conditions are changing in the FX market, they are not necessarily getting
worse, claimed panelists at Profit &
Loss’ Forex Network New York conference.
Although Kevin Kimmel,
Chief Operating Officer, Citadel Execution Services FX, mentioned that FX
market liquidity is “challenged in the near-term”, he said that he was bullish
that the situation will improve as the market adapts to new execution styles
“If I had to say
whether liquidity is up or down, I would say down but I think that the more
important answer is that it’s just different from how it has been in the last
couple of years,” added Philip Simotas, COO of ROW Asset Management.
difference Philip Weisberg, global head of foreign exchange, rates and credit
trading at Thomson Reuters, pointed out that for firms trading in small sizes
at the top of the book liquidity is better than ever because they know where
the market is, they have a lot of data available to them and the cost of
accessing this liquidity is often lower.
“But if you’re a large
portfolio manager and you want to shift a significant amount of risk on a day when
there’s market information being released then I think the liquidity profile of
the market is a lot more challenging unless you take advantage of some of the
tools and technology available in the market,” he added.
However, these changes
in market liquidity are not unique to the FX market, argued Eddie Wen, managing
director and global head of macro e-commerce at JP Morgan.
“There have been
changes to liquidity but this is a common theme that occurs in a number of
other markets,” he said. “The term that I like to use is that liquidity has
been “re-factored”. And this re-factoring occurs due to a combination of the
electronification of the markets, the rise of algorithmic trading, changing
market structure and new rules and regulations. This happens all the time in
financial markets, it’s not unusual but it’s something that we should be aware
of, as we should be aware of the fact that there are tools out there that can
help firms change the way that they operate.”
Looking to algos
Algorithms are often
viewed as one of the key tools for minimising market impact and finding
liquidity, often by breaking up orders into smaller amounts and then executing
them at different times. The panelists broadly agreed that they are useful
tools, but also pointed out that there are a number of nuances that market
participants need to be aware of when deploying algos.
“Liquidity is changing
and while top of book spreads remain tight, it is more difficult to transfer
large risk positions in a single trade at a good price. As a result, algos will
continue to play an increasingly important role,” said Kimmel.
associated with using algos that was identified by the panel was weighing up
the benefits of reducing market impact versus the risk of the market moving
against the firm deploying the algo. If a firm slices up an order into smaller
amounts and takes longer to execute it, the more likely it is that their market
impact will be lower and the liquidity they can find better.
The flipside of this
is that the longer a firm takes to execute an order, the more they move away
from why they put that order into the market in the first place and the greater
the chances that the market will move away from them.
managers will have models in the background that are generating signals, but
these forecasts that they’re generating will decay over time. Algos provide an
additional dimension to the management problem of how do I balance the signal
that’s coming out of my proprietary system with the cost of execution? So the
more that I defer that execution the better my chances of getting an improved
transaction cost, but I also have decay that comes with the signal that I’m
trying to deploy,” explained Simotas.
impact when trading FX is clearly an area of importance for market
participants, and Wen claimed that this could lead to less trading on lit
liquidity pools. He said that volumes on the two primary interdealer platforms
– EBS BrokerTec and Thomson Reuters – have declined as a percentage of the
activity reported by CLS and that is a result of how technology is changing the
“People are realising
that the information processing power and the market data dissemination that
you have on lit pools it creates greater market impact. So what you’re seeing
is essentially more trading happening bilaterally or on third party channels
outside of the traditional trading channels, and this changes the shape of how
people operate,” he said.
In response to this
Weisberg commented that Thomson Reuters is purely agnostic with regards to how
people execute and this is why the firm offers a variety of different liquidity
pools. He added that changing cost pressures in the banking industry are likely
to impact liquidity going forward, and as a result buy side firms could start
managing more risk themselves.
“If you look at the
banking sector, there are now very few banks that are earning their weighted
average cost of capital so we should expect as time progresses that either
they’re going to need to get a lot more efficient or the price that they’re
going to have to charge in order to accommodate compliance functions – such as
cost of capital and risk controls – is going to go up.
“That’s one of the
reasons why customers now have an interesting choice between whether they’re
going to pay to block transfer risk, which has gotten more expensive, or manage
a little bit more of that risk on their own, which becomes relatively more
attractive,” he said.
Is alpha being sucked out of FX?
Following on from the
comments about how technology is changing the markets, the question was put to
the panelists about whether the end-game of this technology would be to suck
the alpha out of the FX market, particularly if artificial intelligence becomes
commonplace. After all, this technology could make markets significantly more
efficient and if markets are truly efficient then there’s no alpha, only beta.
suggestion that technology could cause alpha to disappear was roundly rejected
by the panelists.
“As long as there’s
human emotion involved at any level of the market trading paradigm there’s
always going to be some alpha out there,” said Simotas.
Kimmel added: “There’s
no reason why market participants can’t continue to leverage the technology coming
to market in order to find alpha and provide a great service.”
Weisberg rounded off
by pointing out that although the market is continuing to become more efficient
as a result of technology, there’s now a lot of money that is being managed
passively, which provides opportunity for firms to find alpha.
“If you look at the
speed at which indexes and passive investment products are growing in
popularity it’s clear that there is an overwhelming amount of money being
managed passively now. While I think that’s efficient for beta, I do think that
it creates opportunity for alpha and we’ve seen some dramatic moves in
currency, which is a sign that the FX market isn’t completely efficient,” he