Cash & Liquidity ManagementFXBuyside ‘needs to adapt to divide in FX’ says BoE’s Hauser

Buyside 'needs to adapt to divide in FX' says BoE's Hauser

It’s time for the buyside to recognise, and use, its influence in the FX market to the full as they collectively control trillions of dollars of assets

In his speech on September 13 at Tradetech FX 2019 in Barcelona, Bank of England’s Executive Director, Markets – Andrew Hauser, looked at the impact that innovation is having on FX markets. Though he says that the FX market could be more efficient if these benefits are realised widely, across both the sellside and buyside, he urged the buyside to come together if the market is to work effectively.

His speech titled Run Lola run! The good, the bad and the ugly of FX market fragmentation – and what to do about it took the reference of ‘Run Lola Run’ – an experimental German film from the late 1990s to explain the complexity of the FX markets in terms of outcomes.

Falling concentration amongst liquidity provider pushed a fresh fragmentation of market share in the FX market: “Whatever happens, for today’s market participants, fragmentation is a fact. And that means – just like Lola – they can experience a markedly broad range of outcomes. That has important implications for all three of the characteristics – informational efficiency, resilience and fairness.

The good, the bad and the ugly

He added: “The complexity in FX markets lies not in the products themselves, which for the most part are relatively simple. It lies in the structures that have evolved to deliver them, driven by extraordinary technological innovation. For those with the right access and understanding, the multiple sources of liquidity, trading venues and execution algorithms available in FX markets offer enormous choice, competition and functionality. That’s the ‘good’.

But finding your way around such complexity isn’t a cakewalk. Knowledge is power – and even quite sophisticated investors need their wits about them to benefit from everything the market has to offer. Complexity also poses new challenges to system-wide stability and functioning. And, sadly, it can give rise to new ways to behave inappropriately. When any of these go wrong, that gives you the ‘bad’ – sometimes even the ‘ugly’.”

Disclosures, TCA and the Global Code

By demanding better disclosures, seeking more effective technology, and adopting the Global Code, Andrew feels buyside make practical progress in this area.

He elaborates about disclosures by placing importance of effective disclosures as a necessary precondition for ensuring good service: “As the UK’s Fair and Effective Markets Review argued in 201512, you can’t evaluate an FX transaction if you (or your agent) don’t know when it was executed (timestamping), why some trades were rejected and others not (reject codes), whether your counterparty was acting as principal or agent, how long your request to trade was held before a decision was made (hold time), or what was happening during that hold period.”

He stressed on the using transaction cost analysis (TCA) tools for seeking more effective, robust and independent aggregation, analytical and execution tools to counter fragmentation: “This isn’t a free lunch: but putting liquidity providers into competition through robust aggregation and execution tools makes good business sense. Of course, you need to be alert to the potential for services offering lower spreads to claw back that gain through greater price slippage. To evaluate that, you need an effective TCA tool that goes beyond measuring just the observed spread to include market impact, price variation, hold times and fill ratios, and can give you guidance pre-trade, as well as post-trade analysis.”

Focusing collaborative efforts from the buyside, Andrew urged to sign up to the Global Code since the buyside has so much to gain, and to offer, from a more active collective participation in FX markets: “The GFXC has recognised some of the practical challenges faced by smaller firms when signing up to the Code, and has prepared new material to help ease this process. But we need more of the largest firms too: 17 of the largest 30 global asset managers are still not signed up. That’s $22 trillion of investors’ funds without a voice in the use and development of the Code.”

Buyside to take action

He ends his speech by calling for the buyside to take action: “In many ways, the FX market is in great shape. It’s informationally efficient, resilient, and a cauldron of technological innovation. That technology is bringing many new benefits: wider access, cheaper prices, better services. But we need to ensure those benefits are widely shared if the market is to work effectively. I’ve set out three ways for the buyside, working together, to play its part in that project: demanding better disclosures; seeking robust and independent analytical and execution tools; and signing up to the Global Code.”

The foreign exchange market is by far the globe’s busiest trading space. More than $5 trillion worth currencies are swapped every single day like clockwork – making FX trading activity 25 times larger by volume than the global equities market.

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