It’s an interesting question to be asked, “why do you dislike customers so much?” I was asked just that when talking with someone (obviously a regular reader!) last week and it prompted a degree of introspection on my part before I answered confidently (is there any other way?), “No”.
There is no argument from me regarding the suggestion that I criticise the buy side – I do – but it’s no different to my attitude towards the sell side or service side of the FX industry. At various times since I started writing an opinion column on the FX industry in January 2008 (me neither!), I have been accused by various people of disliking banks, non-bank, platforms, ECNs, fintech firms, voice brokers – the list goes on – and as someone in this business one told me, the braoder the sources of criticism, the more you probably have the balance about right!
To last week’s question, though. To paraphrase it, I was effectively asked what my problem is with the buy side? Where to start?
Well, it is important to observe that many on the buy side are exempt from my criticism – there are plenty of firms who do their very best and are open to ideas when it comes to managing their FX hedges or trading. I observed during last week’s conversation that asset managers, for example, are obsessed with tracking error, but added it’s a pity they can’t bring the same attitude towards their behaviour. At least if they minimised tracking error on behaviour we would have a customer segment with the highest professional values, as exhibited by several of their brethren already, although the cynic in me thinks they will just benchmark to a lower standard.
I also believe that while many hedge funds have adjusted their operating procedures to meet the new market structure, there are still dinosaurs out there who think liquidity is free and that their business is still valuable. Well I can tell them it isn’t any more thanks to changes in the industry. Think of it this way; in the past there were certain big hedge funds who were seen as influential in terms of market direction – thanks not only to their models and trading styles, but also because of the level of information they received. This flow was valued because a trader would typically take an initial hit but go heavily with the flow (thus helping to cement the trend for the hedge fund) – and also because the salesperson was paid in volume credits, not on overall P&L from the trade.
While information from trades is allowed to be used by LPs for their pricing, there is neither the risk appetite at those firms, nor the confidence (in terms of conduct), to trade with these major accounts on this basis. Throw in the fact that better analytics highlights how this flow does not outweigh other business from these firms (to the contrary of what most salespeople have argued over the years) and hedge funds who act aggressively and, to my mind (and many others) abuse liquidity, are detrimental to market health.
In both circumstances we are talking professional financial markets’ participants, one group with a section that is too lazy when it comes to FX and another with a minority that is overly aggressive. That’s the way of the world and while it has to be accepted, it does not mean these attitudes and behaviours should not be called out.
And before we people reach for their keyboards and inform me this is just another rant against the buy side, let me look at the sell side – because attitudes need to change there as well. LPs generally should not be afraid to lose money, should embrace considered risk, and should not resort to a number of defensive measures (yes, last look among them) to avoid taking the odd hit.
Sell side transparency also need to be improved, it has taken huge strides in recent years thanks mainly to the FX Global Code…oh and a few billion dollars in fines; but that does not mean more cannot be done. I have written recently about last look hold times in the era of 5ms market data updates as a prime example of where we need more than just a disclosure to allow the practice to continue.
If this article is sounding a little angry, there is a reason for that – which will be the subject of the midweek column – but in reality these are genuine issues that I see in the industry, most of which are not being effectively dealt with because people either don’t want to rock the boat or are so entrenched in a historical position they are unwilling to even consider the prospect of change. Of course, revenues are at the bottom of it and – again this is a theme of recent chats I have been having – the industry generally being behind the curve when it comes to technology. Yes, there are some firms who are very much in front of the tech – and that is what is occasionally causing some of these issues! After all, where would liquidity recyclers be without last look?
It’s an area where the industry needs leadership, but I totally understand how hard that is when there is no consensus. After all, how do we get the LPs to do the right thing around last look? How do we get some customers to stop machine gunning the market or using interest-only feeds as part of their decision making process? How do we get asset managers to embrace algos more and stop trying to push more and more flow through an inadequate window? To go back to the LPs, how do we make them explicitly explain to the clients how pre-hedging is actually putting profit into the LPs own pocket for effectively front running an order with the full consent of said client? In turn how do we get those clients to agree to a better benchmark so that sell side operations can avoid risking being hauled over the coals again in years to come because someone decides a disclosure is inadequate?
There is plenty out there that needs talking about and I am genuinely grateful to those who engage with me on these subjects – even if I do think they have misread my opinions. Because to go back to the question that actually triggered this piece, if I look at it in balance, I would say that the majority of “LPs” on public platforms do not adhere to the highest standards*, whereas the majority of buy side do. While on that subject, I fervently believe, as I wrote last week, that platforms generally need to raise their standards of transparency, especially when it comes to having rule books and enforcing them.
An old cricket teammate of mine once told me, “You’re not biased, you just hate everybody.” I think hate is a little strong, it’s a word I only consider when thinking about Chelsea FC or the Boston Bruins (or, back in the day, batsmen), but I do believe that no-one should be above criticism.
Of course, if you really want me to get controversial, then perhaps we could start talking about the trading styles of some central banks and sovereign wealth funds?
*To explain that, I am talking about the dozens of firms out there purporting to be “LPs” where they are nothing more than a liquidity recycler cherry picking the flow.