The Last Look…

I will confess, when I first heard of the proposed changes to LSEG FX’ Spot Matching, my initial reaction was ‘uh-oh’. We’ve been here before, and it wasn’t a great story, so will it be any different this time around?

Any time there is a change to one of the primary CLOBs, anxiety rises in the market, for while volumes may have gone down over the years, the importance of the market data has commensurately risen, and it is in the treatment of market data that LSEG may have found a good solution.

The fact is, Matching (and EBS Market) have, to a degree, been fighting with one arm tied behind their back when it comes to competition with the ECNs in particular, because of the resistance to greater granularity. The concerns of the major LPs are genuine – and valid. I have witnessed on too many occasions, a genuine attempt to place an order on one of these venues only serving to trigger “pipping” by other players, often on the ECNs. The best bid/offer suddenly exists elsewhere, hence the primary venue doesn’t get the deal.

This is not to lay the blame for the decline in volumes at this door, as discussed before internalisation can take most of the ‘credit’ for this, but there is no doubt in many minds that a previous experiment at EBS only served to highlight the problem and focus attention elsewhere.

LSEG FX still has a heritage from Reuters (and perhaps a lesson from EBS), and as such we should not be surprised that it is treading carefully by launching this initiative in certain currency pairs. That said, I suspect it has found a workable solution for the pipping problem and as such I would not be surprised if the decimalisation was extended to other pairs pretty soon.

Most firms that engage in “pipping” have the certainty of market data to back them up, they are not given to guessing about anything

The key, as noted, is the market data, and the solution seems, at face value at least, a simple one – don’t publish it pre-trade! I was talking to someone about this last week and they suggested that there is still the opportunity for what they termed “guess pipping”, in that a participant – my conversant cited higher frequency traders as the main culprits – will know there’s a bid or offer inside the whole pips, and will place orders inside at an estimated level. I don’t see this happening at all. Most firms that engage in “pipping” have the certainty of market data to back them up, they are not given to guessing about anything, including likely market direction (although that is changing a little). They will not want to place an order two- or three-tenths above or below where they could, and the key factor here is, they won’t know if they are top of book or not.

This does, to a degree, mean that LSEG FX is giving up on the opportunity to sell more market data perhaps, but as I have noted in this column before, at some stage it, and EBS, have to shore up their volumes if the data is to retain its value – this seems a smart way of doing it.

The impact on market operating could also provide interesting insight, not least around issues such as high/lows, stop losses, and option barriers. Talking to a couple of options traders, they do not see a time when barriers are struck at tenths of a pip, nonetheless, these traders would have to pay close attention to the situation as barriers near. Matching and EBS Market are often the platform of record for these events, and as such players need to be aware that trades will be executed inside the “round pips”. This may mean a change of documentation – I don’t see why it should, 20 should remain 20, for example, it’s not 20.2 – and it may also mean that option dealers’ lives get even trickier around barriers.

Likewise on stop losses, the industry is fortunate that most players have cleaned this up and it is strictly by the book, with no discretion allowed. I hate to think of the potential headaches for sales desks (and traders) from clients insisting they be held in for a pip, all the while the market merrily trades below the stop loss level, but only for tenths! If anyone is still using discretion on stops, this should cure them of that.

A few people have mentioned the increased complexity around high/lows, but I am not sure this changes, all that will happen is that LSEG FX will continue to publish the absolute and market high/lows, but that may now involve an extra decimal point. The principle of highs and lows won’t be changed, they will merely be more granualised.

Talking to LPs about the changes, most seem cautiously positive, which is probably a result for what can be a reactive and conservative group! Some pointed out that tracking their orders may prove trickier, but if nothing else that allowed me to repeat one of my favourite phrases – ‘if you’re dealing on a firm CLOB and don’t want to buy at 15 (or 15.3), then don’t put the bid there!’ I understand they want to keep track of the price they are streaming elsewhere – again, highlighting the real value of the market data from these venues – but is this move going to induce them to price tighter? I am not so sure – LPs margins remain under pressure, a move to tenths on a venue they tend to clear their exhaust flows on could actually help them.

I can envisage a situation where an LP with orders at a certain level can layer them in tenths inside the spread, not give their interest away, thanks to the iceberging, and reap the benefit

Obviously time will tell on whether this move is a success, but I suspect it will be, mainly because of the market data angle, which begs the question, should CME consider something similar with EBS and its data? The first thing to note it that EBS’ core markets have different characteristics to those chosen by LSEG for the first run of decimalisation, and these pairs are more given to decimalisation. Perhaps the question could even be should EBS go to a sixth decimal place and publish market data to five? Before anyone reaches for the shotgun, I am not suggesting this, merely to reiterate that EBS is different to Matching, even though it provides a similar service.

If the trading environment on Matching does improve, and, vitally, brings back increased volumes (not that we will know of course, thanks to the opaque volume reporting methodology – rant over!) then perhaps EBS will consider something similar. There is little doubt in my mind that the FX market needs a venue(s) on which the major players can clear their exhaust risk. If we are entering an era of trends in FX rates, then this will be an increasingly important aspect of the markets – it’s hard to internalise when the market is going one way.

One area this move can really help is by allowing LPs with larger interest to iceberg inside the bid/offer. I can envisage a situation where an LP with orders at a certain level can layer them in tenths inside the spread, not give their interest away, thanks to the iceberging, and reap the benefit. As In have noted so many times, it is the visibility that is hurting the primary venues, perhaps this initiative diminishes the advantage the smaller, more nimble, “pippers” currently have?

On a broader scale, I having been picking up on a nascent sentiment in the market that the firm CLOBs are making something of a comeback, at least in peoples’ thinking. This may be due to the events we have been witnessing, but it may also be a realisation that EBS Market and Matching play a crucial role in the market’s functioning and as such that data needs to be protected with better volumes.

Earlier this year, I suggested in a column that the reality was these venues would never hit the levels of their heyday 10 or 15 years ago, but that they themselves could reverse what seems to some (but not me) and an inexorable downward spiral. Looking back over the year, I would argue they have started to do that. Both have revamped their management structure and there is a sense of stability about both in this area, which is important. Equally both are continuing to evolve their offering, with the decimalisation at LSEG and Spot+ at CME to name just two.

Perhaps the most important factor in the LSEG change is that it does not seem to be about increasing volumes per se, rather it is about reflecting the modern trading environment and improving the environment on its platform. If it is successful, volumes will likely rise, and we will all have a reminder that sometimes just making things fairer can be the key to success.

colin@thefullfx.com