In the wake of the GFC and the allegations of misconduct aimed at institutions and individuals, the buzz word was ‘transparency’ – the word from market participants was that they were going to be transparent about everything, meanwhile regulators everywhere made a sustained push for absolute transparency in markets.

The thing is, in FX terms especially, it hasn’t worked – I am not convinced it has in any market actually – and market participants are showing this in where they put their business.

I should stress I am not talking about transparency of action – I vehemently believe in this concept, people need to be accountable to the results of their decisions and the FX Global Code embodies that – but rather I am talking about transparency in trading. We are still at the stage where few, if any, market participants are willing to come out and say anything remotely negative about transparency for fear that ill-informed regulators will jump on them, but the signs are there that it has been rejected as a concept.

Just look at the level of discussion around market impact. I noted at a conference late last year that a couple of years ago I couldn’t get anyone to engage on this subject – I first really raised it as an issue in the wake of the FX benchmark reforms in 2016 – but that now everyone is all over it. Why is that? Very simply because it is costing people money in terms of slippage – and a big part of that is because the orders may be too public.

Talk to anyone in the execution space today and they lead with one thing – reducing market impact. How they do that is by trying to disguise the business as best they can. Of course there is still something of a speed war going on in FX today, but the bigger battle is between those trying to keep larger tickets quiet and those trying to identify them to “extract some alpha” (read legally front run!)

There is another anecdotal indicator of the trend as well. The relevant parties don’t break down volumes across platforms but generally speaking I would estimate that the primary venues of EBS Market and Matching handle about $40-60 billion of spot business per day. Informed sources tell me that BGC’s MidFX – its dark pool offering that is limited to qualifying parties and therefore not available to the broader market – is handling very similar amounts per day (they actually put the ceiling around $50 billion).

Why, when dark pools are about as popular with regulators as a Manchester United fan in the Kop end at Liverpool, is so much business going there? Simply because it offers a venue on which to hedge reasonable large risk without market impact – it’s a better economic outcome. The last thing the banks operating on the venue want when they are hedging, for example, 50 million in USD/CHF, is for it to go public.

It could be argued, of course, that the growth in a multi-dealer dark pool gives lie to the internalisation numbers spouted by the banks – if the ratios were that good surely they wouldn’t need to worry so much about hedging out their balances? That argument is for another day, however, for in reality a dark pool represents an extended form of internalisation but only because both are aimed at reducing market impact.

I referred to the fear factor surrounding doing anything likely to be seen as questionable by the regulators, but that fear is probably overdone. A lot of the noise around transparency – specifically against any mechanism that reduces it – comes mainly from professional traders or liquidity recyclers and I suppose my question is, should we be listening?

At one level, of course we should because this is a global market with myriad interests and motivations for trading, but I keep coming back to the point that I feel offers the best argument for the FX industry when dealing with regulators – it oils the wheels of the ‘real economy’. Of course speculators are a significant element of the market, but in terms of social good, surely the more important elements are corporations and asset managers – firms hedging real risks?

If we agree they are – and I don’t think there would be a regulator in the world who would disagree – then surely their needs should be given a higher weighting when building a market structure? The biggest argument by the transparency advocates is that by trading going darker it will reduce price discovery, which I believe is nonsense. The only people to really lose out will be those scalpers looking to jump in front of an order and perhaps those trading platforms without real hedging clients. Should we care? I am unconvinced, not least because I find it very easy to find a good market price on various apps on my phone and besides, if I am a hedger the big decisions are taken quite a long time before trading.

To the hedger best execution is about getting a good fill at the time of the trade. They don’t care about what happens to the market in the five minutes, hours or days it takes them to decide whether to hedge or not – nor does it matter to them what happens in the market if they have a fixed hedging policy. All they care about is a measured execution at time of trade – in other words, price discovery starts and ends with their trading window.

Do these firms care about slippage – they should (more than they apparently do) and several do to be fair, and that means executing quietly, both the firm itself and the LPs to whom they offload the risk. It means ensuring that as much volume is absorbed into the LPs process as possible, or in the case of the LP, how much they execute without skew in a dark (or internal) environment.

There have been cases where the execution of trades has not been sufficiently transparent, the ‘administration’ trades by the custody banks many years ago being the most obvious, but even there that was a question of transparency of action, not of markets. Had the customers taken even a cursory glance at the markets at the time of trade, having first, of course, insisted on a time stamp (which frankly could have been to the minute, not the nanosecond) then they would have known that someone’s actions were open to question. At no time, however, could those customers have argued they didn’t know where the market was – even back then sufficiently adequate information would have been available.

I am not sure if the continued demand for full transparency in markets is the result of one vested interest group managing to shout the loudest or the aforementioned fear of the regulators. Either way, however, the FX industry should already be talking to those regulators about the real benefits of reduced market impact – including dark mechanisms and internalisation.

As an industry, FX has the independent means to deliver a fair and independently sourced comparison rate to anyone seeking to check their execution, and the majority will find a direct correlation between improved performance and less public trading. The customers are, too slowly I would argue, starting to understand this, therefore the regulators should be brought up to speed as well. Who does that is an open question of course – the best route would be via those same customers of course – but it is important that someone does it.

Twitter @lamboPnL

Twitter @Profit_and_Loss

Colin Lambert

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