Spot FX Gets Walloped!

The BIS triennial survey, the most comprehensive data point, indicated that overall FX volume shrunk 5% from $5.36 Trln in 2013 to $5.09 in 2016. However, FX spot fell by a whopping 23.7%. London maintained overall geographic leadership but saw its share move down to 37% from 41% in 2013. APAC trading centers saw growth from 15% to 21% market share.  Overall, FX swaps and currency swaps grew, and cross currency swaps grew sharply, while FX option volume nosedived.

Spot fell across the major currency pairs Euro 12.5%, Yen 12.5%, Swiss Franc by 13.6% with Sterling rising by 2.6% as the lead up to Brexit caused considerable repositioning in Sterling assets.  No surprise as the Chinese Renminbi rose 41% and became the 8th most traded currency pair.

Capital constraints, digestion of regulatory change in the US and impending global regulation, changes in traditional liquidity provision, scandals and market disruptions since the last survey in 2013 are the main causes of the drop in spot. Additionally, the impact of the SNB’s surprise move in 2015 dislocated active FX trading and had many prime brokers reevaluating  their risk considerations. Creating challenges for smaller and riskier trading shops and hedge funds in maintain FX prime brokerage probably moved some of the FX spot volume onto exchange trade FX futures.

The market structure in FX continues to change quickly with acceleration in the adoption of digital models for trading and analyzing data in the FX market at the same time as major changes in FX market making and liquidity provision which has impacted spot FX trading.



A last look at Last Look? Barclays and FX market structure

The FX market is trying to digest the latest large FX fine and the impact on market structure. According to last week’s press release from the New York Department of Financial Services (NYDFS), Barclays was fined US$150 million for “automated, electronic foreign exchange trading misconduct.” The order goes on to detail this additional fine is a result of using its Last Look system to automatically reject what Barclays determined would be an unprofitable trade within the time window created by the system’s defined Last Look window. This brings foreign exchange fines by NYDFS against Barclays to $635 million. After spending time this weekend reading the order, it is clear that the issue at hand is not a Last Look issue, but rather improper customer notification and trading practice. In this case, Barclays was abusing both the intent and scope of Last Look. While Last Look gets a lot of discussion recently, it is a byproduct of market making in principal markets, such as FX and fixed income from a pre-electronic age, and the translation of those markets into electronic trading. As FX became more electronic, the European banks were early innovators in mapping principal trading functionality into electronic trading. In the case of FX, it became necessary to create a means to quote to thousands of customers through various channels (i.e. single dealer portals, multi dealer platforms, aggregated feed channels) at acceptable bid/ask spreads. Given that there are different types of clients, it is necessary to be able to quote different types of clients with very different risk profiles, technology ability, and holding time frames in different ways. A liquidity provider looks at an HFT counterparty much differently than a large asset manager putting on a hedging FX trade. Last Look is not inherently a bad practice, but it is a practice that when performed needs to be clearly mapped out to users of a platform. Platforms that incorporate Last Look functionality will be ensuring that guidelines are clear, functionality is sound, and procedures are well documented. In an OTC principal market, liquidity provision is not free. In the current FX market structure, Last Look is a necessary tool for many liquidity providers. Over time Last Look will become a less important component of FX trading. It is not clear that can be regulated away without disrupting the ability of market makers to provide liquidity in the current market structure, and given the global nature of FX. At the same time, concerns around Last Look are changing the calculus of liquidity between disclosed liquidity and anonymous liquidity. In my latest report FX Trading 2.0: Technology and Platforms, I explore the evolution of FX and how the market will incorporate all the forces at play. In many ways, after building on incremental change over decades, the FX landscape has shifted abruptly recently. The venue landscape has brought together once disparate centers of liquidity within the same firms. From the perspective of identifying the ideal venue to interact with, the landscape has become more challenging. Many of the FX platforms are separate or partially separate pools of liquidity within the same firm.

MiFID II, multi-asset trading among key themes at Fixed Income Leaders Summit

Several key themes emerged from the sessions at the Fixed Income Leaders Summit last week in Barcelona. Below are the two of the major themes: Regulation – MiFIR/MiFID II dominated the agenda Following last month’s RTS release, most people wanted details on the impact to their business, likelihood of changes to the ESMA document and if there will be a push back to the January 2017 start.
  • While European sell side and large buy side have been engaged in varying degrees with the process, US firms and smaller European buy side firms are still not clear that Europe is boiling the ocean with MiFIR/MiFID II.
  • It was clear that buy side preparation for engaging with the evolving execution space OTF/MTS/RM and SI is extremely low. And of course, the reasons are clear—there is a fundamental lack of clarity on expectations to operate in the new regime as well as the actual timing when these requirements will be manifest.
  • While the debate to finalize and accept the RTS proposal from ESMA occurs, there is tremendous confusion on final requirements. Without a delay to the January 2017 implementation, the longer the debate, potentially the less time firms will have to prepare and implement to the final required state.
  • The top concern that the buy side had was the fear that their traditional market making liquidity providers will exit the credit and rates markets and the liquidity from alternative providers,and in platforms, will not be sufficient to satisfy their trading needs.
Multi-Asset Trading Most buy side firms are looking to leverage the best tools that exist from other asset classes into their daily workflows in fixed income products. While all were cognizant of the deep differences between equities, FX and the fixed income universe, the buy side was engaged in discussions on the details of the regulatory, market structure, liquidity, and technology challenges; and clearly were looking for multi-asset solutions for fixed income connectivity, analysis and TCA.
  • Firms were deeply engaged in discussions that shed light on the process that other asset classes went through, and how that process played out. There is a great deal of trying to understand the context of the MiFIR/MiFID II change with lessons from other recent regulatory changes. There was a strong desire to understand the implications of Regulation NMS on US equities and the respective market structure, fragmentation and technology implications. Likewise, MiFID I and the SEF rules in the US and the move to centrally cleared swaps and derivatives in the US was another area that was discussed to glean lessons for changes that might come to Europe.
  • Europe is boiling the ocean in fixed income with MiFID II and firms are trying to understand the myriad changes, the timing of change, and the many complicated means of judging the type of rules that will apply in government and corporate bonds.

Swiss Banking 2025: getting to tomorrow

What will the Swiss Capital Markets look like in a decade from now-in 2025? As private banking and wealth management digest the many changes in the post-crisis financial world what will be the implications on sourcing financial products and liquidity? We have already seen new business models reacting to these new pressures. At our next client roundtable this September 22 in Zurich, the Celent wealth management and capital markets teams will look at opportunities for innovation in the face of regulatory and economic pressures, including the pressures on flow businesses that support a variety of clients, operational forces driving automation and the hunt for liquidity in capital markets. Topics such as competition from emerging offshore hubs such as Singapore will be discussed as well. Joining us for a lively and interactive discussion will be strategy, technology and innovation leaders from European banks, brokerages and other financial institutions. This will be a great opportunity to hear the views of numerous financial service leaders in a private setting. While space for the roundtable is limited, I’d welcome hearing from individuals interested in the topics above and/or potentially attending.

FX ECNs 2.0 getting gobbled up?

It looks like a couple more of the second wave of institutional FX ECNs might become part of large exchanges. Last month unsubstantiated rumours circulated about 360T running a sale process-receiving bids from several parties, including Deutsche Boerse-and on Monday rumours circulated about Intercontinental Exchange (ICE) and FastMatch ECN. Generally, where there is smoke there is fire, but it is likely that in both situations, it is nothing more than market speculation, or wishful thinking. However, exchanges are the most likely strategic buyers; they are able to consummate deals in the current business and regulatory environment. Moreover, global exchanges need to scale across products, and they have ample currency to get large FX FinTech platform deals done. There are still other FX ECN platforms available. In recent years, the last of the first wave FX venues have been acquired. Earlier this year BATS picked up Hotspot, and in 2012 Thomson Reuters acquired FXall. Considerable discussion has taken place around valuations for these deals. The valuations reflect the allure of asset class expansion, the scarcity of major independent e-FX venues, and overall FinTech valuations. Furthermore, foreign exchange, like all flow products is at a major inflection point. The gathering forces of regulation, transparency, combined with the necessity of many FX players to further automate their pricing and trading makes this trend inexorable. And of course, scandal- $5.5 bln in fines already –a huge number. The foreign exchange scandal has been a major distortion in the FX world: creating an unusual opportunity to see change on a major scale. The scandal has been very expensive in terms of money and resources, but is producing a clear roadmap to a more open, transparent and automated FX market.

RegTech: is there an artificially intelligent Big Brother watching you?

I just came back from sabbatical (it was great, but you knew that already). I’ve come back charged up and with stars in my eyes from what some of my colleagues call a sect, Singularity University. Well true that the founders want to make the world a better place, and that some of them could become god-wannabes when they will have artificial intelligence implanted in their brains and will have been able to fight ageing through DNA nano-modification and thousands of top notch anti-oxidant pills but to me right now they are just great crazy people who hope to make a difference through the exponential power technology has – and I am proud to be one of their alumni. So… what’s in it for you? Well FinTech, I guess. I am currently trying to look at what Artificial Intelligence (AI) will change in capital markets. The good news is: you already all know what AI is, even though some of you may be scared by it. But here I am not going to look at what AI will do in your bodies, just in your day-to-day jobs (not that scary, or so you may think). What many of our clients (buy side, sell side, exchanges, info providers, tech providers) have been trying to figure out in the past few years is what are they going to do with all the data they have. They have built or bought Big data softwares that parse, recognize, organize data and create products thanks to this data, whether algorithms that find trading opportunities through structured and unstructured data or corporate investor relations service that highlights where in the world is there a bad news about a specific company and what to do about it live via a data push, or even just create trade pairs when there are no matches in illiquid markets. So far, so good. What our clients are facing now at an increasing (did I say exponential?) pace is something bigger than this, what we call RegTech. Think of the current regulatory environment where you all have to adapt to MiFID II and EMIR and T2S and CSDR etc. at the same time. You all have to create new business models, technology or operations systems that will enable your company to abide by these new regulations. But RegTech is more than that: it is also the technology that you have to use to force change within your organization so that you can prove your bankers are acting in the best interest of their clients, say even in FX, where there are no real regulatory changes, but a lot of regulatory willingness to change things right now. These could be artificial intelligence machine learning algorithms that know how a typical FX trader acts and how the computer should block the non-compliant tentative trades or even just do the trades in a compliant way instead of the trader itself? You can’t really fire all your FX traders in one go and replace them all with AI computers, but you get my point. Even further than that, and I think where it gets scary, regulators, governments and supranational watchdogs are building (or have built already? Brownie points for who knows the answer to this one) big machine learning type AI to monitor what all the buy side, sell side, exchanges, trading platforms and hedge funds do on the markets, and off the markets through BIC accounts, every day, every minute, every second. When these smart systems see that somebody out there is not doing what he/she is supposed to be doing, even just from a simple compliance stand-point, his/her company will be in deep trouble. Of course I don’t expect the SEC or FCA or Consob telling us that they are building them, but there is more than meets the eye, get ready for this change to arrive at a watchdog near you.

Corporate bonds: developing the secondary market through electronification

Corporate bonds have become a popular vehicle of investment in recent years.
  • In the developed world a key driver of growth has been the low interest rate regime persisting in some markets which has made many companies issue new bonds at a relatively low cost of borrowing. Potential for higher returns from these bonds makes them a lucrative proposition for many investors, particularly institutional investors like pension funds and insurance companies.
  • In the emerging markets, buoyed by long term growth opportunities companies have been issuing bonds to raise funds from global and local investors for over a decade now. While the activity in the primary market – where sales of new bonds by issuers to investors take place – has been growing steadily, the secondary market – where trading of such bonds take place among different types of investors (and market makers) – has been an issue of concern.
  • Buyers of corporate bonds, particularly those in the emerging markets, typically hold on to them till maturity. This means the pool of securities available for sell in the secondary market is not very deep. The resulting illiquidity means the cost of trading (bid-ask spread) in the secondary market can be substantially high, especially compared to other asset classes like equities or FX.
  • The problem is exacerbated by the lack of standardization among issued bonds. Different corporates issue bonds at different points of time with varying tenors and coupon rates purely based on its specific requirements. Even the bonds issued by the same company at different points of time can have different terms, unlike that seen in case of equities.
These issues limit the choice of investors in the secondary bond market. This gap is typically filled by dealer banks who act as market makers by taking their own positions and buying bonds from sellers or selling them to buyers. However, recent regulations brought in since the crisis of 2008 have made this task of market making very expensive for the dealers banks because of which many of them have significantly reduced their inventories. According to Mark Carney, the governor of the Bank of England, it now takes seven times as long to liquidate bond portfolios compared to what it took in 2008. As some of the central banks consider raising interest rates again, many investors are expected to sell their bonds. If there are too many sellers with only a handful buyers and market makers, that can have serious impact on the already distressed market and the asset class as a whole. In last few years efforts have been made to develop a viable secondary market by connecting investors and dealers to other investors and dealers through (all-to-all) exchange type electronic trading venues. Here, dealers will not be the central agents; even two investors can connect to each other through the venue to complete a trade. Following other asset classes like equities and FX where electronic trading has already become popular, entry of such platforms in the bond space would be a logical extension. Further electronification of trading is also on the regulators’ agenda as they seek to improve transparency in trading in all asset classes. Trading in bond is still dominated by voice (over the phone) execution method and extent of adoption of electronic trading is relatively limited so far. The structural shifts taking place in this market may finally expedite this process. A number of players have developed or are developing trading platforms; even some of the leading exchanges like the Swiss SIX exchange and the Singapore Exchange are looking to add bond trading platforms. Such trading platforms have the potential to improve price discovery in bond markets and reduce trading costs, boosting investment returns in the sector. A key challenge in this regard would be to first change not only the mind-set but also the technology and operational practices of the participants in this market. Moving away from a phone based trading desk to electronic tools will require adequate investments and know-how of running the operations. What will ultimately change the nature of the markets substantially are not just electronic trading tools, but a robust best execution rule which requires an interconnected market. As orders start to migrate to electronic platforms and an increasingly interconnected market appears, aggregation and distribution technology will be required to support this evolution. These issues can be handled at the level of trading venues and trading members, and if dealt with adequately should contribute to growing electronification of the market. However, lack of standardisation of issued bonds will still be a challenge and is something that can only be addressed by the issuers, and therefore may take time.

Use of OTC Derivatives by Asian Corporates

Asia accounts for less than 10% of notional outstanding of the global OTC derivative market. Even within Asia, trading activity is primarily dominated by the four advanced countries Japan, Singapore, Hong Kong and Australia. Most of the OTC products in Asia are plain vanilla in nature, and as a result the OTC markets emerging Asian countries are at a very early stage of development. Corporates in Asia primarily use OTC derivatives to satisfy their need for customization. Foreign Exchange (FX) derivatives are the most popular OTC instruments used by Asian corporates. Many corporates have regional or international operations; they use cross currency swaps as net investment hedges for foreign currency exchange risk of international operations. In addition, corporates engaged in significant imports and exports use forward foreign exchange contracts as cash flow hedges for exposure to foreign currency exchange risks arising from forecasted or committed expenditure. Interest rate instruments are also popular among Asian corporates. Many Asian corporates have issued foreign currency denominated debt and therefore use cross currency interest rate swaps to hedge interest rate risk and cash flow hedges to hedge currency risk arising from issued bonds. In addition, corporates also engage in OTC commodity derivatives.  Commodity derivatives, particularly those involving palm oil and rubber, are in demand from Southeast Asian corporates. Moreover, corporates in the energy and manufacturing sectors use them to hedge against price fluctuations in the underlying commodities. Emerging Asian countries lack necessary infrastructure for onshore OTC commodity derivatives trading. Corporates in those countries therefore have to deal with international exchanges or with international counterparties.  Asian corporates typically engage in OTC derivatives for hedging, and not for trading purposes. Therefore many of them have not set up infrastructure for exchange trading. Small percentage of them is using centrally cleared derivatives at present. However, this is likely to change in the future since regulators are now encouraging and incentivizing central clearing of standardized OTC derivatives as part of the OTC derivative market reform process. While reducing counterparty risk is an obvious benefit of using central clearing, CCP also reduces clearing costs, as without central clearing one has to pay higher margins up front. With requirements of central clearing and other associated reforms, it is argued that the use of OTC derivatives may decline. If that happens, it will be mostly limited to financial institutions’ use of these instruments who engage in them for trading purposes; the need for OTC derivatives for hedging purpose is likely to increase. Non-financial corporates accounted for around 20% of OTC derivative trading in the emerging Asian economies, while they accounted for only 6% in the four advanced countries. This indicates the involvement of real economic actors and trade related activities are higher in the emerging country OTC markets. This is also due to the fact that in advanced countries large dealers and other financial institutions engage in significant trading and market making activities in the OTC space. Corporates’ high share in emerging country OTC market is likely to continue or even increase as the real economic output of the countries grows.  This will be driven by economic growth, growing international operations and trading activity of local firms, liberalization of financial markets and regulatory initiatives facilitating more cross border trading. The developments in the emerging economies will also contribute to the growth of OTC activity in the advanced countries, particularly in Hong Kong and Singapore, as a significant proportion of activity in those markets comes from investors in the neighbouring countries who cannot meet their demand in local markets. However, this process is likely to evolve slowly as regulators in the region are traditionally conservative in nature.

Chat, Instant Messaging, Blogs and Trading

This morning I read an article in my favorite financial (serious) paper about how the FX price manipulation scandal that is unfolding may make banks ban traders from using trading chat rooms. And that some were looking at ways to replace these trader conversations to bilateral phone conversations. I did check and today is not April fool’s day. Maybe I am out of my mind, could be, please do let me know if so, this is a blog, not a serious article. But in the meantime, please let me try to provide you with a little trading perspective here. Electronification is THE secular trend that trading is going through, I don’t see who and how one could stop this. Seriously, even when I write about fixed income trading, notably the most voice-traded assets in financial services, I have to write about electronification. Ok I did work for an exchange once upon a time, but I also did work for a notable dealer known for making heaps of money on voice trades. But even outside of trading, my retail banking colleagues keep writing about electronic transactions, handheld, cloud and the likes. And outside of finance, well guess who uses the internet to chat, talk, socialize, buy consumer goods, nearly everyone we all know. What would you say about banning teenagers from using facebook because they could meet dangerous people on it or expose their personal lifes unnecessarily? Sounds like a just cause but you can’t, facebook is here to stay, like linkedin is here to stay for us analysts, and like electronic chat groups for traders. A trader’s job is to make the best price for his bank/broker on an asset and reap a profit from it by buying and selling these assets. To make the best price for his banks he needs as much (relevant) information he can have to make his own mind/models like I need to read what my competitors and clients think to make my opinion on something, and so do traders. If you remove such multi-dealer chat rooms as Bloomberg’s, there will always be other chat rooms popping up like mushrooms, only this time they will be less legal than the ones traders use now, and they will really cause insider trading concerns. At least when a chat takes place on Bloomberg, the surveillance department of each trader’s bank could have access to the message exchange via Bloomberg and Orange’s Vault services. Etrali is another important player working with Bloomberg and Google Glass could well become a way to capture traders’ voice, chat, instant messages, etc. and put into the Vault too. This way the surveillance department can also look via key words in those message exchanges live, as they happen. Last time I asked a telco service provider if he was able to provide a reliable search facility through conversations taking place on the turrets (phones of the traders), they told me they could not because traders use strange words nobody outside of a trading floor understands and that conversations take place in an awkward sequence: 2 sec with someone and then 1min with someone else and then back to the first one, etc. But with a chat messages exchange then you see the historical trail visually, and yes, they surely use strange words but with time surely one can build a “trader dictionary” to translate these conversations in Oxford’s English and it surely would be easier to read the word written by the trader rather than having to read its transcript done by a none-trader inside a conversation with loud shouts from a trading floor in the background. Ok, I have waited a few hours before posting this to check with my editorial board if I was out of my mind, and they say they agree with me: next time a bank tries to make amends via such a press release, wait a few hours to give them such an outrageous headline please.

FX Spot IDB Trading Platforms: Competition is Heating Up

Last week the media was inundated with the very interesting news that EBS (part of ICAP), one of the leading global wholesale FX electronic platform, was starting a consultation with its clients to change its business model: it would potentially remove the “first in, first out” (remember that FIFO rule in accounting?), for entry order and put a system that batches together all orders that arrive in a given millisecond-based window so that there is no speed advantage for incoming orders, reflecting the industry trend to try to curb potentially damaging HFT flows. This significant change of strategy, for an FX platform which opened direct access to funds ten years ago, follows its move last autumn away from “decimalization”, so that the fifth decimal point in a quote had to be a “5” or “0”, rather than increments of a 10th. Its aim is to keep having the buy side tap in their liquidity pools, but in a way that is safe for the dealers providing liquidity, as highlighted in our March 2013 report The Blurring of the IDB vs. D2C Models in Fixed Income and FX: Emergence of a Convergence?. The randomization of trade entry can also be found on another Spot FX trading platform, ParFX, run by competitor IDB Tradition, with the backing of a consortium of 11 global banks. It has launched on April 18th 2013 and trading is already live. ParFX not only randomizes the value of a trade entry so that it gets matched in an unknown order, but it is also designed as a fair trading venue with an anonymous Central Limit Order Book single matching engine offering executable prices (no second look), that actually even releases the name of the intermediated fund once execution is done to the other trade party, as opposed to the traditional Prime Broker (PB) model whereby the PB keeps anonymous the name of the client fund it has intermediated all the way to settlement. In ParFX the PB uses its name just for the  settlement. Another differentiating factor to try to promote fairness is the pricing: at ParFX a global bank like Barclays and local bank in Italy pay the same fee (2000 US$/month) to access ParFX’s standard FIX interface that provides the APIs to standard market data consumption, order entry FIX session and post-trade services – Drop-copy. They also pay the same brokerage fee (2US$ per US$ equivalent), no discounts for large sizes or levy for price makers. An All-to-All, level-playing-field platform. Have we mentioned that TulletPrebon, another leading IDB, had also launched a competitor  FX Spot platform called tpSPOTDEAL? And what about Thomson Reuters? Will they merge the FXAll multidealer-to-client activities they acquired with their wholesale platform in some way or another? Competition is fierce in the revolution of FX Spot trading. We will certainly keep watching this space…