Profit & Loss introduced a new format at Forex Network Chicago, which took place September 28-29. The second day was dedicated to the Profit & Loss Challenge, during which conference participants broke into working groups under five key topics: Geopolitics, Regulatory, Liquidity, Execution and Technology.

Raising the curtain on the day’s discussions during a new format on Day 2 at Forex Network Chicago, managing editor Colin Lambert kicked off with a series of questions to get the conversations going with topic speakers. Mario Manna, CEO, Nightberg, led the discussion around Geopolitics; Chip Lowry, senior managing director, State Street Global Markets, and chair of the Foreign Exchange Professionals Association (FXPA) led the Regulatory topic; Jeremy Smart, global head of distribution, XTX Markets, ran the Liquidity group; Paul Aston, CEO, Tixall Global Advisors, led the Execution group; and Svante Hedin, global head of electronic markets at SEB Merchant Bank, headed the Technology discussion.

The day started with a Q&A with each of the five main topic speakers, who then joined the working groups to address a set of three key questions: What are your biggest concerns? What is at the root of these problems? How do we solve them?

Starting with Geopolitics [Ed’s note: the session took place six weeks before the US elections], Manna said: “The importance of geopolitics is rising, first as a topic of intense interest due to what we read and people we talk to, but it’s also a big source of a rise in volatility. Post-crisis, central banks have done all the heavy lifting that they can do, and although there’s been some progress, we’re still not booming – we are still in this funk – and that is causing a lot of frustration.

“There’s a desire to get back to some sort of normality,” he continued. “What we’re seeing is that politics has been the outlet of these frustrations and angst. We are seeing it around the world – one great example being the Brexit vote – a political event that caused the biggest one-day drop in the British pound’s history. So right there you have a political event causing this market move, and it’s much more than a [referendum], it’s a systematic change going on – there are treaties to be rewritten and renegotiated – it has gone beyond a single event, it’s a systematic change. This is where we’re seeing political angst being institutionalised.

“We’re moving from a strategic horizon, where the outlook was five to 10 years, to now, where the investible horizon is 12 to 18 months. Within that, we have some very big events coming that need to be factored in. This year, we have the US elections and the Italian referendum, while next year we have elections in Germany, France and the Netherlands. These events will carry even more weight going forward.

“Looking ahead, we need to have a practical process, actionable tools to sink our teeth into in order to get a clear line of sight. There are three sources of volatility – economics, politics and monetary policy c and we’re seeing a clear shift towards politics at the moment. So what can we do? In this digital ecosystem, we need to have tools to look at these events with predictive analysis,” he concluded.

On the Regulatory topic, Lowry raised a number of themes for his group to consider. “Like ether, regulation permeates everything, it’s everywhere and impacts everything,” he noted. “What are the implications of liquidity on the bifurcation of markets? For example, what are the implications of uncleared margin rules? The implications of reporting? Will it change the way people trade? Who pays? The answer is, we all pay. Regulations increase costs – from hiring people, to technology, to even just the general budgeting process – it all impacts what we do.”

With a nod to Spike Lee, Lowry raised the prospect of how do you know how to “Do the Right Thing”? “How do we know what to do? It’s not even clear we know how to act. Phase 1 of the Global Code is out, and there’s going to be a Phase 2. So it’s not final, and you see people trying to do the right thing, but you also see people getting fined for not doing the right thing. The big question is, how do we know if we are being compliant? How do we handle that internally in our own processes?”

Looking at the impact on market structure, Lowry queried the effect of regulation on one’s ability to survive. “Are people bilaterally trading or being forced to clear? Do regulators really want to move everything to clearing and we’re just dragging our feet? What are the implications of that?” he asked.

Along this line of thought, he raised the question about how the Global Code will be given teeth to be effective? “Unless you regulate the entire industry – some are regulated under the Code, but some aren’t – how do you evidence adherence without an overarching regulator?” he asked.

Turning to Liquidity, Smart opened: “Is there less liquidity in the spot market today than there used to be? I think so. But you have to think about discovery – how you find and access liquidity – is it all done on the same basis?”

Beyond spot, Smart mentioned options and NDFs. “If you look at the options market, it may not be dead, but it’s pretty unhealthy looking. Will that market come back?” he asked. “Certainly with clearing, non-banks would have the ability to provide pricing, but until then it remains a bank domain. You can say the same for term trading in forwards and NDFs as well. What has been the impact of there being less liquidity? Is liquidity ever actually coming back?”

Another theme he raised was around fragmentation – will markets come back together again, or will there be further fragmentation?

“Obviously, there is more fragmentation of markets, but now we’re seeing fragmentation by protocol as well. Private rooms are being set up – risk capital is disappearing from the traditional core market venues into private rooms – just as it did in equities, where allegedly 30% of the market is trading in dark pools. Is that a trend that’s going to continue in FX as well? Are we going to see more risk capital disappearing into private rooms and individual bilateral relationships, and away from the traditional core market venues? Is that healthy for transparency and core price in the lit market?” Smart asked.

For Execution, Aston explained that one’s vantage point is key. “You can’t execute unless you can really see what your liquidity looks like, what the market looks like, and what it’s all about,” he said. “The issue of how much control you can maintain over execution when you’re dealing with counterparties is important. Obviously, that control can shift and be out of your control at certain points, while the real driving force is managing your implementation costs. This goes to a more holistic level than just transaction costs. I look at implementation as the overall net effect on your mandate, whether maintaining assets under management or trying to transact in a corporate sense – all that filters in,” he said.

“Visibility is also key. Everyone has a different picture of the market and that is shaped by the fact that this is a credit-based market. You have participant relationships or streams as your view of the market, but it may not be a complete view, so to make sure you execute as efficiently as possible and manage implementation costs, it’s critical to have sources of liquidity that can give you that complete vantage point – so you can see what your opportunities are and where you can deal. A lot of counterparties like real money accounts are heavily banked. They’re going through banks almost exclusively in many cases and you can say they have a very censored view of the market.

“You could also say very sophisticated prop trading and hedge funds are executing through non-banks, platform execution methods, or through prime brokers, and perhaps missing out on the ability to have a bigger balance sheet to help them with bigger transactions. The market gets very squirrely and liquidity dries up, particularly in certain currencies, so that liquidity perspective is critical. The issue of control, whenever you’re executing, in the way you leave your order with a counterparty is critical. You can lose control of your implementation immediately.

“If you use algo execution, you’ve abdicated control to that algo. Unless you built it yourself, do you know what its mechanics are, its flaws, what information it’s leaking to others in the market? This is especially true as we see more and more externalisation of liquidity as market makers get more and more diverse – less is being internalised and risk is being constrained. So if you have an algorithm working on your behalf or leave a large order with a counterparty that is relatively trusted, if they’re externalising, all of a sudden they have control of your order, they’re taking on your fiduciary responsibility. That needs to be looked at, maintained and managed.

“So with regards to implementation, what you’re really trying to manage is not just transaction cost and a point in time notion that I’ve got a really tight spread against this timestamped millisecond, you’re looking at the broader picture,” continued Aston. “Implementation takes place across time, you’re looking at a continuum or dynamic path of mid- prices or a dynamic path of opportunities, but what you’re really trying to manage is market impact and information leakage. Those can be very deleterious effects – information leakage can spin out of control.

“Just the very nature of going and lifting liquidity out of the market, if the counterparty who provided you with liquidity turns back to the market to cover their risk and you have another slice going in – you’re now looking for liquidity and so are they. If you then go lift another slice of liquidity, you’re propagating the market impact. The only way to manage it is to go back to the visibility – if you can’t see what’s happening, you don’t know whether to hold back or speed up your implementation and if you’re not in control of that, there’s nothing you can do – you’ve just given the order to someone else and they may be implementing sub-optimally,” concluded Aston.

In the final topic, Technology, Hedin noted, “The financial industry at large is both sophisticated and complex compared to other industries; however, some areas are stuck in the ‘80s in the way that they do things – processes, but also technology and solutions – that we rely on as an industry,” he explained. “We have representation here at this conference from buy side and sell side market participants, fintech, technology vendors, brokers and trading platforms. Do we agree that as an overall industry we are still challenged in many aspects of how we conduct business digitally and front-to-back? If so, how does the industry find efficiency and progress to where we should be? And as we have representatives here from all sides – how will the banks manage to engage with fintechs in a more effective way?

“How will tech firms help drive this change, and indeed what are those areas? Is it true that banks are so stifled by regulation and other aspects that it is becoming an obstacle for them to move forward?” Hedin asked.

Lambert closed the scene setter by asking whether technology advances at such a pace that disruptors are in danger of being disrupted themselves? “Disruptors become incumbents and I guess the cycle repeats,” replied Hedin.

Galen Stops

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