Hotspot: A Fresh Approach

Following hot on the heels of its second ownership change in a relatively short time, Hotspot is maintaining the momentum of change by launching new products, specifically outright deliverable forwards. It has also announced a raft of new hires and sought to broaden its geographical footprint. Galen Stops speaks to senior staff at the platform about what these changes – which include the addition of non-deliverable forwards to the platform – are building towards, as well as their view on the changing FX market structure.

Profit & Loss recently
reported
that Hotspot has begun offering outright deliverable FX forwards
products on its platform, claiming that it is the first to offer these products
via an anonymous central-limit order book.

One important element to this launch was that it enables
prime brokerage clients to enter a price into the platform and remain passive
on the order book, a capability that no other platform currently offers, claims
Paul Millward, head of product strategy at Hotspot.

One reason why this is significant is because it can allow
the introduction of non-bank market makers into the outright forwards market.
“Right now in the OTC market place there’s only a handful of primary banks that
are able to supply liquidity into this outright forward market because credit
restrictions prevent non-banks from supplying liquidity,” says Millward, adding
this is not the only benefit. “With this set-up you could end up with a market
maker that is a non-bank effectively trading with a non-bank consumer through
the credit intermediary of the two prime brokers, so it helps with price
distribution, but also with market data.

“This will be one of the first times that you have a
transparent point on the curve that people can use to take that data and put it
into their own pricing models and curve models,” he explains.

This is in contrast to the current market environment where
users of outright forwards are having to aggregate data from a number of bank
single-dealer platforms or go to a third party system to source their data.

Millward admits that there were some significant challenges
on the PB side in terms of workflow changes in order to accommodate its new
product launch. For example, although FX forward transactions are not subject
to Dodd-Frank transaction rules, they are subject to reporting requirements
under the regulation. Therefore, the way that the PBs reported trades had to be
adjusted to ensure transactions remained anonymous.

Typically in an RFQ model where clients are dealing directly
with an executing broker (EB), the PB wouldn’t receive that trade until after
it had been done and the reporting would be done by the EB. But on Hotspot’s
platform the PBs report the leg of the trade between the PB and the bank so
that the EB on the other side of the trade doesn’t know that the person
conducting the transaction is a client of that PB.

“Not only that, but the PBs have to be comfortable extending
credit out of the curve,” says Millward. “Instead of just having settlement
risk, which is pretty much negated by CLS in the currency pairs that they
cover, banks on the PB side have to be comfortable with the controls that we
have in place on the platform that allow them to do that. It was a big lift for
them.”

NDFs Up Next

Hotspot is also preparing to launch NDF products via its
swap execution facility (SEF) Javelin, which it acquired
last year
. Given that data from the FIA SEF Tracker indicates that Javelin
had no trading on its platform when it was acquired and that overall FX volumes
on SEFs have remained relatively muted in the absence of a mandate to trade
them on these platforms, this might seem like a strange strategic purchase.

But in acquiring Javelin, Hotspot was never looking for
customers or flow, but rather looking to acquire the certification and
regulatory standing that it already had with the Commodity Futures Trading
Commission (CFTC). Hotspot has now integrated Javelin functionality with it’s
own, and the next stage is to begin onboarding customers to the platform.

Although there is, of course, plenty of paperwork to be
filled out during this process, the API is the same as for the Hotspot forwards
platform and very similar to the spot API, which could help expedite getting
existing customers onto the SEF.

Further, Millward argues that the SEF will offer a couple of
key value propositions for firms trading NDFs. “None of the SEFs offering NDF
products have been successful outside of the voice market, but we believe that
this is primarily due to the fact that PBs have been concerned about extending
credit onto the SEFs,” he says. “We believe that our rules address the concerns
that PBs have about these platforms, and that subsequently they’ll be willing
to extend credit onto our SEF. This will enable non-banks to come in and be
passive, just like on the forwards platform.

“Secondly, one of the minimum requirements for SEFs is to
provide an all-to-all order book,” Millward continues. “We provide this, but in
addition, we’re going to allow firms to create configured liquidity pools, in
the same way that they’re able to on our ECN. We think there’s demand in the US
market for NDFs that is not currently being satisfied, and we think that these
factors will differentiate our platform and help address this demand.”

Unique Liquidity

Explaining the decision to expand Hotspot’s product
coverage, Bryan Harkins, head of US equities and global FX at CBOE, says that
it is an important step in attracting more unique liquidity to the platform.
“If we diversify our products enough so that we can truly provide a full
package then we can attract some more unique liquidity and then we become a
one-stop-shop versus our competitors. That helps the core business of our spot
market,” he says.

The concept of “unique liquidity”, though highly popular in
press releases, marketing campaigns and client meetings, often proves more
challenging when firms are trying to tangibly prove that they have it on their
platforms. Especially in the hyper-competitive spot market where the same
segment of market participants are providing the vast majority of liquidity
across all the major multi-dealer platforms.

This is why Hotspot is trying to shift how it conducts its
spot FX business, trying to take a more quantitative and statistics based
approach to how it matches trades.

“How do we know when we’re customising liquidity that we’re
truly maximising what’s good for Hotspot and for our clients? That’s hard to
tell,” says Harkins. “At Hotspot we’re incentivised to match everyone as much
as possible, but we’re asking  where is that sweet spot for our
clients and what liquidity do we want to attract to our pool to improve it?”

Getting away from the simplistic “more is better” approach
to matching clients, Harkins says that Hotspot is focusing more on increasing
the percentage of high quality liquidity onto its platform, and then proving
the value of this liquidity via quantifiable data sets.

With so many liquidity providers and liquidity takers
operating a range of different strategies on the platform, what is the optimal
combination on either side of the equation so that both sides have a better
trading experience?

This is the question that Hotspot is trying to address, so
that the value-add that it is providing resides in how it manages the liquidity
on its platform, creating what Harkins refers to as “happy collisions”.

“Not all liquidity is created equal and ultimately the proof
should be in the pudding in terms of what the data says about the quality of
liquidity that you’re bringing to the market,” he suggests. “We’re not trying
to judge good and bad liquidity, we’re just looking at how we can help create
those collisions for our clients, because if we do that and it increases their
profitability then they’re going to take more risk and provide better markets.”

This is why Hotspot recently announced the hire
of Jon Weinberg
in London as its new head of FX liquidity analysis, tasked
with creating these “happy collisions” between users of the platform.

CBOE Takeover

Weinberg is actually part of a raft of new senior hires
announced by Hotspot since the start of the year, with Benjamin Leit joining as
head of sales for Europe, Matt Vickerman joining the FX sales team as a
director in New York and Rahul Bowry joining in the same role in Singapore.
Jonathan Watras was also re-located from New York to Singapore to become head
of sales for the APAC region.

Harkins says that Hotspot has traditionally been a very New
York-centric organisation and that these hires represent an attempt to extend
the company’s focus.

Approximately 10% of Hotspot’s volumes now come via its
London matching engine in LD4, which was launched, in part, because of the
differences in local liquidity between London and New York. As the platform
provider beefs up its Asia presence, the obvious question is then whether or
not it will look to launch a matching engine in TY3.

“It all comes down to the business case,” says Harkins.
“Just because everyone is in TY3 that doesn’t necessarily mean that we’ll go
that route. We want to look at where the market is saturated and commoditised
and then look at where we can change the game. Something outside of Tokyo might
be on the cards, our focus is not necessarily just on spot trading but on
whether we can build out a larger presence in some of these frontier products
that trade more away from Japan.”

As Hotspot looks to expand its geographical footprint,
Harkins insists that its acquisition by CBOE has major benefits for the
platform. “Coming back to this one-stop-shop concept, one advantage of being
part of such a large company is the presence we have in all the biggest and
most liquid markets in the world, in US equities, European equities, US
derivatives and the FX market,” he says. “Also, we have the biggest trading
firms in the world as clients across all of our businesses, and that’s a great
strategic weapon that some of our competitors do not have.”

Despite Hotspot being absorbed twice in fairly rapid succession,
first by Bats
Global Markets in 2015
and then by CBOE
in 2017
, senior management at the firm have always maintained that very
little has changed for the platform because neither of the companies that
acquired it had an existing FX businesses that needed to be integrated.

Wild Card

Hotspot is hardly the first OTC FX platform to begin hyping
up the advantages of scale and offering a more complete product range to
clients in recent years. But what Harkins and Millward argue sets their
strategy apart is the focus that they are applying to their expansion and the
homogenous nature of the technology underpinning it.

“We’re being very focused in terms of what we’re offering,”
says Millward. “We’re starting off with forwards, which will operate in the
same manner as an ECN order book does, Then we will move on to launch NDFs,
which again will operate the same was as an order book.

“Rather than trying to do everything at the same time we’re
being very direct in terms of building out one product at a time and then, once
we have broadened out across the product set, possibly broadening out how we
allow clients to execute,” he continues. “But I don’t think that we’re looking
to offer post-trade or pre-trade services, we’re very focused on the execution
piece.”

Harkins adds: “One thing that Bats has done well is that we
“clone” our matching software when we enter different markets. This way we play
to our strengths and never get too far out of our comfort zone.”

Harkins has been in his current role since long-time Hotspot
employee, Bill Goodbody, left
the company
at the start of the year. Prior to this, his background has
been in the equities market, potentially making him well placed to weigh in
regarding the interminable debate about whether FX market structure will
eventually come to mirror that of equities.

“It’s easy to make assumptions when you come from my
background and are on the outside looking,” he says. “The moment you’re
actually in the FX market dealing directly with customers day in and day out,
you realise that disclosed relationships are just so valuable for market makers
and that last look is a useful tool for managing risk across a fragmented
market place.”

Harkins also emphasises the impact that the Global Code of
Conduct, which Hotspot has been publicly supportive of, could have on the FX
industry. He points out that, even though the Code provides guidelines rather
than rules, the practices and adherence to certain standards of business
outlined in these guidelines are reminiscent of exchange rulebooks.

So does Harkins ultimately see FX drifting towards an
equities model? “I think that the wild card is what happens to last look over
time,” he responds. “If last look either changes drastically in form or is
whittled out of the market through either commercial forces or regulatory
pressure then that could drastically change the industry. I don’t think that it
would necessarily lead to FX becoming a full on all-to-all market, but if it
becomes a firm price market then that boosts the importance of data and it
would be interesting to see how that plays out.”

galen@profit-loss.com

Twitter @Galen_Stops

Twitter @Profit_and_Loss

Colin Lambert

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