As always when I write something vaguely controversial I feel the need to follow up on last Thursday’s column – because some people either got the wrong end of the stick on what I was trying to say or I feel the even greater need to beat them down on their views of last look. […]
I have been quite vocal in recent weeks about the need for responsibility in financial markets generally and in particular have expressed the opinion (which has not gone down that well I will confess) that unless there are specific circumstances, for example, a bilateral trade on a private venue where both parties agree it was wrong, we should never consider re-papering trades. It is now time to take a different perspective on this, although I hasten to add I have not changed my mind – “always certain”!
The communications channels have been buzzing following Thursday’s column about banks taking more risk in their FICC businesses – especially FX – and some really good points were made by correspondents. But while there was general agreement that more risk-takers would benefit the broader industry, my correspondents and I diverged on a key point. To me this is not about spreads or the advantage of man over machine (or vice versa), it is about the risk taking role adding something different.
A new research note from Pragma Securities is seeking to challenge the perception that banks are increasingly stepping back from providing liquidity to FX markets.
The firm notes in the paper that the “typical narrative” is that? reduced appetite for risk, controls on ?capital at banks, as well as juniorisation of dealer staff have all contributed to this withdrawal that led to an “increased fragility of the FX markets”. The paper adds that the general consensus seems ?to be that liquidity is getting more expensive, and while spreads are? narrow in times of normal volatility, in? times of market stress dealers effectively pull away from the markets, contributing to extreme volatility and events like flash crashes. ?
Monday’s column touched a nerve with its criticism of market makers that quote ridiculously large spreads. Of course, we should also question the quality of controls at a participant that allows someone (or something) to hit a big 35 big figures below the last price.
Going back to market makers though, perhaps we need, using the execution quality analytics now available, to start naming and shaming the worst offenders? I personally have no problem with this and I think I would have quite a bit of support.
Patchy liquidity and the lack of pre-positioning cannot alone account for why we get some wild moves in markets – sometimes the liquidity providers should wear some of the blame. How else do we explain spreads in Cable that are almost as wide as the entire range this decade?
The lack of incentive to take any risk doesn’t help, but what justification can a market maker have for quoting 50 big figures wide? At that spread, they might as well pull out of the market altogether.