Following the results
of the UK referendum decision to leave the European Union last week the common
consensus amongst FX market participants has been that the biggest surprise –
apart from the result itself – was how well the FX market handled the resultant
“Two months ago if
you’d told me that we’d have a Brexit overnight I would have been worried,”
says a senior figure at one trading firm. “But the reality is that it was
surprisingly orderly and although volumes were high it seems as though
everyone’s systems worked well.”
market source expressed surprise that there appeared to be no major problems in
the FX market, no fat fingering and no large misfires through a big figure – on
a day when there were multiple big figure moves, something that they pointed
out has been unheard of the past couple of years.
“Nothing broke down,
no one blew up and no venues went down, which is pretty remarkable given the
huge volumes that were being done,” observes a source at one market making
As Profit & Loss reported on the day,
although spreads widened in many cases there
was liquidity available in the market, in contrast with when the Swiss
National Bank dropped its peg to the euro.
In particular, many
have noted how active the non-bank market making community was on Friday. In
recent years some of these firms have faced the often lazy accusation that they
simply exit the market when trading conditions become stressed. From all
reports, this was not the case on Friday, with a number of them reporting
record trading volumes.
Pillitteri, managing director and global head of FX at Global Trading Systems
(GTS), claims that presence of the non-bank market makers was one of the
factors that contributed to maintaining orderly markets during the volatility
“I think that the
presence of alternative liquidity providers, like GTS, was beneficial to the
market on Friday. Firms like GTS contributed to an ecosystem that remained
orderly even in conditions where liquidity was extremely challenging and market
moves were very violent,” he says.
Pillitteri goes on to add: “This is a technology intensive game and the spreads
that you show to the Street will be determined by how your systems are able to
cope with a major event like we saw on Friday.
makers such as GTS are backed by cutting edge technology and are able to leverage
that to keep providing prices while efficiently managing their risk, which
helped absorb some of the shocks. I think that this is positive news from the
market, for regulators and for investors in general.”
Gaining market share
Certainly, Friday was positive
news for these alternative liquidity providers, with the firms that Profit & Loss spoke with all
reporting a significant jump in their trading volumes, both into ECN platforms
and into the banks that they work with.
“As a result of
our consistent and relatively tight pricing during high volatility, we picked
up significant market share, both on ECNs and with our direct clients,
including several major banks,” says Kevin Kimmel, chief operating officer
at Citadel Execution Services (CES) FX.
Incidentally, CES FX
reported that its June 24 volume was more than four times its regular volume,
the latter being defined as its year-to-date average daily volume prior to the
Brexit decision. The firm declined to give hard numbers, however.
The banks must have
been busy on the phones on Friday, because again every single non-bank market
maker Profit & Loss interviewed
said that they had received calls from their bank partners on the day thanking
them for the liquidity that they had provided on the day.
And what of the banks
From the non-bank
market making community, the opinion seems split on this one. A senior figure
at one firm claims to have seen a number of banks “pulling out aggressively”,
while another says that a couple of the banks that they work with turned off
their auto-hedgers and basically stopped pricing clients.
liquidity provider disputes claims that banks left the market altogether,
suggesting that they were still in the anonymous ECNs but just not in the
single dealer feeds. They add that they saw both banks and non-banks widening
out their prices though.
Asked about whether
some banks pulled out of the market during the volatile market conditions and
one non-bank market maker simply shrugs, stating that they don’t know what bank
liquidity was like but they felt like their firm was getting more flow during
volatile trading conditions, suggesting that some firms – and not necessarily
banks – may have stepped out of the market.
And yet speaking to
market participants the general opinion was that, although the banks widened
spreads in some cases and “actively managed” their risk at a higher frequency
than usual, they did a good job on the day as liquidity providers.
approached by Profit & Loss
officially declined to comment, sources on several trading platforms and bank
trading teams are more positive about how things went. “There are probably
seven or eight major bank liquidity providers and they were all in the market
throughout the event,” says a senior source at a trading venue. “They weren’t
always top of book but they provided depth of market and did significant
source tells Profit & Loss that
their venue saw a “significant” number of large trades during the sterling sell
off on Friday and that “the liquidity provider in every one was a bank”.
The source adds,
“Non-banks were great throughout the event but so were the banks – I didn’t see
much difference between them.”
A bank e-trading
source is slightly more cynical over the non-bank claims arguing, “If you
measure your success by being top of book in the smallest amount possible then
yes, they were better, but most real clients wanted a price in more and they
got that from our feeds.”
The e-trading source
adds, “We focused on our disclosed, single dealer stream to make sure our core
customers were well serviced and there were no issues. We measure our success
by how happy our clients are, not by how happy our competitors are.”
Known Unknowns Vs. Unknown Knowns
Although the performance
of liquidity providers, on both the bank and non-bank side, no doubt
contributed the orderly functioning of the market, the fact that the UK
referendum was a known risk event is probably a more significant factor that
This “known unknown”
meant that market participants could prepare for either outcome of the
referendum. This meant retail
platforms were able to raise margins ahead of the event, banks were very
careful in terms of the credit that they allocated to clients and ECNs checked
over their technology and ensured that extra support staff were on hand to deal
with the increased trading volumes.
Some of the non-bank
market makers also emphasise the preparation that they under-took ahead of the
referendum to ensure that their systems worked as expected.
“We had weeks of
preparation ahead of this event. We had been in talks with trading partners at
the banks, at the ECNs and with our direct customer relationships and we
calibrated our technology ahead of the event? in preparation,” says Isaac Lieberman,
CEO of Aston Capital Management (ACM).
He adds: “We
built all this high-tech ?machinery and ?structured all our credit and trading
relationships ?alongside our risk management and ?quantitative strategies?,
?but prior to Friday’s volatility it ?felt like having a Ferrari that had never
been taken out on the track.”
The head of another
alternative liquidity provider says that in the build up to the referendum that
their firm had been re-checking its systems to ensure that it could handle the
possible heightened volumes and volatility. In addition, they explain that
staff at the firm had been preparing for a variety of possible scenarios, such
as if a trading venue that they are executing on suddenly goes down in the
middle of a volatile market movement.
described the build up to the referendum as “business as usual”, stating that
they felt it necessary to make limited preparations for the event beyond having
extra staff on the desks or monitoring the trading systems more carefully ahead
of and during the vote.
While it is no doubt
impressive that the FX market continued to function well during a period of
sizable volatility, there remains the question of whether this is an accurate
barometer of the industry’s ability to cope with unexpectedly stressed market
conditions given that market participants had so much time to prepare for it.
In response to this
question some, while acknowledging that an unexpected risk event is always
going to have a greater impact than an expected one, still claim that Friday
illustrates how the market has improved its ability to handle extreme
volatility and volumes.
They point out that
although a vote in favour of a Brexit was always known as a possible outcome,
this is not what the market expected. At the New York close, the exit polls had
the “Remain” campaign in the lead and even Nigel Farage, one of the most
prominent “Leave” campaigners, said that he expected his side to lose the vote.
Therefore, it could be
argued, considering that the market was wrong-footed by the result of the vote
and just the sheer size of the moves that were occurring in sterling, this was
a good test of the FX markets’ ability to function in stressed conditions.
“What was really
unique about Brexit was the absolute range of the day from the high of cable to
the low. The large intraday swings experienced used to be more natural FX
trading behaviour but they got dissipated over the past couple of years with
electronification and all the asset class correlation? linkage?,” says
Lieberman, who claims that the response
to the Brexit vote has proven the robustness of the FX market.
Others, however, say
that the timeframe that market participants were working to before and during
means that Friday is simply not an accurate gauge of whether the market has
improved its ability to handle another SNB-like event.
They point out that
firms have had weeks to prepare for every scenario, were overstaffed and had
people working throughout the night to ensure that things ran smoothly. In addition,
they highlight the fact that voting results were dripped into the market,
meaning that trading sentiment slowly shifted as it became increasingly clear
that the “Leave” campaign was going to win. Because of this, markets had time
Nazarali, head of CES FX, says that although a known event like the UK
referendum is not directly comparable to a surprise event like the SNB
de-pegging, experiencing the former can help firms to more effectively deal
with the latter when they occur.
“I think that the
industry’s development of playbooks for various scenarios was one of the good
things to come from all of the preparation done ahead of the vote. The
existence of these contingencies will help minimise disruption from future
unanticipated events,” he explains.
Regardless of what
June 24 tells us about the FX industry’s ability to handle future Black Swan
events, both known and unknown, it seems that overall it was a positive day for
the FX industry. During a highly volatile market, trading continued smoothly
and it seems evident that the non-bank market makers were an important part of
the eco-system that enabled this.