This is the 1000th column I have written about (mainly) our industry (no, I am not sure I can believe it either!), and if it wasn’t going to be last look then what is a more appropriate subject that something I have been looking at for more than a decade – yes, we are back to the Fix, if only briefly and to try to clear up some misconceptions about my views and also to explain those views a little better.
Several people have been in touch to highlight, as I touched upon in a previous column, that the Fix merely reflects the balance of flow submitted. I totally agree.
Others have also stated that lengthening the window will not change the directional influence on exchange rates. I totally agree.
Yet others have said that lengthening the window will not change anything. I totally disagree – and to argue my case I will head to the current crisis on Covid-19.
I think we can all agree that a lot of Fix flow emanates from passive investment programmes? According to an article earlier this year in the Financial Times, citing Morningstar data, the assets under management of passive funds (including ETFs) in 2014 (the year the Fix window was widened) was around $5 trillion. At the end of 2019 that same segment had AUM of $11.4 trillion.
So, by assumption, not only do we have better data, analytics and ability to trade off that data – as I have already discussed – but the investment pool most likely to access the Fix has more than doubled. Inevitably, this must push more (correlated) flow to the 4pm window?
The point I have been making that several correspondents are struggling to understand (probably due to my inarticulacy as much as anything else) is that we cannot and, frankly, should not, stop this flow hitting the FX market, because it is why the FX market exists – to allow hedging of cross border assets.
The problem is, a simple look at the performance of the various MSCI indices can tell us what is likely to happen at month end especially, and as such there will be market impact. What I am saying is that we can reduce that market impact.
How does a big bank sell their services to a customer in FX – especially if that customer executes large tickets? They point to their internalisation programme. Why is that some banks that maybe five years ago were establishing stand-alone agency execution businesses, are now keen to stress how they have the appropriate links to their principal businesses to enable their algos to execute against those desks’ flow? Because they want to access the internalisation programme because nearly everyone recognises that internalisation reduces market impact.
It is hard to internalise over five minutes, especially when the principal business is reluctant to be involved because either they are going home soon and don’t want a position or, more pertinently, they don’t want to face awkward questions if they accidentally manage to trade in front of part of the bank’s Fix flow. Internalising over 30 minutes, or more ideally an hour? That’s a very different prospect. Not only will the principal business be more involved naturally, but speculators keen to jump in front of the flow have a great deal more uncertainty – can they go for an hour without being stopped out because another order came the other way? If the impact is likely to be in the low single digits over the hour, is the risk/reward worth it?
All of which brings me to my Covid-19 analogy (and at this point supporters of The Don can probably look away). Governments around the world listened to the scientific evidence and introduced social distancing rules and even lockdowns. This was not to stop the spread of the disease as such, more it was, to use a phrase oft-used in the UK, the “flatten the curve”.
They knew they were going to get hundreds of thousands of cases, the idea behind the precautions was to spread them out over a longer time period so the health services would not be overwhelmed.
We know there are occasionally going to be flows to the FX markets that will overwhelm available liquidity, but that they will come at a specific time. The best way to reduce the impact and not overwhelm the market is a longer window, so when we come to handling these important flows the FX industry can also say, “we are flattening the curve.”