Albert Einstein is often alleged to have said, “The definition of insanity is doing the same thing over and over again and expecting different results.”
I say allegedly, because it is claimed in many circles that he never actually uttered, or wrote, those words. No matter, for this column is about the Einsteins in the asset management community that continue to insist that the London 4pm Fix is a perfectly adequate benchmark. It isn’t and this was proven yet again, at Thursday’s month-end Fix.
I am not sure I need to go into my thoughts again over this flawed mechanism, so here are the numbers:
At 3.45pm London time on Thursday, EUR/USD was trading around 1.0895.
At 3.57:30pm London time on Thursday, the opening of the Fix window, it was trading at 1.0920.
At 4.02:30pm – the end of the window – it was trading at 1.0968.
Just a reminder, this is EUR/USD, not Cable, not AUD, this is the most liquid currency pair – probably the most liquid market – in the world.
Some more numbers, and let’s assume a group of index trackers has to buy EUR 5 billion at the Fix – and that is probably a conservative number:
If we take 3.45pm as the benchmark for an implementation shortfall measure (EUR/USD was already at the high of the day having spent most of it between 1.0850-90), on a gross basis that’s a cost of $36.5 million, let’s take a third of it as being the real slippage and you are still over $10 million. That’s ten million dollars, probably more, given away by firms that claim to adhere to best execution policies and look after their investors – and that’s just in one currency pair.
USD/JPY – the second most liquid pair on the planet – was a little better, it rose from 106.60 at 3.45pm, to a peak of 107.20 as the window opened, before falling back to 106.85 at the close. If the Fix was close to 90 that’s just the 30-point move (which incidentally mirrored what happened earlier at the even more ridiculous Tokyo Fix).
Cable over the same time frame went from 1.2550 to 1.2600 at the start of the window – and left it at 1.2635.
So, who were these buyers that saw such a move at a time when the world’s attention is on the FX markets? Well it could have been banks handling the Fix orders pre-hedging because of the orders’ size. We have to assume that they are not insane and that they have shared their trading strategy with the clients, who signed off on it. Indeed, some algos out there allow the client to pre-hedge. So who should be looking at themselves asking why the market went higher? Not the executing agents following rules, it is the clients who signed off on it.
It could also be, or additionally be, speculators. It’s not hard to work out what the flows will be and there’s plenty of analysis of it available from various sources, so these participants look could have looked carefully for signs of pre-hedging and, in its absence, or indeed in its presence, they have the signal to trade. Who is to blame for this action – the speculators, acting on publicly available information, or the clients choosing a methodology that offers more signals than the Royal Navy on Fleet Day?
To me there is little doubt that a fair bit of the price action was speculators taking advantage of the information, for at 4.05pm London time, just two and a half minutes after the window closed, EUR/USD was 25 points lower at 1.0943 and Cable was 1.2611, also 25 points lower (USD/JPY sat blissfully unaware at the same level – suggesting that pair’s price action was indeed pre-hedging, or that the punters got out earlier in the window).
Whichever way you look at it, this was a prime example of why the Fix doesn’t work in its current format and why the window needs to be much longer. I am fed up of apologists arguing “that’s the way it has to be done under fund rules” – we need to change the rules. That or we own up to investors that tens of millions of dollars of their hard-earned investments are being thrown (other adverbs spring to mind) away on a monthly basis – as regular as clockwork.
This is not about how the banks handle the flow – they generally use an agency model TWAP to mirror the WM mechanism – and it is not about WM itself, that company provides what its customers want, a robust measure of that TWAP. No, this is about the people that are using it not pushing for change. I am sure if WM wanted to, it could produce a very transparent and robust Fix over, say, an hour, or three. It won’t do that, however, until its customers understand the need to change and accede to it.
Current market conditions in FX – and as we heard on our first Dial-in Day on Wednesday, they have improved significantly from March – clearly exacerbated the situation, but it is ridiculous to argue the problem didn’t exist before. It wasn’t as stark a problem, but it was a problem nonetheless.
I am sure the people responsible for directing funds to use this Fix are handsomely paid – some may even be geniuses. Whatever they are, they are not, in my opinion, doing their job. They are being lazy to be charitable, and negligent if we are being less so.
Einstein’s famous equation was E=mc2 basically energy equals mass times the speed of light squared. It would be nice to think that the Einsteins who continue to enforce the use of the Fix in its current format would gain more mass in their brains, put some energy into their decision making – and make it, if not at the speed of light squared, at least quicker than they currently seem likely to.
Because frankly, this is getting beyond a joke now.