There seems to be general acceptance that last week’s flash crash in sterling merely highlighted what we have known for so long – there is a growing structural problem in FX markets.
Identifying a problem and solving it are, however, two entirely different things and in spite of the spirit of innovation reawakening in foreign exchange markets, my sense is that whilst the solution I propose here is unpalatable to some in authority it may help central banks better understand markets and curb flash events
Bob Savage, CEO of CCTrack Solutions, talks to Profit & Loss deputy editor, Galen Stops, about why geopolitical unrest this year hasn’t translated into more FX volatility.
This year has been marked by a high degree of geopolitical unrest and uncertainty, with Britain voting to leave the European Union, Italian banks struggling ahead of an important referendum later this year, questions being raised about the future of Europe and a divisive US presidential election.
Meanwhile the war in Syria continues, ISIS has not been defeated, Russia is considered to be actively attempting to expand its sphere of influence and there is the suggestion that some long-time US allies in Asia – such as the Philippines – could drift closer in their relations to China in the coming years.
Today’s column is definitely not one for the teenagers – indeed it looks at an issue only those of us of a (ahem) certain vintage, will remember.
I was fascinated to read over the weekend that there is a something bubbling up in Malaysia over FX losses made by the country’s central bank in the early 1990s. Apparently the issue has re-emerged as a whistle blower now claims that the bank lost $10 billion trading and that there was no official investigation.
Following the sterling flash crash last year there has been much industry debate about what the increasingly regularity and severity of these events means for FX market participants and whether anything can be done to prevent or mitigate their impact in the future.
According to Neil Crammond, risk manager for FX at Avem Capital, part of the reason why these flash events are occurring is simply that markets aren’t used to the levels of volatility that used to exist prior to the financial crisis and the implementation of quantitative easing by a number of central banks.
“I think that the problem with the modern FX market is that pre-2008 if you came in every day and someone said to you that “we’re going to have a 300 tick move in the cable every day”, you’d trade according to that,” he says.
Following his retirement from Citi, where he spent nearly 30 years and most recently served as global head of G10 FX, James Bindler, reflected at Forex Network London about the changes that he’s observed in the industry.
He’s also made a number of predictions regarding its future.
1. The line between banks and non-banks will continue to blur
“As always with all these things, it comes from both sides of the equation. Banks will get faster and high-frequency traders will seek capital to backstop their risk taking activities,” said Bindler.
Discussing the challenges facing market makers, Bindler noted that the cost of FX trading is generally rising, particularly for firms that need to use prime brokers to access the market.
The starting point for this column has to be the observation that, by and large, foreign exchange dealers do like a moan. Let’s face it, we’re a bunch of whingers and the events of the past week – thanks to flip-flopping central bankers – have only reinforced this trait. Are we, however, looking at things the wrong way? Markets undoubtedly adjust quicker to events than they used to, but is there an opportunity for traders in this? I happen to think there is.
I am very grateful for the responses to Thursday’s column, ranging from congratulations, through jokes, to guesses as to exactly what event triggered the Cable drop I was talking of. On the latter the favourite was the infamous (and possibly apocryphal) story of the “Carrier Down” message, but I think it was later than that.
Either way, to complete my self –indulgent look at my top 10 events from my 40 years in foreign exchange, here are the top five.
There was, naturally, quite a lot of attention on the return of EUR/CHF to 1.20 on Friday, most of if, naturally again, frivolous. On a return basis, anyone who didn't care about mark-to-market would have been back in the black in the mid-1.19s thanks to carry, but that didn't stop people like me joining in the frivolity, tweeting the market may have an issue working through the 1.20005 offer for 20 yards. It shows though, how much the event is embedded in the market’s psyche that we are commenting about it.
The Bank for International Settlements’ Markets Committee has released a report by a recently-formed study group, which looks at the evolution of what it terms fast-paced electronic markets, focusing mainly on spot FX, and the challenges this evolution has for central banks.
The report says the market structure changes have implications for central banks’ approaches to market monitoring, including the range of participants with which they engage, the types of data they collect, and the tools and technologies they utilise.