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C-View: “We Know Where the Bodies are Buried”

C-View: “We Know Where the Bodies are Buried”

Speaking at Profit & Loss’ Forex Network London, Paul Chappell, CIO of buy side firm C-View, explained how liquidity trends are being negatively impacted by the Fix scandal.

In a featured new segment introduced at Profit & Loss’ Forex Network London called BURSTS, Paul Chappell, CIO of buy side firm C-View, sought to explain liquidity trends in the FX market in the context of the recent scandals that have plagued the industry.

In this TED Talks-styled presentation, Chappell sought to address why there are, in his opinion, only a few genuine market makers left in the FX market that everyone else prices off, and why currency managers have seen their returns significantly reduced. 

Tackling the first question, he argued: “We believe that it’s the right time to discuss exploding the myth that we’re still living in a previous environment and understand and embrace the realities of the current landscape. We’re no longer looking at a world where the straight-forward relationship of the sell-side bank market maker and buy-side taker in the form of corporates or asset managers exists. These relationships have been thrown up in the air and reshuffled in a most dramatic fashion.”

To embrace this new reality, Chappell made the case that the FX industry needs to comprehensively address one legacy issue: that for a protracted number of years, market making banks engaged in inappropriate behaviour by colluding and manipulating markets using their combined size to enrich themselves.

This was compounded, he added, by a number of these organisations later employing ‘last look’ tactics – both asymmetrical and symmetrical – in order to make more money by assessing their counterparts’ trading intentions before accepting or rejecting their trades.

“Unquestionably this created an unfair advantage to those large market makers against minor market participants and buy-side firms. Undoubtedly, it was to the substantive disadvantage of small to medium sized and regional banks seeking to make markets in the same or similar currencies. This goes some way to describing how we have a current market structure of a few large dominating entities,” said Chappell.

He continued: “Simply put: the smaller players got forced out of the market by their inability to compete in an unfair technological arms race and without the appropriate economies of scale. Many of them have now become instead distributors of pricing for the major market makers through agency type arrangements.”

Similarly, he claimed that currency managers were disadvantaged by this arrangement, because the market makers were gaming their intentions.

“This goes some considerable way to explaining why the typical aggregate currency manager returns of 5-10% prior to 2007 collapse to near zero thereafter, unless you consider that currency managers all become dumb and dumber at exactly the same time,” argued Chappell.

Further, Chappell issued this stark warning: “From what we’ve analysed, we’ve deduced the identify of some of the worst malfeasance and last look practitioners and the severity of some of those practices. Simply put: we know where the bodies are buried, and in some instances, we know how deep.”

He also addressed the question of why there is an abundance of FX liquidity during the day and yet the market remains constrained and gridlocked, only to explode into action at night when liquidity is much thinner.

According to Chappell, the credit constraints and deleveraging that have occurred in the FX market since “the Swiss franc debacle”, in conjunction with the regulatory constraints on market making banks that reduce their ability to warehouse exposures and proprietary risk, “has led to a steady shift towards short-term and spot-only execution and facilities”.

Subsequently, he said, there has been a decline in liquidity provision – and therefore activity – in FX options, forwards and NDF products.

“So everyone sits around all day watching spot rates, luxuriating in extensive spot liquidity that, absent any market moving event, are tide bound during the day. Once everybody in the UK and US gets satisfied with their execution requirements, or frustrated with their directional exposures, and are squared up, markets are left overnight to make much sharper and more erratic moves when liquidity is much thinner, culminating in the occasional flash crash,” said Chappell.

But, he added, this change in liquidity patterns represents an opportunity for trading firms that are able to adjust to the new market conditions. 

This is why, explained Chappell, “rather than complain about these characteristics, we at C-View in our strategies have taken account of them to better try to take advantage of overnight moves, with smaller exposures with wider parameters and larger intraday exposures with narrower ones”.