Liquidity, fragmentation and geopolitics dominate closing conversations on Day 2 at Profit & Loss Forex Network Chicago.

After each of the five topic speakers gave their debriefing of discussions within the working groups, the conversation opened up between the panelists to explore some of the themes raised during the working group recaps.

Drawing on discussions around both liquidity and geopolitics, Chip Lowry, senior managing director, State Street Global Markets, kicked things off with the topic of de-globalisation, and whether the current trend of countries looking more inward is affecting liquidity.

“I definitely think we’re in a period of de-globalisation, and we are seeing this in the domestic political agenda of a lot of countries,” said Jeremy Smart, global head of distribution, XTX Markets. “There’s been a growth of extreme politics on the left and right, across Europe and the US particularly. To some degree, the Brexit vote was an example of that.”[Ed’s note: this session took place six weeks before the US elections]

This trend, he suggested, is exacerbated by poor liquidity in emerging markets. “Generally,” he continued, “the issue with having very poor liquidity in emerging markets is that it stems the flow of global trade and the flow of capital from one market to another and makes it harder for investment managers, etc, to access a broader set of market places (which by definition makes it more insular and more inward looking). That is fundamentally not positive for growth at a time when we already have insipid growth. It becomes a bit self-fulfilling and that’s the biggest issue around; global politics becomes self- referential and self-fulfilling and that is worrying, and is reflective of de-globalisation.”

Referencing a question raised on a panel the previous day, whether regulators care about liquidity in certain markets, moderator Colin Lambert, managing editor of Profit & Loss, asked: “Do regulators even understand our problems beyond liquidity?”

“Whilst politicians and regulators have focused quite rightly on improving the stability of the financial system, they do care about the second order issues of liquidity and markets with the impact it actually has on growth and economic opportunity,” said Smart. “We see these issues now coming very much to the forefront of their thinking, but poorer liquidity is caused by a complex set of issues that cannot be solved easily or quickly.”

Panellists pondered whether regulators pre-supposed the conclusion without doing the argument from A to B to C.

“For example,” said Lowry, “in NDF clearing, the supposition is that all clearing is good, therefore NDF clearing is good and we’ll mandate NDF clearing without understanding the implications of that with respect to how it fits in a global marketplace, as opposed to a US-centric marketplace. That’s probably repeated around the world.”

Noting that FX is the one asset class the world over that has always been around, Paul Aston, CEO, Tixall Global Advisors, said: “Currency predates exchanges; foreign exchange is the truest, freest form of capital markets that exists, and it’s always going to exist regardless of whatever governmental or regulatory regime that’s in place. But when you put regulatory restraints in place – you’ve essentially put a leash on the dog and the dog can only run as far as that leash allows it to run.”

The panel agreed that regulations can lead to suboptimal solutions. “I think you’re going to start seeing regimes deregulating or re-regulating more on a principles-based approach than a prescriptive approach, which will allow commerce to work freely, markets to capitalise and decide for themselves which are the best mechanisms for doing so,” Aston continued. “But that’s going to take a lot of global coordination and we’re not seeing that – certainly not in the current political cycle – but I think markets are going to start forcing the hand on that.”

Harking back to the topic of pensions that was raised earlier in the day, Aston turned to what could be looming on the horizon. “We’re going to go into a generational period where we start seeing massive redemptions from the system as the baby boom generation starts retiring. That will put massive pressure on liquidity, because the directional flow will be divesting rather than investing and there’s nothing yet on the horizon to replace that. With zero interest rates, there’s been no ability to build that up – we’ve been in a stagnant economic performance environment for the better part of a decade now, and Japan even longer.

“When markets suddenly start divesting, what’s going to happen to liquidity? We could potentially see a financial collapse that metastasizes into a larger problem. Regulators need to understand that, while there needs to be some reforms, checks and balances, they can’t get into overly prescriptive rules that we’ve seen in our markets like trying to get swaps onto exchanges and force the wrong solution onto the problem,” Aston added.

The panellists then looked at what could drive future growth. “The one driver of growth that would be out there is EM, but that’s stifled through this de-globalisation that’s going on,” said Smart. “It is not easy for senior managers at banks to build businesses investing in, say Africa, because of the difficulty of KYC and the risks of lending or trading with the wrong person. The risk/reward is hard to justify and I don’t know how we get over that – because at some stage, we’ve got to bring some risk back into the system in order to kick start growth.”

That means removing the fear factor, noted Lambert. “Does it start with technology? Does it come down to someone being brave enough to fund an innovative idea that works, and then everyone passes through that crack?” Lambert asked Svante Hedin, global head of electronic markets, at SEB Merchant Bank.

“There seems to be slight paralysis, certainly in terms of innovation and taking the industry forward,” Hedin said. “Banks are not innovating at the pace they were due to all the current challenges. Will technology be the answer? It’s hard to say.

“There’s all sorts of reasons why banks are reducing stock, one being that they’re finding efficiency gains by putting into play new processes and better ways of doing things. Does that measure into global growth?” asked Hedin.

“You also need free flow of capital,” added Lowry. “Jeremy hit the nail on the head when he asked who would do business in Africa right now, because the cost of being wrong is pretty big.”

“It doesn’t even have to be Africa,” noted Aston, “Look at Europe’s homogeneity of property rights and laws. You’re not seeing free flow of capital in a very developed market, let alone Africa.”

Going back to the theme of the low, global interest rateenvironment, speaking from the floor, Bob Savage, CEO of, suggested giving up on the idea that central banks with low interest rates are going to solve the world’s problems. “The problem is, a bank with zero interest rates has no incentive to lend credit to small- and medium-sized businesses, which is where the growth is, and that’s being disintermediated using technology as we speak. I’m very, very optimistic that productivity will be going up as banks get out of the business and this zero interest rate policy becomes meaningless,” Savage said.

Lowry added: “There’s no reason you couldn’t have micro- lending equivalents of crowdsourcing like GoFundMe for SMEs where, with the right governance structure around that, people all over the world could lend that company money in any currency and that would be great for our business.”

seems to be slight paralysis, certainly in terms of innovation and taking the
industry forward. Banks are not innovating at the pace they were due to all the
current challenges. Will technology be the answer? It’s hard to say.”

Tracking Trends

Moving back to the subject of fragmentation, Lambert asked the panellists if they thought fragmentation would continue – and whether there was an optimum point for fragmentation.

“I think it will continue,” said Smart, “which is remarkable if you consider how fragmented the market already is. The reason it will continue is because people will try to find an optimal mix of how to deal for their own particular situation, and increasingly, they find that, that’s not by dealing through a single, central pool of liquidity, but by having a relationship-based way of executing where everybody understands the basis on which the transaction is being executed. People will go more and more direct relationships with protocols set to suit both parties and direct agreements around that, so I think we will see more and more fragmentation, not less.”

Whether or not that’s healthy for markets, Smart was unsure: “It’s critical to have at least some coalescence of liquidity in central venues, because that helps price discovery and transparency of markets. Certainly at XTX, we would like to see a greater proportion of the market traded through the CLOBs, but I’m not sure I see the driver to bring that liquidity back together.”

“In a way, it’s just a function of innovation,” added Hedin. “The market finds new ways of doing things, and hopefully new players will emerge and have something new to offer, and that process in itself – until incumbents start losing critical mass and shutting down – drives fragmentation. I don’t think we will see any major consolidation in the foreseeable future.”

“What does an optimum point of fragmentation mean?” queried Lambert.

Aston noted that this topic came up in the discussions around execution. “There’s good and bad about fragmentation,” he said. “If a lot of different entities can take a little bit of risk and together produce a lot of liquidity, there’s capacitance in the market, and that keeps risks in check, because no single organism grows larger than it naturally should, and shocks tend to get mitigated. Maybe a couple of them get taken out, but not the entire system.

“But now, with the consolidation and defragmentation seen in the banking system, you get a big shock and it’s like a flash flood in the desert, there’s not the same capacitance anymore and the same small effect can now have major impacts on the system. So yes, there’s an optimal point. The question is, what is the shoe leather cost to bring all that fragmentation together? If it’s too diffuse, it’s not going to do any good. But again, this is where technology comes into play – a quasi- centralised market that’s pulled together by technology and screens and an ability to have a globally centralised electronic marketplace allows a lot of fragmentation to come to a central point.”

with the consolidation and defragmentation seen in the banking system, you get
a big shock and it’s like a flash flood in the desert, there’s not the same
capacitance anymore and the same small effect can now have major impacts on the


Pivot to Asia

Questions around fragmentation soon shifted towards China. “When we talk about fragmentation, it seems quite clear that we’re moving into a world in which China is a clear part of that. The rise of the renminbi is clearly an alternative to the dollar and the nation that’s going to be using that most aggressively is probably going to be Russia next year when they begin to really finance themselves using the renminbi,” noted Savage from the floor. “Are there any ideas about how technology can really work in a two or three world system? Clearing in China is not going to be the same as clearing in the US – just as during the Cold War when clearing in the Soviet Union had nothing to do with clearing in the US – so how does technology and the world deal with that type of situation and what are the answers?”

“I think they have to be joined at the hip,” said Aston. “At some point – maybe at a central bank level – unless you have shared reserves in those two currencies, there’s no reason to join together or settle them. Those two or three centres start operating an autarchy, and there’s no cross-pollination, there’s no real global trade, but once you get those reserve balances connected, and that’s why the dollar is such a dominant currency despite what’s happened, is because the menu is dollar priced pretty much around the world – it’s the most predominant currency and it won’t go away for a long time, although we may start to see ruble and renminbi starting to gain greater presence in terms of the reserves naturally being held, particularly in large, productive population centres such as those.”


Lambert asked the panelists if they thought that a correct balance between competition and cost efficiency is achievable? “There’s enough competition to keep everyone on their toes, but increasing fragmentation is going to cost a fortune to connect to so many different venues and take so many data feeds,” said Lowry. “Ultimately though, is the next level of fragmentation of markets going to be aggregating the aggregators?”

“Only once the products are the same and homogenous,” said Smart. “That’s the problem, the products are not the same – so you can’t actually compare a price over here with a price over there, because you don’t actually know the basis for which the price is being made – whether it’s last looked or not last looked – whether it’s someone utilising the information you give them in the trade to transact in the market, take a position, or part of a price signal, or isn’t. You can’t compare, because you don’t know the basis on which the price is being put together or displayed.

“What everyone is doing is creating segregated marketplaces which operate on different rule and matching sets,” Smart continued, “The price in one venue is formed on a fundamentally different basis to the price in another, and that doesn’t lend itself towards aggregating an aggregator.”

“That is clearly the purpose of those types of products – to bridge the fragmentation issues in the market, that in itself created room for a lot of new venues to come up and be meaningful,” said Hedin.

“Does this lower the barrier to entry?” asked Lambert.

“If regulators or the markets converged and said you can’t use last look, you can’t use a client’s information in your price signal or to trade or take position or change your hedging strategy, you’d start to see a standardisation of the basis on which prices are made, and that would lend itself to a homogeneity that would support a better comparison of prices,” added Smart.

“Spread compression played a big role in this,” said Aston. “In spread compression, you almost need last look or some other optionality – like airline prices – if you’re going to be competing on really razor thin margins for a seat on an airline, of course they’re going to charge for extra leg room and an extra bag, they have add-ons, because they have to cover those costs.”

“But it’s the other way round in our market, isn’t it? Some people use last look as a mechanism to say, because they have this mechanism, they are able to show you a really tight price because they don’t have to stand behind it or because they are pre-hedging in the last-look window. It becomes, ‘I can’t compare that price with one made on full amount, non- last look basis, because they’re two fundamentally different animals’. However, none of this is transparent to the client pre-trade, and also, many do not have the ability to compare the impact that this difference has on their execution,” said Smart.

“That’s absolutely right,” said Aston. 

difficulty with having a principles- based Code at the moment is because of the
way it has been enforced in the past.”

Lambert asked if at some stage, regulators will get into the granular details of how the market operates in such areas as last look?

“I don’t think they have the appetite for that,” said Lowry. “There’s a huge incentive for regulators to want to have a principles-based Code. The difficulty with having a principles- based Code at the moment is because of the way it has been enforced in the past. People say if anything is grey, there’s no such thing as grey; if it’s grey it’s black and I don’t do it, and that leads to some part of the reduction in risk appetite that you see within markets. If you’re a bank, you are super incentivised to make sure that if anything is in the grey, you either time stamp it and record every action you take and make sure you have a complete audit trail of everything, or you just don’t do it. Honestly, a lot of people in a lot of areas are saying, ‘I just won’t do it’. The risk-reward just isn’t there anymore and that leads to this general reduction in risk appetite. It’s also placing considerable strain on banks’ technology budgets and that is slowing innovation in that sector.”

Paper Trail

Moving a step further, Lambert noted that banks must be 100% clean in today’s environment, 99.9% doesn’t cut it. “In the UK, we now have the Senior Managers’ Regime (SMR),” said Smart. “So if you run a 600-person FX business like we did back in the day, the question senior managers have to ask themselves is, ‘Do I know what employee 600 is doing and do I have complete confidence in what employee 600 is doing?’, because I am liable if they do something wrong and that leads to significant risk adversity. Additionally, the pace of market change is different globally and managers and employees have to be cognisant of the global rules.”

“Because the manager doesn’t know what employee 600 is doing, all the investment is going into market surveillance and making sure you’re complying with the rules,” said Lowry. “Even if you think it’s grey, if you know it’s white, you’re still time stamping it to prove it was white when you did it.”

“If you look at the Conduct of Business rules that exist in the UK, if you think an order is likely to be disruptive to the market, which is a completely subjective judgement, you are required by Conduct of Business rules to pre-hedge it. The rules don’t give you any guidance on how soon or in what way you should do so. That makes it difficult because many variables can impact that decision and how it can be viewed at a later date,” Smart added.

“Also, if you thought that not only was an order going to be disruptive to the market, but was designed to be disruptive, you should have known that,” Lowry added.

The CFTC’s definition of spoofing can mean any time you cancel an order you could be accused of spoofing, Lambert posited.

“Always look to see what the backup evidence is. If you look at the intent of what someone’s doing by looking at communication that says, ‘I’m getting hit on all these orders that I don’t want to get hit on’, that’s a clear indication you’re spoofing. But it is that greyness of the rules and principles that create the uncertainty and fear factor among senior managers, and not just among the banks, it goes right across the spectrum – and that undoubtedly diminishes risk appetite in the market,” said Smart.


Turning to execution, Lambert asked the panelists whether they felt the industry needs big data around the execution piece?

“XTX stands for the correlation between two time series,” said Smart. “It’s a correlation-based approach that we take, but less correlation on the risk management side, more on pricing and understan

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