The Last Look…
Posted by Colin Lambert. Last updated: December 3, 2024
Last week’s column prompted several of you to get in touch with what was pretty much the same question. Where did the expression “pre-hedging” come from?
I suspect it was around 20 years ago executing balances at the 4pm WM Fix become so troublesome for dealers, and that group, naturally worried by how it looks buying ahead of the benchmark setting, came up with the name. I am not certain, however, so anyone with better insight, feel free to reach out via the usual channels.
What is interesting, is I am sure the first time I heard the phrase it was in relation to the 4pm Fix, but the industry has managed to cloudy the waters further by now deciding that dealing ahead of the benchmark window is not “pre-hedging”, it is “hedging ahead of the Fix”. Pre-hedging is now something entirely different, which does make we wonder why we keep moving the goalposts, or rather create so much ambiguity?
In spite of what some seem to want IOSCO to believe, pre-hedging really should only be associated with very large trades – the type of deals that provide a customer with two choices – execute it themselves, and take on the market risk, or risk transfer it.
The latter comes with a cost, the former a risk. Either way though, there is a spread attached to risk transfer and dealers should be good enough to make it realistic, and competitive. The problem is many customers have been overly-influenced by the top-of-book brigade, who will make you think it’s a good thing to get your half a yard done in ones, so they demand tighter spreads on larger trades.
Banks also have to take their share of the blame, by shifting to the brokerage model, they have lost the skill, or willingness, to quote large tickets accurately. Too many are obsessed with selling their algo rather than promoting a major risk function that can price these large deals well.
Regulators, finally, also take a right hook over this, because they have squeezed the risk function, all of which means that yet again, liquidity is under-appreciated and under-valued.
Ultimately, one of the problems with trying to establish pre-hedging as a best practice is that the only real way the customer can keep a pre-hedger’s activity in check is by acting deceitfully and unprofessionally themselves – enquire for a trade and give the wrong details, for example.
They can watch the pre-hedging do its stuff and then work, or have someone else work, the genuine order in the market. Yes, this would keep the pre-hedgers “honest”, but is this really where we want to go?
