Concannon Ready to Create Price War in FX to Make Hotspot Leading ECN
Hotspot plans to increase competition in the FX market by creating a price war, Chris Concannon, president and CEO BATS Global Markets, says of the recently acquired FX platform. Speaking at Profit & Loss Forex Network London 2015,
Concannon outlined the exchange group’s plans for growing Hotspot, but warned the FX industry not to follow the example of the US equities market, particularly in terms of market structure.
“Do I see the FX market looking like the equity market? The answer is no,” he said. “I think it’s adopting certain things from the equity markets, algos for example, but the regulatory structure and the interaction of the market structure is very different.”
According to Concannon, the FX market also cannot just migrate to a pure exchange model and still places huge value on customised liquidity solutions. “I would argue that the equity market needs more customising,” he explained.
BATS is heavily involved in the ongoing US equity market structure debate, but Concannon reiterated how the FX market should not follow this example. “Given that the FX market is a global market, I don’t think just one regulator can step in and dictate market structure, but what they can try to do is dictate market behaviour. That ultimately affects all banks and participants.”
Concannon, a former SEC lawyer, argued that FX regulations are being determined by the “next great settlement”, which he believes is a problem for the market in itself as “regulators should not set policy through enforcement”.
In addition, he believes that the FX market is not just fragmented within one jurisdiction, but rather that it’s fragmented around the globe across the full 24-hour period.
He observed: “There are liquid periods and very illiquid periods. When you have a fragmented but fully automated market you get a thin layer of electronic liquidity. Once you pierce that layer you have an SNB event, a mini-flash crash.
“As an industry we now need to spend some time deciding what the proper collar is to put on our market – where we stop and think whether that price is rational – and start trading again, Concannon added.
But he does not believe there is a role on Hotspot for latency buffers, etc, and says there are no plans to drive the ECN into a super-fast, pure “all-to-all” market.
“It’s a mix of both – firm quotes and non-firm quotes,” he said. “I think that’s more important than raw speed. There’s only a few exchanges that have implemented latency floors and there’s probably a reason for that.”
Instead, he sees the main challenge for Hotspot, and the industry, lying in liquidity management and working out how to grow liquidity over time.
As the end user becomes more sophisticated in terms of technology then all flows become sharper, he explained.
When weighing up the relative benefits of acquiring Hotspot, Concannon said that one key factor was that the Hotspot client base is near-identical to the BATS global client base.
Growth for Hotspot is expected to come organically, and as the overall market grows year-on-year, he added.
“We can differentiate Hotspot in terms of technology, service and ultimately cost,” Concannon explained. “When a market goes through structural change – where a component that was once principal-based converts to agency – then cost control becomes a focus.”
In the early stages there are a number of structural changes the company has to make, he added, including the launch of a London hub and relocating the existing Hotspot data centre to the BATS data centre in New York.
Precious metals is a market that has also been underperforming, according to Concannon, and it’s also a market that is very London based, particularly for spot gold, which Hotspot launched earlier in the week.
He added: “We want to grow that spot market. It’s been very dominated by futures, partly due to regulatory pressures. The spot gold market has been very much underserved.”
Further down the line, the business plans to look at adding other FX products such as swaps, forwards, NDFs and FX options.
While BATS is currently “very close” to being the number one US equities exchange, Concannon said it is also planning on becoming the number one US equity options venue, as
well as number one in FX for electronic execution in terms of ECNs. BATS is already the number one stock exchange in Europe by market share, and operates Europe’s largest trade- reporting facility.
“Are we heading towards a price war? That is our intention,” he said. “I want to create a price war. We’ve already started.”
Is a Mandate Irrelevant in Moving the Market to Clearing FX?
While many market participants believe that FX clearing took a big step backwards in February when the European Securities and Markets Authority (ESMA) decided to postpone a mandate for clearing non-deliverable forwards, LCH.Clearnet’s Gavin Wells maintains that such a mandate is largely “irrelevant” for the market to move to clearing.
“It isn’t about a mandate or a stick anymore. Although the market got ready for clearing under threat, it is now preparing for clearing because it makes commercial sense,” said Wells, global head of ForexClear at the multinational central counterparty clearing house, speaking on the “FX Clearing: One Step Forward, Two Steps Back?” panel at Profit & Loss Forex Network in London.
“The reason the buy side want to clear forwards, while the banks want to clear certain options and want others to clear forwards, is because it is possible to achieve better netting in one place, it is cheaper and truly mitigates counterparty risk,” he explained. “What better way to mitigate balance sheet risk but through multilateral compression? So mandates are basically irrelevant.”
He said that FX options are steaming ahead and will be ready to clear in 13 months’ time, with or without a mandate, “not because you have to, but because it saves you money”.
But does the buy side have a full picture of the business benefits? Steven French, director of product strategy, Traiana, thinks that all market players have more work still to do to educate their clients. “There is a genuine interest from the client community with respect to clearing, but they need a clear business driver. They need to understand what the portfolio- margining opportunities could be. Everyone talks about it at a high level, but we need to distil it down and explain the benefits in granular detail.”
While agreeing with French and Wells that the market driver will come down to economics, Dicky Wilkinson, director, post- trade solutions, Contango, believes that delaying the requirement to post uncleared margin until September 2016 may stall the voluntary uptake of clearing, because it is not cheaper at the moment to clear.
“People will carry on as they have done because they don’t have the budget to reinvest in technology,” he said. “A lot of people are confused about exactly where regulation is going to land. They don’t have the budget today and the last thing they want to do is spend on something that becomes a white elephant.”
Additionally, Alex McDonald, CEO, the Wholesale Markets Brokers’ Association (WMBA), stressed that the lack of harmonisation across jurisdictions has meant that “the hurry up and wait” argument is still ongoing. “The process is inter- jurisdictional, inter-product and it is global in the sense of execution, as well as location of clearing houses. All of these ducks need to line up and it feels like we are in this extended period of lining ducks up.”
Wilkinson also contends that the issue of concentrating risk in a diminishing number of clearing brokers is delaying buy side take-up. “The reduction in the number of GCMs [general clearing members] and FCMs [futures commission merchants] means that the buy side, rather than having 15 or 20 counterparties, is going to have to push their business into one FCM or maybe two, because of geographical spread depending on the number of CCPs – currently there is only LCH.Clearnet and Nasdaq,” he explained.
He thinks that it could get down to 10 or 12 FCMs that will clear all markets. “People talk about ‘skin in the game’, but CCPs aren’t looking at the concentration risk that is coming as more and more FCMs drop out, because they can’t make money as a result of regulations.”
The panel discussion also touched on the increased rhetoric around CCP risk, recovery and resolution that has been dogging the industry this year.
Wells argued that the ‘skin in the game’ debate completely misses the point. “The assertion is that the banks are well capitalised, as are many institutions, so why shouldn’t CCPs be? But the capital of a CCP is not about guaranteeing the loss– that is the margin,” he said. “A CCP is not exposed; its net is zero. In default it is only exposed briefly until it auctions off the positions back into the market. That is its function.”
While the FX market has always been widely cleared, it has been cleared by the banks and brokers, not CCPs. “However, as CCPs are linked to payments systems, and FX is all about payments, then CCPs need ‘skin in the game’ and they need resolution protocol,” argued McDonald.
McDonald is also unconvinced that much will have changed five years into the future as to what the FX market looks like in terms of clearing. “Clearing won’t really happen until you have a trading mandate, which will kick in after MiFID II is implemented. You will then have far more venue trading and more banks acting as agents, rather than principals.”
Wells returned to his original point. “I don’t think you need a trading mandate, because clearing is about reduction in cost, which in turn increases liquidity. So a trading mandate is not needed to decide whether to clear, nor is regulation. What is needed is a commercial imperative.”
Emerging Markets: Leading the Way Onto Exchange?
Emerging market currencies continue to be an important area of development and opportunity for the global foreign exchange market, notwithstanding the increased focus on G10 currencies as volatility returns. With NDF clearing on the horizon, will EMs take the lead towards a future industry structure? Does an exchange-traded model work better in EMs than the traditional OTC model?
These questions were hotly debated among a panel of EM FX industry experts – two participants from the bank side and two from exchanges – at the Profit & Loss Forex Network London 2015 conference.
Marc Millington-Buck, head of international FX sales, Moscow Exchange (MoEx), led the charge in favour of trading EM currencies on exchange, outlining a number of technical and legal reforms MoEx put in place during the past 18 to 24 months to provide FX market participants with assured net settlement.
“Our members and end traders see this as a safe way to trade. Yes, volatility is back, but that can be good or bad, depending on whether the marketplace is able to handle that volatility,” he said.
“A positive factor of completing the MoEx FX market reforms and receiving Iosco certification as a CCP was that we had opened and increased international access to MoEx such that almost 50% of all MoEx FX trades came from international clients or were transacted by their international subsidiary exchange members,” he added.
“Consequently, despite the increase in geopolitical tensions reducing offshore OTC bilateral credit lines for RUB FX trading, MoEx FX total average daily volumes increased from $12 billion at the start of 2012 to $24 billion by the end of 2014. In addition, MoEx FX market share of the regulated USD/RUB market increased from 30% to almost 60% during the same period.”
The exchange uses a CCP cleared model to reduce counterparty risk. In addition, the Central Bank of Russia (CBR) provides a swap line to the CCP, which is a highly capitalised and regulated bank with the best credit rating in Russia, to ensure enough liquidity for settlement to occur. “Other venues struggle because they don’t have those assurances – instead they have bilateral trading, with counterparty and gross settlement risk,” Millington-Buck said. During recent events, such as when the ruble (RUB) saw a 40% move on 16 December, the MoEx remained open and settled every trade without a single default, according to Millington-Buck. “Everyone was able to trade using the pre- trade risk system, including international traders. We believe that this showed the world how a CCP on-exchange cleared model with net settlement could work on a large volatility day when a central bank decides to stop supporting or actively intervening in the currency market.
“This model really works for EM and in times of high volatility would even work for a developed currency like the Swissie in January, where again the MoEx FX CCP model was also proven to work. MoEx regulated FX market share was operating around 90% in December and January and has since remained around the 70% level due to both reduced counterparty and settlement risk in bilateral OTC FX venues and the aftershock of the Swissie event.”
David Pavitt, head EM FX trading London and head of RMB business development for markets EMEA, HSBC, agreed that trading on exchange provides risk mitigation and removes the need to worry about the credit of the name covering the price, which should aid markets during extreme volatility. However, he wasn’t convinced that this solution addresses the specific challenges of trading EM currencies.
“A price can go missing from time to time in EM and that doesn’t happen in G10 – obviously leaving aside the Swissie. Generally speaking there is always a price in most G10 markets. It might be an expensive or volatile price, but there is always a price,” he explained.
“However, at times there is no price in EMs. At that point you are trading on your experience and knowledge of the market to make a client price as a market maker, even though there is no price to base your price on.”
Millington-Buck countered, “If more EM exchanges followed the example of MoEx and provided a cleared CCP model with net settlement and central bank-backed liquidity, that creates a platform where local banks and non-bank market makers can continue to provide prices for the international and local participants. As a result you won’t get a situation where you don’t have a price.”
Stéphane Malrait, head of global e-commerce, financial markets, ING Bank, pointed out that EM currencies haven’t moved onto exchange mainly because these are largely still voice driven. “We need EMs to go more electronic before we see a real move towards exchange trading. While there is a lot of local liquidity in EM currencies, it is the voice traders, not electronic markets, that provide it.”
Interestingly, both Millington-Buck and Will Patrick, executive director of FX products, CME Group, agreed that not all volumes will – or should – shift onto exchange. They believe that OTC markets play an important role in a well-functioning market and that it is important for the exchanges to support the OTC market by being a major source of liquidity for OTC markets to make prices.
“The OTC market needs to exist and we want to clear that business,” Patrick explained. “And when we do, natural market forces will drive customers towards us, because they will want to portfolio-margin their OTC cleared with their futures. Most clearing houses are aimed at gaining cross-margin capital efficiency.”
The panel discussed the European Securities and Markets Authority’s (ESMA) recent decision to postpone implementing a clearing mandate for non-deliverable forwards (NDFs). Many market participants saw this as a step backwards in terms of market evolution, particularly since some larger EMs, such as Brazil and Russia, already centrally clear a substantial amount of NDFs.
“For the past year, with the advent of SEFs and regulations, etc, the market believed that we were heading in that direction,” said Pavitt. “So it was a real surprise to the market that, that didn’t happen and could now significantly delay trading NDFs on exchanges, although we are aware that trading NDFs on exchanges could pose challenges to our clients.”
But Malrait made the point that the industry just wasn’t ready. “I believe that participants are less confused now than three years ago, especially in terms of regulation and harmonisation between the regions. As soon as we get more clarity then we will see greater evolution; but we have to give time for the market and players to adapt.”
The panel also debated the importance of CLS for trading and reducing settlement risk in EM currencies.
In the context of growing volumes of CNH, which is not a CLS currency, Pavitt raised the issue that this has resulted in more bilateral credit exposure between counterparties that participate in that market. “Potentially that could have a spill- over effect in other non-CLS EM currencies, in terms of product and credit structure, because CNH is eating up bilateral credit between market participants,” he explained.
The question is of particular relevance for the RUB. In September 2014, CLS decided to delay the Russian currency’s addition after almost a year of preparation by the Central Bank of Russia.
MoEx has addressed the credit and settlement risk issue, according to Millington-Buck, through a CCP model with a swap line from the central bank. “We have reduced credit risk for members, so that issue won’t crop up as RUB volumes grow. Plus MoEx has its own original version of CLS operating in Asian, European and American time zones providing net settlement for RUB, USD, EUR, GBP, CNY and HKD.
International and domestic clearing members are even clearing their OTC trades and making use of MoEx net settlement facility,” he explained.
“Although we have never needed to use the swap line, it is there to provide confidence that net settlement will happen. This is a good example for emerging currencies to follow.”
Additionally, Millington-Buck doesn’t believe that CLS addresses the particular requirements of EM currencies. “The USD/RUB settles in the afternoon for good reasons, because it isn’t an easy currency to settle, even if you have a central counterparty,” he said. “Maybe there needs to be a version of CLS for the EMs that understands the nuances of why things settle when they do and how they work.”
FEMR: Where London Goes, the Rest of the World Follows
HSBC’s global head of FX and commodities regulatory change is “very optimistic” that the processes and procedures put in place to address recent concerns will have a positive outcome on the global FX industry.
Speaking at Profit & Loss Forex Network London 2015 , Allan Guild said the industry has significantly invested in improving conduct, developing granular business standards and ensuring continuous training, with the aim of improving the culture of the market.
“But we can’t just draw a line and say that is enough,” he added. “We need to be constantly improving the way we offer products and services to our customers, and know that success relies on how we structure and conduct ourselves as an industry.”
The Fair and Effective Markets Review (FEMR) was an appropriate way to begin the process, according to Guild, specifically in identifying potential conduct grey areas. Established by the UK Chancellor, Bank of England and Financial Conduct Authority, FEMR has gained international significance as the benchmark for a market that is truly global in scope.
Guild also expressed his support for the “global preamble” on codes of conduct agreed by eight central bank FX committees in March. “Everyone should read it,” he advised, “It does a good job of setting out the conduct expected of participants in the FX market. It is extremely helpful for central banks to set out standards across different regions, FX products and participants.”
The next step is moving from the type of guidance seen in codes of conduct to policies and procedures around how to handle benchmark orders and stop/loss orders, for example. “The primary responsibility lies with the individual and institution, but the more we can consult with each other and work with regulators on harmonising business standards that are transparent to everyone in the market, the better the outcome will be,” he said. “The more granular the business standards the easier it is to put in place necessary systems and controls to monitor compliance.
“Within the major institutions and more broadly there is a huge focus on developing and training staff,” Guild added. “But this isn’t a ‘licence to trade’ stamp, or a box ticking exercise, where an individual sits one test in their career. It is about an ongoing program of people development and making sure the right individuals are making the right calls.”
Whether trading qualifications will be part of an accredited programme is one of the many ideas being considered ahead of FEMR’s final recommendations expected to be released in June.
Panellists Cite Regulation, Technology as Biggest Disruptors in FX
Disruption’ is a word frequently bandied about in the foreign exchange markets. By definition, disruption takes a different direction to the status quo and literally uproots and changes how people think, behave and do business. Therefore, it came as no surprise when regulation and technology were cited as two of the biggest disruptors in FX by a panel of speakers at Forex Network London.
“Over history, the number one disruption to markets – aside from macro events – is regulation,” said Chris Concannon, chief executive of BATS Global Markets. “If you look at the major changes that have occurred across different asset classes, regulation has been very disruptive. Sometimes it is good for certain participants – typically the goal is to be disruptive for end users – but sometimes it can end up with unintended consequences.”
Concannon’s comment comes amid a sea-change in the FICC trading landscape. With higher capital requirements, tougher regulatory oversight and numerous new rules such as the incoming Basel III regime, the Volcker Rule, MiFID II and those within Dodd-Frank and EMIR, banks have had to retrench and adapt to a new and often confusing world.
The foreign exchange market in particular is facing an unprecedented amount of regulatory scrutiny and is awaiting the final responses to the Fair and Effective Market Review (FEMR), which wants to increase financial transparency after a string of scandals around the alleged rigging of the Libor and FX benchmarks.
Technology meanwhile has been a major disruptor in voice- driven markets, especially as firms have found more innovative ways to overcome the difficulties in negotiated markets.
“Disruptors can have a negative connotation but to me, technology has been, and will continue to be, disruptive in a good way,” said Alan Schwarz, chief executive of FXspotstream. “As a result of innovative technology, people are interacting in a different way, which causes prices in the market to get better, costs to go down and as the ability to trade with each other improves, trading becomes more transparent.”
Recent types of innovations coming on to the market include mid-match trading and randomisation, added Simon Jones, director at Pierrepoint FX.
Other disruptions to the market have been caused by the Swiss National Bank’s decision to scrap its cap on the franc, agreed the panellists. Not only did the move send the Swiss franc soaring against the euro and create turmoil in the markets, the whole prime brokerage space is now being challenged with firms raising capital requirements, dropping smaller clients, reducing their prime brokerage operations, or closing them down altogether.
“When it comes to disruption there’s intended and unintended disruption,” said Andy Coyne, an independent consultant, formerly chief executive of Traiana and head of FX prime and G10 e- commerce at Citi. “With the SNB’s move there was some unintended disruption that came out of that. There are clients who are being asked to exit from the prime brokers and moving to prime of primes, but we’re not so sure if all clients will find a home. There is also an issue around credit and the control of credit.
“Credit never kept pace with technological development on the execution side so there are a lot of discussions about the benefits of pre-trade and post-trade credit. With Basel III regulation coming in, people have to look at how to reduce their balance sheet and credit exposures. We are starting to
see different pricing models from the PBs because they have to pay much closer attention to balance sheet usage. All of these things are part of the evolution of the market,” he said.
New UK Consumer Bill Could Open ‘Super Highway’ to Class Actions
The UK Consumer Rights Bill 2015, which increases the remit of the Competition Appeals Tribunal (CAT), has the potential to radically change the legal landscape, effectively opening up a “super highway” to the type of civil litigations common in the US, according to a legal expert speaking at the Profit & Loss Forex Network London 2015.
Set to come into force on 1 October, the Bill will give provision for collective actions based on an opt-out class mechanism. Opt-out claims are usually wider, as all members of a defined group are included in the claim unless they take an affirmative step to opt out.
However, the European Commission has yet to decide on an overarching European-wide class action rule to harmonise collective redress, and historically has favoured an opt-in mechanism that requires claimants to actively join the action.
The opt-out methodology allowed under the Consumer Rights Bill means that there is no need to identify exactly whom the victims are in cases of market misconduct, a question posed to the panel. It is an important line of inquiry because many clients profited as well as suffered during the alleged FX market manipulation.
“A victim is not who claims to be one, but who can prove to be a victim.” said Andrew Bullion, founding partner at Hausfeld, adding that some analytic firms are now offering law firms an “FX damage calculator” product to help potential victims to identify damages caused by FX manipulation.
However, he also explained that analysing the impact of market manipulation is complex. “So if you are a victim for 50% of those transactions, do you have to then set off any which may be the plus side? Or is it purely all losses that you should be repaid for and yet be able to reap the windfall? Producing an impact assessment is not straightforward.”
Bullion believes that one reason there hasn’t been a slew of lawsuits in this jurisdiction, despite the many law firms able to run such cases, is the nuance in properly identifying who the victims are and exactly to what extent they have been damaged. “The US, through its class action system has not, regarding the recent settlements, required all victims to provide claimant-by-claimant impact analysis, one reason why that region may be termed a bit more ‘Wild West’,” he added.
The conference session, entitled “P&L Discussion: The Legal Minefield”, was well-timed just after the news broke of Deutsche Bank’s $2.5 billion settlement with the FCA, the US Commodity Futures Trading Commission (CFTC) and other regulatory bodies.
In addition, three banks – Bank of America, JP Morgan and UBS – recently reached settlements of around $100 million each in an antitrust litigation lawsuit accusing the banks of rigging prices in the foreign exchange market. There are nine additional banks implicated in the lawsuit that have not yet settled.
Matthew Kulkin, principal, Squire Patton Boggs, pointed out that the settlements include a “laundry list” of remedial activities that the banks have to undertake to clean up their shops and ensure monitoring is in place. “It will be curious to see how these settlements play out, because the negotiations leading up to them were rarely focused on the dollar amount and much more focused on the substantive scope of the remedial steps required,” he said.
The panel explored whether the punitive fines meted out to institutions and potential jail time for individuals were enough of a disincentive to correct future behaviour. There was general consensus that to prohibit misconduct is not enough; instead people must be incentivised to behave properly.
The panel also highlighted the political element to the increasing number of quick settlements, particularly as the US prepares for its presidential elections in 2016. The Department of Justice is coming under increased pressure to be seen to be punishing the “bad guys”. But banks play an important role in the marketplace, and if arbitrary restrictions are placed on them for the sake of political points, then that poses serious risks to the market.
“Frankly, the marketplace has suffered because suddenly there is increased scrutiny by policy makers around the world, trying to figure out this market that operates 24/7,” said Kulkin. “They are looking at how it is currently regulated – or not regulated – and what measures should be put in place now. So, in some instances, a policymaker may have a solution and is looking for the problem. If they don’t quite understand what they are doing, then that can be tremendously dangerous.”
While supporting the renewed industry focus on codes of conduct, the panel agreed that the codes have to be adopted and implemented by a regulatory body in each jurisdiction or they will remain just a “nice thing” without teeth. “Unless it is a regulatory violation, it is hard to pursue any sort of prosecution, civil action or enforcement order for violation of a model code,” said Kulkin.
However, when asked to give advice to a new dealer coming into FX, Bullion answered that it was not possible to mandate morality. “If you are ever in the position of authority, hire people for their talent and their brains, but also hire for who they are,” he said, before adding, “As a young person you will be in a position of actually doing wrong or right, it is not just about making more or less money. If you don’t think you can stay out of trouble or hire good sorts rather than bad sorts, then pick another profession.”