy to report, I won
the day and extracted an admission that there was not a single unique market
maker on the platform.

This is actually the case across so many venues it’s not
funny. That regional European bank you may have making you zloty and forint?
Yep, they’re making prices to at least one other venue as well – indeed I am so
confident in my assertion I would go as far as to say the only way a platform
gets unique liquidity is it if is the only venue supporting a particular
currency pair.

Where it is perhaps acceptable to use the phrase “unique
liquidity” is where traditional hedgers and alpha chasers are actually making
markets, but even there I believe there has to be a caveat. If the bid or offer
is in place to execute a hedging transaction or to get into or out of an
existing position then it is likely to be unique (I’ll overlook the fact that
several alpha chasers put take profit orders in the market across two or more
venues – I’m feeling generous!)

If, as I noted earlier, they are requesting quotes or
streams – that is not liquidity provision.

In sum then, I believe it is reason behind the trade that
can mean the liquidity is “unique” on occasions, but rarely – if ever – is the
market participant itself.

After all, another major change in the market structure over
the past 10 years or so has been that most two way pricing is generated not
from customer interest as it used to be, but rather it is from data. Outside of
some of the regional banks that are not big internalisers, just about every
price placed in the market (and I accept this is largely due to the new
demographic of market maker) is derived from a data set of pricing on other
venues, not a proprietary order book.

I also think there should be a sense of realism over the
value of some of this “liquidity” coming from the alpha chasers, because a lot
of it is retail and in smaller amounts. It may technically be “unique” but
there are few major institutional clients that would want to execute against it
– last time I checked hitting “unique liquidity” that amounts to maybe one
million units when you have more than 100 million to do (or even 10 million)
wasn’t a sensible way of executing.

It would be an interesting exercise to have those platforms
claiming the “unique liquidity” to quantify it. How many participants that
place bids and offers on their platform are only connected to them? What
proportion of the venue’s volume do these participants generate? What is the
average size of their “unique” order flow?

I suspect the answer to those questions will either; a) not
be forthcoming; or b) show the phrase up for what it is – yet another
ridiculously generic slogan.

Actually, given where I am sitting writing this (I’ll give
you a clue there is a cacophony of car horns and sirens outside – no wonder
this city “never sleeps”), perhaps I should label the phrase “unique liquidity”
for what it is – an alternative fact.

Colin_lambert@profit-loss.com

Twitter @lamboPnL

Twitter @Profit_and_Loss

Colin Lambert

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