I’ve been pondering not only the decline in volumes at the primary FX venues, but also what seems to be a struggle on the part of any anonymous venue to really build numbers, and have come to the conclusion that while the slippery slope may not get any steeper, I don’t see many opportunities for traction.
The next week or two should see the semi-annual FX turnover reports released by the world’s FX committees, so I could immediately be shot down in flames (again) but in keeping with this column’s motto – ‘sometimes right, sometimes wrong; always certain!’ – I feel confident that even short-term blips in the chart will do little to arrest what is a steady decline in the share of anonymous trading. The numbers may not go down in real terms, but neither will they grow, and looking at the broader picture with an independent eye, it strikes me that the only way this decline in share will be halted is through regulation. The problem for those optimistic about these venues is I can’t see how any regulatory effort will come unless the FX market succeeds in shooting itself in the foot again.
Hopefully in the FX Global Code world that will not happen. We will, inevitably, have the odd instance of misconduct – most likely from this extended WFH period – but when it comes to the type of systemic wrongdoing witnessed in the run up to 2013-14, it would take something spectacularly stupid to see a repeat.
The problem for the anonymous venues is that without really deep liquidity, even those clients who feel their LPs are gaming them are going to struggle to get their business done. It’s a case of the lesser of all evils because on one hand there may be a skew in the price or rejections but the deal will ultimately get done; whilst on the other they will get part of the deal done at top of book, but the whole world will quickly know something has gone on. Whichever way you look at it, advances in data and analytics is working against the anonymous trading model.
The rise of independent TCA is also a factor here, although there is the paradox that so much is computed based upon the declining volumes in anonymous venues or upon pricing subject to last look. TCA providers now can do so much more than produce a report with your transactions alongside top of book – there is some real expertise on the server side when it comes to TCA and they can help even the most inexperienced customer identify potential issues with their executions – so why go to the trouble of connecting to an anonymous venue?
That advert for independent TCA aside – and it has to be noted that by benchmarking to public markets the TCA is effectively telling the client how their alternative execution would have gone sans information leakage – the real problem for these venues is the quality of the LPs and how the top group of that set of players now fully understand the value of what they provide. I saw another platform the other day boasting its 250+ LPs in a release, well will all due disrespect to most of that number, all but 20-25 are messing around thanks to last look or the fact they can stream in amounts only the retail end of the spectrum will appreciate. If you are a true institutional hedger, you don’t want to go near the vast majority of LPs that any platform claims.
So, if you are limited to maybe 15 LPs (including regional specialists), and you have access to independent TCA, what is your best option for execution? On one hand there the “Cheers” channel, a curated, aggregated liquidity pool where everyone knows your name (what’s not to like about an 80’s cultural reference that half the audience doesn’t understand?), on the other there is the “Alien” channel – the one where you step inside and immediately know there are countless and grisly ways of getting hurt!
The aggregators’ ability to monitor behaviour in the “Cheers” pools is probably the main differentiator and they have to tread a fine line between LPs and consumers, but either way, the data is now available to make any awkward conversations a little less so. This means that if any anonymous venue is to really grow, it has to probably adhere to even higher standards that its disclosed competition, the basic fact of the matter is people are naturally more suspicious and quick to jump to conclusions when they don’t have all the information. I don’t think there is a crisis of confidence in those who run the anonymous pools as such, but I do think there are serious doubts as to the appropriateness of the model (and some of the behaviour from certain segments therein).
In my mind there is no doubt that the primary venues in particular have been hit hard by internalisation, and while some competitor venues did go through a growth period that has largely flat-lined over the past two years – a period in which spot volumes have probably climbed overall – as more major LPs improve their “true” internalisation through increased client-to-client matching, what we saw with the primaries could well happen with the other anonymous venues. This means that how well they run their businesses becomes an important factor in the health of the various venues.
One final factor is the target audience. In disclosed venues the quality of the buy side client list is important, on anonymous platforms that becomes largely irrelevant because everyone is judged by the lowest common denominator of behaviour. Boasting an impressive buy side line up is quite difficult when you can’t prove it without breaking the fundamental principle of the model?
There will always be anonymous trading in FX, it is, after all, how the “exhaust” flows are executed. The problem is that as LPs in particular continue to build efficiency even further, the trickle down to the anonymous venues will be just that – a trickle. When that happens, it seems inevitable in my mind that more people than are already doing so now will be moved to ask, “why do we need so many of these venues?”