The Last Look…

There has been a fair bit of information to consume over the past week, what with the FX committee turnover surveys and the JP Morgan e-Trading Edit, and my overall impression is that the FX market is in something of a sweet spot at the moment, although there is a challenge for regional or specialist players.

It should be observed that the JPM survey provides results across asset classes, not just FX, so there is a degree of guesswork involved, but what stood out to me was how volatility was a big challenge for the buy side, but accessing liquidity wasn’t. Many years ago, there was equal frustration and hilarity in the UK when the national rail network ground to a halt due to “the wrong type of snow”. Liquidity access has not always been easy in these surveys, which suggests that what we are seeing now is “the right sort of volatility”. It’s busy, but there are not excessive or prolonged moves of the kind that would see LPs build up positions they may not want.

This is also a good environment for the smaller, nimbler, non-bank market maker, of whom we have seen a few join the market in recent months, because they can price, internalise over a very short time horizon, rinse and repeat.

This could raise a challenge for the market, however, in that it is clear that competing at the top level is becoming more expensive and more of an arms race, so where does this leave regional specialists? Their big advantage is inventory and local knowledge, but as markets become more electronic (and it was interesting that the JPM Edit did not indicate this was happening), the big players can compete more easily.

There is still the credit barrier to overcome, of course, but the general trend seems to be back towards the big players, and perhaps the non-bank LPs, becoming more influential in markets they once stayed away from.

Personally, I think it is important we have a healthy regional and specialist LP network, because we have seen, when things go horribly pear-shaped, inventory is all, and the broking business model of churn and burn is worthless. I also think it healthy for some clients that they can go through a local or specialist provider to help minimise information leakage – although that naturally depends upon how good the local or specialist player is at shielding business! The question is, how do you do it?

The simplest solution is a form of white label, but I am still not convinced by this model. Different providers are naturally developing products at different paces, and that means that there is nearly always a new shiny toy on the street. More pertinently, history has shown that extended white label relationships can turn sour, because the provider simply stops investing in the tech. On the fintech side this may be because they have to monetise the business, on the bank side it could be because the management has changed and feels (as they almost always do) that they need to “go in a different direction”, which I should stress (sarcasm alert) is never change for change’s sake…

The idea of white labelling is a good one, perhaps we need a different model, maybe a multi-faceted partnership where liquidity and risk management comes from one source and the tech from another? Either that or there are investment, improvement and performance targets built into the contract (i.e. you will invest X amount in your technology every year).

A friend also mentioned to me recently, the idea of a dedicated regional platform, that allows every provider to use the same tech and services. They simply provide their pricing into a platform that already has the analytics etc built in. This sounds like a multi-dealer platform, and may indeed be one – but it would be “closed” or “ring-fenced” to limit participants. At face value this seems OK, but I have one word of warning – Centradia.

Another option is for the local and regional specialists to actually spend the money and compete through investment, although I am not sure the ROI will satisfy the Board, but this does raise an interesting question from the JPM Edit – how much does a bank actually have to offer in the form of ancillary services and analytics to retain clients?

I don’t think the answer is simple because on one hand you can argue that the top clients require an all-singing-all-dancing platform, but then exactly how valuable are these clients? They are the ones with the most stringent best execution rules, have the execution specialists, and exploit information to time their executions. This adds up to a tricky consumer who won’t exactly be providing revenue, unless you’re a PB perhaps, which most regionals aren’t.

We have a slightly different look to the FX market and it is not one I am sure customers are totally comfortable with

On the other hand, the valuable clients, in terms of mark outs and perhaps mark-ups, have more simple needs. Certainly they need automation and the efficiency it brings, but do they need micro-second pricing and all the analytical tools? Probably not.

So, we have a situation where the most valuable clients don’t necessarily need the most sophisticated platform, and most sophisticated clients are undesirable at some level on the customer roster – which suggests that the tech lift may not need to be that big. Even as client sophistication grows, so too can the tech capabilities of the platform from the regional or specialist player, which raises another message in the JPM report – information leakage and internalisation are being seen as benefits of the single dealer platform. As noted earlier, a skilful player outside the top 10 or 20 LPs can be valuable to a big client who wants to mask certain elements of their business.

My take on the FX committee reports is very much that non-bank players are grabbing a share of the market again, how long this will last is debatable of course, because as I have noted before reject rates appear to be on the rise as well. They are likely to be doing so at the expense of bank LPs in the 8-15 range, which may include the odd regional or specialist player.

This leaves us with a slightly different look to the market and it is not one I am sure customers are totally comfortable with, for talking to consumers over the past few months it is clear they still harbour doubts (with one or two exceptions) about non-bank market makers. Be it the relationship aspect, or the fear that non-banks will be “flaky” under pressure, my sense is the traditional regional or specialist player is still welcome by the consumers.

As far as pressure situations are concerned, as long as the “right” kind of volatility exists, non-bank players will not be found out (if indeed they are if the “wrong” kind emerges), which means that there is a burden of responsibility on the consumer to ensure they don’t forget those regional and specialist players.

It should not be a case of charity, rather the two should meet halfway, with the regional player improving their game (possibly in conjunction with a global player or tech firm) and the customer understanding that there are benefits by playing the long game. There is little doubt in my mind that a diverse pool of liquidity providers is healthy for a customer and the industry more broadly.

colin@thefullfx.com