The Last Look…
Posted by Colin Lambert. Last updated: April 25, 2022
I was talking to someone in the platform world the other day who suggested these were golden days for the multi-dealer platform community. Looking at the volume data this air of optimism is justified, however it should be noted that the backdrop is a generally optimistic tone across the industry. Frankly, if you’re not hitting new or recent highs, start asking questions.
Sell siders are also telling me that volumes are at, or above, recent highs and that aggregation channels are seeing an increased percentage of business – in excess of the gains seen by platforms. If this is proven in the BIS Triennial Survey later this year, this will be an impressive performance, because looking at the platforms in March (Refinitiv, for some reason, is delayed in reporting its data for that month) just about everybody has either hit a new peak or is their highest since the pandemic hit in March 2020.
More LPs seem keen to redirect flow from some customers away from the multi-dealer platforms and onto aggregation channels – mainly citing cost, although even aggregation on some venues can come at a cost. Several buy siders I have spoken to in recent months have told me they are being lobbied harder than usual by some players to go direct – still in competition – via a channel that doesn’t cost the LP as much to support.
In some ways I find this a little surprising, because times are clearly good, and money is being made – historically that is a time when market participants worry less about their costs. This could signify that many LPs don’t expect the market to sustain recent volume levels, although I am not sure why they have that view. To me the shock of the Ukraine war has been priced in, but the markets still face tremendous uncertainty over the length and breadth of monetary policy tightening around the world. That, more than anything, will drive market volatility and volumes.
When looking at the respective channels in FX markets I like to look at what is happening in the algo execution world. Talking to a couple of providers they see very different dynamics driving uptake. Some customers are looking at performance alone and, apparently, like a high percentage of trades executed against internal flows; while others are purely interested in executing externally.
The latter approach always intrigues me, because it is hard to imagine that the slight top-of-book improvement (if it even exists) compensates adequately for the cost of signalling risk from trading publicly. Some customers remain obsessed (thanks to their oversight mainly) with being able to tick the TCA box, and this often means they do not even consider signalling risk or, even more eccentrically, market impact.
Talking to someone about this the other week, we decided it comes down to business structure – some firms are so rigid there is no room for imagination on FX hedging – as well as a lack of trust in the executing banks. I am not sure why this is still the case, independent third-party TCA is a part of the market fabric and has been proven, why not use it?
Whether clients can be persuaded to adopt different channels (with the same level of workflow access) succeeds or not really depends upon the desire of the clients to actually pay attention to the data. The only way change will occur is if the pricing can be tight enough (open to question at top of book) and sufficiently robust (beyond doubt) and the data proves it.
Against this backdrop, the platforms are, apparently, picking up some extra volume from algo providers using strategies that largely ignore internal pools, and this is probably good news for the venues – after all, if a customer remains unwilling to engage with internal liquidity after the past two years (and more in reality) they likely never are.
This means that increased algo activity will benefit the platforms – but will it remain a good news story? In reality what will happen is dependent upon market conditions. I have no doubt that if volatility remains at or close to current levels, reject rates will become a big thing again; if things quieten down most venues will benefit.
To return to the key theme, however, it is interesting that LPs are still making noise about trading channels with their clients. To be clear, they are not saying use the SDP, rather it is all about putting them in competition with each other, on a cheaper channel for them. In some cases this is through the algo business, but a couple of banks, as I have mentioned before, are pushing a 2020’s version of white labelling.
Whether clients can be persuaded to adopt different channels (with the same level of workflow access) succeeds or not really depends upon the desire of the clients to actually pay attention to the data. The only way change will occur is if the pricing can be tight enough (open to question at top of book) and sufficiently robust (beyond doubt) and the data proves it. My sense is that as a new generation of traders populate the buy side, there is a greater openness to embrace the value of good data analytics. The best firms have been doing this for years of course, but it has to be said on the buy side especially, adoption is nothing like universal.
People that look at this stuff constantly tell me that the data shows one thing – LPs pushing their better liquidity down the cheaper channels, so yes, times are good at the platforms, but there should be no resting on laurels.
I suspect that the trading environment on these venues will become an even bigger theme over the next 12 months, not necessarily around issues such as zero hold time, but more about reject rates and market impact. Some platforms continue to evolve their trading ecosystem, but there are others who are not. They should be wary – for as the LPs are highlighting, times may be good right now, but in six months’ time?
Underpinning this is cost of connectivity and trading, which means now is the time for platforms to reinforce their strong position by putting in place procedures and monitoring to ensure the LP and client experience is a positive one. That is only part of the solution, however, for without a genuine USP, I suspect platforms will find that they are being squeezed on costs as well. In those circumstances, they had better hope that volumes continue at current levels, or there might be the perfect storm of reduced activity and lower revenue streams.