Section Two – e-FX Initiatives

We are called The Full FX, but we have long believed that the emerging world of digital assets will, at some stage, not only touch FX, but intersect in a meaningful way. This will cause some uncertainty in the FX world, but it is also vital that it is done right for the digital assets world, which is, to put it lightly, hungry for institutional business.

Of course, there is a question as to what “institutional” means, and in the digital assets world it is often very different to that in FX. That said, the end target is, undoubtedly, the larger money managers.

A decade and more on from when bitcoin raised its head in the financial markets sphere, there is still an uncertainty on the part of some providers as to what will get “true” institutional in the door. We can provide that answer – infrastructure and a model that these firms understand, and often use, from the FX markets.

Step forward LMAX Group. Seven years on from the launch of LMAX Digital, the firm is widely seen as the trusted source of both FX and crypto trading technology, thanks to taking the same approach to both markets. Effectively, the firm understands that if it works in FX, it is likely to be attractive to the next generation of digital assets players. At the same time, good ideas in the crypto space, will be welcomed in TradFi, if they are presented properly.

LMAX has had the advantage of being an early mover in the FX/digital assets space, but history has shown that that does not necessarily mean long-term success as competition grows. By providing a familiar entry point for new players, however, the firm has managed to build on its early mover status, to evolve as and when necessary.

It is hard to think of many players that are firmly embedded in both camps, but as FX and crypto inevitably come closer together, the perfect entry is under the LMAX Group banner.

It is testimony to how BestX changed the TCA and analysis landscape that the product needs no introduction – the firm solved a problem that was perplexing banks and their clients when it came to high-quality, independent, analysis of a firm’s trading. The original build also ensured the robustness and ‘future=proofing’ of the service, meaning changes, when they come, are largely incremental – often the sign of a successful business.

BestXecutor, long a product idea of the firm it should be noted, is an incremental change in that it does not interrupt the clients’ closely-protected workflow, but it is also a leap forward for those seeking a better way to conduct pre-trade analysis, not just around algos, but also RFQ/RFS trades.

BestXecutor offers a high level of parameterisation, meaning it is more easily tailored to individual client needs and operating methods, thus bringing to the pre-trade space, a feature that was largely offered post-trade. The flexibility extends to aspects such as time-of-day analysis (as well as the more standard views such as currency pair).

Perhaps the key change, however, is in how BestX has managed, without disruption, to embed itself earlier in the trading workflow. By providing analysis around different execution styles and, in an RFQ/RFS environment, an optimal panel of dealers for pricing, it has become more of a decision-making assistant, rather than a justifier.

Ultimately, BestXecutor offers best-in-class analytics, in a workflow-friendly environment. Equally, and this may become more important going forward, it provides a single-dealer platform level of quality functionality and analytics, in an independent environment.

Price Elision from LSEG FX potentially solves a very big problem for the firm’s flagship spot Matching platform, and offers the wider industry an opportunity to once again trade in a “pure” environment in which order data is not used by the dealers to make it harder for the original participant to get their order done.

The decline in activity on the two original primary FX venues is a well-worn story, and while it has largely been the result of the growth of internalisation at the major dealers, it has also been a story of data and market impact. There is little that can be done about the major dealers getting more efficient in how they manage flow, but something could be done about the market data issue – specifically how it was making life more difficult for dealers, especially those below the top-tier banks, to post interest without being “pipped” by the growing number of non-bank LPs.

A sub-theme over the past 15 or more years has been the growth of decimalisation, just about every single dealer platform has offered it, as have a large number of ECNs and multi-dealer platforms. It has also been offered on the primaries, with less-than-great results, largely because the aforementioned ‘pipping’ became even easier.

This meant a less-than-friendly environment on the CLOBs for those who wanted to post interest and deal at, let’s face it, best price. Things have changed a little, but the primaries are still very much a major source of market data, therefore if you deal on one of these venues, you’re probably dealing at the “true” market.

How then, to embrace decimalisation, without creating a toxic environment and minimising “pipping”, all the while not disillusioning (and maybe even disenfranchising) your core client group, the banks?

LSEG FX’ solution to this conundrum is both simple and brilliant – it allows participants to place orders at granular levels (depending upon the currency pair), but doesn’t publish the market data beyond pip level. Yes, some firms might want to “guess pip” the order book, but they can’t be sure, and if there is one thing that those firms that came out of the HFT world like, it is certainty.

So effectively, in the chosen currency pairs (and the programme has been expanded since launch – a sure sign of a warm reception) the market has all the features of an ECN, meaning the CLOB no longer competes with one arm tied behind its back, but the market data has an element of “dark” about it.

We are very unlikely to ever revisit the heyday of the CLOBs in terms of volume, internalisation will see to that, but they remain vitally important components of the FX market. This means it is important they offer a good trading environment, while still being in step with the modernisation of the industry.

Price Elision offers a simple solution to a fairly sizeable problem and is likely to ensure that the vital function of the CLOB can continue for years to come – and that is great news for the FX industry.

The first thing to make clear about this award is yes, we know this is, per se, a relaunch of a service. That said, we see the redesigned CLS Cleared FX Service as very much the right product at the right time – something that wasn’t the case in 2018 when it first opened.

FX, especially at the short end, has largely avoided the worst excesses of regulation, thanks in no small part to the role played by CLS in mitigating settlement risk, but equally there has been a rise in interest in (and regulatory demand for) increased clearing. How to bring the two together?

Capital costs are a much bigger issue for market participants than they were in 2018 and the FX swaps market, in particular, has eyed clearing for some years now, especially attracted by the capital benefits. The problem has been the lack of workflow benefits because they wanted to settle inside CLS, but the workflows ran parallel to each other. This is something that has been solved with the updated Cleared FX service.

There are still questions over the economics it has to be stressed, but as a functioning model, this ensures that a critical infrastructure in the FX market, CLS, and a growing presence, initially LCH ForexClear but others could join, can work together in a seamless fashion.

At a time when banks in particular (but a growing proportion of the buy side as well) are even more focused on the cost of doing business, the key to this service will be delivering the undoubted benefits it can, at a cost that doesn’t outweigh the regulatory benefits. If this succeeds, then CLS Cleared FX could be seen in years to come as a significant moment in the FX industry’s evolution.

A feature of the FX market in recent years has been the rise in importance of futures, specifically CME FX futures, in price formation, but this has had one drawback for a large number of participants, especially those away from the top table – they didn’t have access to the market, nor did they have the resources to connect.

For the major players this was not an issue, but one look at the latest BIS Triennial Survey of FX Turnover will tell you of the importance of smaller, regional banks – just the $712 billion per day traded in spot alone by “non-reporting banks”. Regional banks are, behind the reporting dealers for the BIS survey, comfortably the largest counterparty segment in the FX market (double the activity of hedge funds and prop trading firms as a guide), but they didn’t have easy access to 90 yards of liquidity a day in the CME futures market.

CME’s solution was FX Spot+, a platform that brings listed FX liquidity to non-futures market players, in an easily-connected OTC environment. In reality, as was the case with an earlier award, the main benefit from Spot+ is likely to be felt by its owner. CME Group, and EBS before it came under the Merc’s umbrella, have long struggled to break the structure between the two primary venues, where certain currencies largely exist on one venue. Spot+ can break that mould by bringing some strong futures liquidity in, for example, Scandies and Commonwealth pairs, to the CME OTC business.

There will also be a benefit to the broader industry, because the early evidence is that two venues that may have had cause to be nervous – EBS Market and LSEG Spot Matching – have not yet been impacted by Spot+. The latter has, naturally, grown volumes, but maybe not at the expense of the two incumbents – it may well be growing the overall pie, largely by bringing the worlds together.

Overall, it makes sense for a company with control over two of what have become the three primary market CLOBs to bring that liquidity together. At the same time, the need to expand the range of bank participants can be satisfied. That is a ‘win-win’ for CME and market participants.

After a lead-up period, LoopFX launched earlier this year with multiple counterparties using the service. New platforms rarely make a splash in the FX market, but this one has, mainly because Loop has managed to create a new model, whilst not upsetting one of the core franchises involved – banks and asset managers.

Information leakage, and by association market impact, has grown as a theme in markets over the past few years as they have become increasingly electronic and delivered more and more data. This has led to some questions over the market environment for participants looking to execute larger tickets (and the whole concept of what is ‘large’ has changed over the past decade or so). LoopFX has been launched to solve this problem, but it has done so in an intelligent way.

We have to be blunt and state that anyone seeking to deliver a pure peer-to-peer platform for spot FX is going to have to wait a long time for meaningful volume to emerge. Yes, between certain client segments there are natural offsets, but that fact is they rarely happen at the same time. The reason internalisation is so successful is because, albeit for milli-or a small number of seconds, the LP is holding the risk – instantaneous matching of buy-side-to-buy-side interest rarely occurs, if it did the 4pm Fix would look a lot different in terms of market impact profile.

Loop’s solution was to introduce that third element to P2P – 2B. It brought the banks interest into the pie and suddenly the potential for matches grew significantly, but, notably, without the information leakage.

We have long been fans of a ‘dark’ trading environment for larger tickets, it also rewards those LPs willing to take on larger risk – which should be encouraged for the health of the FX ecosystem. It has to be done wisely, however, and in LoopFX we have the best solution to-date; it helps the buy-side, but does not disenfranchise the major players in the industry – the banks.

The fact that it does so without disrupting their workflow is the cherry on the cake. Progress will not be stratospheric, but this could be the start of a significant shift in how an important segment of the FX market interacts.