The Last Look…

Interesting times in the platform world with word reaching me that Refinitiv is consulting with key clients over a change to how data is distributed on Matching. As always a proposed change to either of the major CLOBs is eliciting heated responses, which if nothing else highlights just how important they remain in the modern FX market.

Multiple sources report that Refinitiv is proposing a similar deal to that rolled out by EBS some four or five years ago, where the amount of passive volume transacted on Matching dictates whether a participant gets the binary market data feed at 5ms. My sense from talking to these sources is that the jury is most definitely out on the proposal, possibly tilting towards it being a bad idea. It should be stressed, however, that my observation is based upon anecdotal evidence, the firm itself could be getting a much broader, more positive response.

So, is it a good idea? Well I think most people accept that the “primaries” need to do something to arrest the decline in their volumes – even if the primary (pun intended) cause of the decline is internalisation, which is largely proven to offer better execution outcomes for clients. Before that noisy minority jumps onto their email and WhatsApp to tear into me, I might as well point out that I am not buying their (inevitable) argument. Yes, the top of book on public venues is often tighter than a single dealer or small aggregated pool, but once the first two million is done, what happens to the next 98? We cannot judge best execution on just hitting top of book all the time – market impact has to play a bigger role.

Back to Refinitiv’s idea. Yes, most agree that more volume through these venues would bolster the quality of market data, but this is one of the paradoxes of the situation. The “primaries” need to sustain volume to sell their market data, but the very fact that everyone is using that data to inform their pricing and risk means it is the last place someone seeks to place interest in the market. They are the brightest of the “lit” venues and as such, any trading on there will have a ripple effect.

It can also be argued that the same tactic didn’t work for EBS so why should it work for Refinitiv? There are some nuances here, EBS’ core markets are at the epicentre of internalisation, whereas Matching still has a lot of what might be termed niche currencies where even the biggest players need external data. I think it fair to say that Matching still plays a significant role in EM and, to a lesser extent, the Commonwealth currencies, than EBS does in its core pairs outside of NDFs and China.

One interesting question could be would such a move shift the balance if both “primaries” adopt the same tactic? Some critics have pointed out to me that Cboe FX is an alternative, however it should be noted that that firm’s CLOB also rewards certain behaviour with faster market data feeds – is there a trend developing here, and if three FX CLOBs are aligned, does the balance shift even further?

Another prominent criticism is that the move would be anti-competitive. Maybe it is, I am no legal expert, but given EBS and Cboe FX have a similar arrangement I would have thought the legality would have been challenged before now.

It is an interesting idea, but you have to ask the question, is it ignoring the reality of the modern foreign exchange market?

Those I have spoken to in favour of the move argue that it can help improve market quality by removing a lot of the white noise on the platform. To go back to my point about the small differences between EBS Market and Matching, several correspondents have highlighted how they would like to be able to post resting interest (often on behalf of customers, so the LP doesn’t have to worry about arguments over whether a fill was correct or not) on the “primaries”. This is less of an issue in the G3, but when you get to markets like Cable, AUD, CAD, NZD – all Matching strongholds – it can make a difference. The proponents for change argue that too many orders are sent in and cancelled, meaning the genuine interest is rarely at top of book, where it could attract decent counter interest. As one trader put it to me, “There are so many people messing around on the primaries, it’s hard to know sometimes where the real market is.”

As you can guess, there is a divide on this issue along bank/non-bank lines, although it should be noted it is not exclusively so. What I would say to those in favour of the change, supporting such a move by placing the occasional order in the market is not going to be enough – sustained support in the form of more interest posted to the venue is the only way such a move will be a success.

If my anecdotal view is right and this is signalling something of a return to the days when the banks were king of the primaries, the I guess we need to ask the question, “Is this ignoring the reality of the modern FX market?”

The fact is, at a very broad level, the number of banks playing a significant role in the risk process is smaller than ever before, more and more banks are all about the credit intermediation. There is a small group of banks that sees a majority of the flow, but on the broader spectrum, are those smaller and regional players – that used to be so important to the market – still going to be involved?

The challenge for the “primaries” is that in a world in which everything is about the customer, their customers’ customers won’t notice either way because they don’t use Matching. Too many players are likely to be ambivalent because their focus is exclusively upon the client. Matching and EBS Market remain important venues for the exhaust flow and little else. They don’t meet clients on these venues so why bother?

FX should avoid the equities trap of trying to go faster and faster, leading to what we have in US equities in particular at the moment, a heated, ongoing and occasionally vicious argument about market structure.

My view is pretty much what it always has been, something needs to be done, but perhaps, with more surveillance, data and analytical tools available, a less blunt instrument should be used? Perhaps it should be based upon the number of passive orders placed in the market that are actually executed upon, with the number of quote/cancels also thrown in for good measure (as a negative input)? This might better reflect how a participant is using the platform rather than using the blunt instrument of absolute passive volume. Perhaps also, the mark out from trades could be measured, to identify those on the aggressor side who are making conditions tough? If they get to a high enough cumulative level of mark out then their access to the fastest market data feed is restricted?

I like that Refinitiv is at least thinking differently about its own business – this is not a new idea, and it has not really worked before, but that does not mean, with a tweak or two, it cannot be made to work. The healthier the CLOB(s) is the better the overall market works in my opinion, because people can price with confidence. FX should, however, avoid the equities trap of trying to go faster and faster, leading to what we have in US equities in particular at the moment, a heated, ongoing and occasionally vicious argument about market structure.

One idea, and this is with tongue firmly in cheek I ought to point out, is to actually slow the market data down. Make people price on these venues according to their position or view – an old-fashioned idea yes, but not necessarily the worst one!

Either way, both “primaries” continue to work hard on reversing the decline of recent years on their venues. I have always liked the idea of trying things – people should not be afraid to get it wrong occasionally. Things are pretty dire in terms of activity compared to 10 years ago, so why not try something different?

One final irony in this whole debate, however, could be the great unknown in all of this. If the last few months are showing us how the FX market will behave in 2022, we could see the return of a trend and of volatility – two conditions that often help firm venues. Imagine going through all the angst of change and the emotional debate it elicits, only to have economy do the recovery job for you!

colin@thefullfx.com

@ColinlambertFX