The Last Look…
Posted by Colin Lambert. Last updated: September 7, 2021
Are we about to get movement on one of my regular themes in this (and previous) columns, the London 4pm Fix?
I have to confess I felt a frisson of excitement when I read a Reuters story indicating Refinitiv Benchmarks was considering changes to the Fix – I have previously reported sources’ information that the firm has been conducting quantitative analysis of price action around the Fix, perhaps something is finally going to get done as I have been calling for over more years than I can care to remember?
There are two ways of looking at this. On the basis there is no smoke without fire, and that Shirley Barrow, global head of benchmarks and indexes at Refinitiv was quoted in the story, one would surmise that change could be upon us.
On the other hand, the story actually says the firm is “considering” changes to the length of the window (and number of pricing sources used), and will release a white paper this month seeking feedback. I think changes have been under consideration for some time, in an interview I conducted with Shirley Barrow at Profit & Loss last year, we talked about the process of change, and how consultation was a huge part of it.
If the white paper heralds a period of consultation, then it seems the issue may finally be moving forward and, being an optimist, I think the latest interview is just a case of the firm being careful in managing expectations.
That being the case, what will now be needed around said white paper is a full and frank debate among industry participants. There is a niggling concern that the easy way to respond to a white paper or any consultation, is to promote the status quo. Throw in the fact that several users of the Fix don’t see the problem – some undoubtedly do – and feel that a 20-minute window would be no different to a five-minute session, and you have the first signs of inertia; even though this school of thought ignores the logic of time/volume/market impact.
Overall, however, a white paper and consultation by Refinitiv marks a critical juncture in the FX industry’s evolution – this is the chance to at least partly heal one of the running sores in the business. Yes, the company is in constant consultation with the industry, but that is very different to asking what is effectively the question, “Does this Fix need mending?”
Looking at the high-level aspects of the argument, the upside to no change is that Refinitiv doesn’t have to handle more data and that it is business as usual for users of the Fix. The downside is continued legal risk (yes, I know disclosures exist, but ask Mark Johnson, who is currently in a US jail whether (pre) hedging looks acceptable to the man in the street?) and, frankly, poor execution quality for the end investors.
Obviously there is no doubt over where I sit. I am fed up of listening to people argue that because the order is firm it can be hedged without consequence. The fact of the matter is, an order that goes firm at 3.45pm, is generally speaking too large to push through a five-minute window, and is therefore (pre) hedged, but the customer does not get the benefit, or, on the one in one thousand occasions (pre) hedging might go wrong, the cost).
The biggest irony of all is that while the buy side seems so intent on trimming margins elsewhere in their FX activities and are very focused on improving execution quality, they continue to ignore what is probably their biggest revenue giveaway
As an example, just look at the last month end Fix in Cable. A seller of Cable at the Fix (the majority of firms) could have sold at 1.37764 using a 20-minute calculation window. On the other hand, in spite of the fact that the order was executed over a 20-minute window, but only calculated over five, they actually sold it at 1.37628. How is that to the benefit of the client? I understand that on a pure revaluation nothing changes, but these are actual trades, therefore there is an economic outcome and as it stands now it is to the detriment of the end investor.
So the sensible thing to do here as far as Refinitiv is concerned, is to extend the window. There will be no change in paperwork for the buy side that they seem so concerned about, the name of the fixing mechanism and calculation methodology will be the same, it will just be over a different time. A lot less flow will have to be (pre) hedged, meaning banks face less risk of a nasty lawsuit (whether it is winnable or not, they don’t want to be dragged through the courts again), and algo execution providers can demonstrate the benefits of reduced market impact.
There is still the question of other trading firms keying off the flow and creating market impact, but there were some interesting observations to be made from the data in the our last month-end fix analysis. In Cable, at the start of the 20-minute calculation window the market actually went up, presumably because there were expectations of dollar selling, which were proved wrong and because hedging activity was lower. In the 10 minutes ahead of the WM window, when the (pre) hedging really kicked in, it dropped some 30-35 points. If a trading firm were following the flow in a 20-minute window, I would argue the smaller slices being executed by the algos would be harder to spot and could, as possibly happened on 31 August, even be consumed by a larger ticket the other way. Confusing data signals are the enemy of a directional trader and would, I suggest, lead many of them to stop trying to trade off the Fix flow – the risk-reward just wouldn’t cut it.
So, obviously as someone who has campaigned for a change for so long, I fervently hope this is the start of a process of change that will benefit the entire FX industry (I also hope this doesn’t end up in misguided compromise and a 10-minute window). The emphasis is on the users of the Fix to do their analysis, look at the numbers and consider their investor clients, by backing a much longer window.
If they don’t then frankly they deserve everything that comes their way – banks are making good money out of the Fix at the moment in addition to their fees (and incidentally, if banks started losing money from (pre) hedging as they claim they could, how long do we think they would continue offering the service and/or executing in this style?).
The biggest irony of all, however, is that while the buy side seems so intent on trimming margins elsewhere in their FX activities and are very focused on improving execution quality, they continue to ignore what is probably their biggest revenue giveaway. Go figure.