So we’ve just published our Q3 edition of Profit & Loss magazine, which includes our prime services special report, and I wanted to share some thoughts about one segment of it.
When I first started the report I was very negative on the prospects for FX prime brokers, over the eighteen months or so I’d heard so many complaints about credit constraints, about offboarding – I don’t think that was even a phrase that I’d heard prior to SNB – and the general retrenchment of FXPBs.
Now obviously SNB was a catalyst for a lot of these issues, but really it just exacerbated a trend that already existed and this was caused by the introduction of new regulations that made it more expensive for banks to offer FXPB services to a lot of clients.
Paul Aston, CEO of Tixall Global Advisors, discusses the feasibility of peer-to-peer FX matching between large buy-side firms.
One of the long-standing problems with the concept of peer-to-peer matching between buy-side firms is that the probability of being able to actually put together complimentary buyers and sellers is very low. For example, the chances of a large asset manager needing to sell a certain amount of a particular currency at the exact same time that an insurance company needs to buy the same amount of that currency are remote.
Aston refers to the need to “get away from the quantum problem of having to know when something is available in time and level”, and suggests that there needs to be some form of “dark mechanism” whereby these buy-side firms can leave an order without it being exposed to the market, in order to make peer-to-peer trading more feasible.
As P&L’s resident cryptocurrency enthusiast I'm excited by some of the developments that have occurred in this space over the past few months, because it could signal the start of these digital assets moving towards the financial mainstream.
To help explain why I think this is such an interesting time in the cryptocurrency space, I explain how I first became interested in them after joining Profit & Loss, that I refused to buy bitcoin when it was at $1,000 because "it will never go higher than this" (it's now at $4,300) and why recent regulatory developments could have significant implications for financial services firms looking at trading cryptocurrencies.
Although Greg Wood, SVP, global industry operations and technology at the Futures Industry Association (FIA), says that technology is increasingly causing FX to trade in smaller sizes, he explains that experience in other asset classes shows that this doesn’t necessarily mean that liquidity is diminishing.
With more trading firms using algorithmic execution tools to slice up large FX orders into smaller amounts to reduce market impact, this could potentially create a cyclical pattern where the amount of small orders going through exacerbates the impact of larger orders, forcing firms to execute in smaller and smaller sizes.
“It is to a degree a vicious circle and to a degree we’ve seen it happen in other asset classes, such as futures and equities,” says Wood.
The structure of the FX market means that transaction cost analysis (TCA) within this asset class is unlikely to look like it does equities for the foreseeable future, according Dan Torrey, global head of FX e-commerce sales at Northern Trust.
TCA is clearly much easier to perform in the equities market because it has a consolidated tape, which provides one uniform data set from which firms can analyse the cost and effectiveness of their execution. This, says Torrey, turned equities TCA into “more of a science that’s very hard to dispute”.
By contrast, he points out that, not only is FX an OTC market without a central tape, but that the reference points for pricing has become more diverse over the past decade.
A number of factors, including the increased need for an audit trail for FX execution and a desire to limit market impact, are driving the adoption of algorithmic execution tools amongst buy side firms, says Petra Wikström, global head of execution and alpha solutions at BNP Paribas.
Although Wikström says that the continuing automation and electronification of the FX market naturally leads to more firms broadly using algos as one of their execution tools, there are other specific factors driving the adoption of algo tools by the buy side.
Market making in emerging market currencies is a key way for liquidity providers to differentiate themselves in an increasingly competitive G3 landscape, says Kevin Kimmel, global head of e-FX at Citadel Securities.
“Where there’s a lot of demand and where there’s also an opportunity to differentiate yourself as a liquidity providers is in the less liquidity currencies, in the Scandies, in Ems, where you don’t necessarily have as many people with really tight top of book liquidity,” he comments
In contrast, G3 spot FX market making has become so commoditised and the pricing is so tight already that Kimmel says that he is unsure whether a new market maker pricing just these currencies would really add significant value to the overall FX ecosystem.
CTAs have, generally, not been doing well in 2017, judging by the major indices that track their performance. Profit & Loss deputy editor, Galen Stops, relays a conversation that he had with a portfolio manager at one alternative investment firm (with AUM of over $10bn) to illustrate why some investors are very negative about the outlook for investing in these firms right now, even beyond the immediate problem of low returns.
For a more in-depth look at some of the challenges facing CTAs and the trends that are shaping this segment of the market, see Profit & Loss' previously published piece: CTA Performance: Decline or Dip?
Fintechs from Silicon Valley are being hampered by their lack of understanding about how the incumbent financial services firms in the market operate, according to Rosario Ingargiola, founder and CEO of OTCXN.
Discussing the biggest barriers to adoption for fintech solutions, Ingargiola explains that the primary concern is usually related to how these solutions comply with the existing regulations in the market.
Specifically, he says that financial services firms want to ensure that the necessary Anti-Money Laundering (AML) and Know Your Customer (KYC) requirements are in place before they’ll even begin taking an in-depth look at the solutions being offered by fintech firms.
The Foreign Exchange Professionals Association (FXPA) will be promoting the FX Global Code of Conduct given that it addresses so many issues that the association has already been working on, according to its chairman.
“There’s a preamble in the Code that it wants to promote a robust, fair, liquid, open, transparent market and those are the exact same adjectives that we use in the FXPA [mission statement], and so we look at this as being very complementary to our mission and we’re certainly going to be promoting the Code,” says Chip Lowry, senior managing director at State Street Global Markets and chairman of the FXPA.