A very challenging discussion, held under the Chatham House rule to prevent attributed quotation, began by asking why, if the buy-side have never had it so good, is there any need to change the way FX trading is taking place?
The first response undercut some of the assumptions that underpinned that statement. The transaction cost analysis (TCA) that buy-side firms use is not as effective as it appears, it was argued, so despite everyone in the market believing they were getting mid-price, without an independent price source to benchmark that the participants noted that nothing is free. The value of a consolidated tape for FX was debated and found some support – although there were questions over what the ultimate value would be compared with independent commercial offerings.
Secondly, it was noted that that firms that are getting mid, are paying for the price they receive somewhere in the service they receive from their banks and counterparties. With post-trade processes using “Victorian” service levels while trading had evolved to 21st century standards, that meant investors could also be misled by their performance measures.
Questions were also asked about the validity of measuring best execution against anything other than arrival price, even when execution goals might need to factor in time to trade and market impact.
These points gave support to the idea that execution could be better optimised, both in the swaps and the spot markets. Existing benchmarks such as CME-owned EBS and LSEG’s Refinitiv Matching, which are designating as ‘primary markets’ by the Bank for International Settlements are seeing volumes falling off while they migrate to the futures market, for example on CME.
This creates potential risk. The primary markets are used for pricing but no longer reflect majority of trading, while the futures market, is not open 24 hours a day and has limit up/limit down restrictions on sudden market moves, due to the rules of the exchange they trade upon. As a result, if there is a sudden directional activity which cannot be pushed through the futures exchange, the spot market may struggle to provide the level of intermediation needed.
A central limit order book (CLOB) was agreed to be a potential solution in the FX swaps market, the question then was, who would lead change? The current need for provision of credit to support FX trading, which is predicated upon bilateral bank to client relationships, is a big barrier to change in market structure, although some firms are offering methods for working around that issue.
Much of the work banks are doing to deliver services such as streaming liquidity was seen as a precursor to supporting a central limit order book, panellists said, and so they could potentially support third-party platforms more effectively to provide liquidity in the future.
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