The Last Look…

When the whole chat room/Fix scandal blew up, a regular feature of my columns in P&L’s Squawkbox was how the buy side itself had to be involved in any remediation efforts by the industry and had to accept some of the responsibility for what occurred.

To a degree it has fulfilled the former, through some firms’ membership of the Global FX Committee, but when it comes to finding solutions, or adjusting existing solutions, the buy side has gone missing. Whispers are starting to reach me, however, that suggest some firms may start to regret that action.

I have to stress I have only two independent sources for what I am about to discuss and in such a matter more confirmation is probably needed, but I am told that some law firms are starting to look at asset managers’ use of the Fix as part of a broader look at how they hedge foreign exchange exposures. Long term readers of my output will know this is something I wrote about quite a lot when we moved to the second phase of the chat room fiasco, the fines from regulators – as well as during the third phase, asset managers suing their banks.

I have long held that asset managers taking the legal route are playing with fire. On one hand they can say “we’re victims here and we’re seeking recompense for our clients” but on the other they can’t exactly say they haven’t been warned about how trading at the Fix can negatively impact their clients. I am told by one source that these firms’ acceptance of “standing instruction” trades for so long, in spite of being warned about them or enquiring about them several years before, is also in focus.

There is plenty of academic literature out there that studies both sides of the Fix argument, but I still maintain that while the mechanism itself in the spot markets works fine, it is no longer fit for purpose given the sheer size put through the market, especially at month and quarter ends. Reminding users of the need to constantly assess the rectitude of using the mechanism has been a staple of various industry and central bank bodies since the initial Financial Stability Board report into benchmarks in 2014 – how many have actually done that?

Every time one speaks with users of the Fix, or indeed with people close to the providers, the message is the same – the buy side are saying they don’t want it changed. That should not, however, stop people from looking to do just that. Too many on the buy side still pay less attention to their FX hedging than they should, and they are very reactionary when it comes to change – especially on what are, to many, administrative tasks.

If you asked a bank to work a large order on your behalf you would expect minimum slippage and an accurate “all in” price – so why don’t you want that from your fixing orders?

Now, perhaps, these firms may have to face up to class actions from investors, fuelled no doubt by promises from law firms armed with data highlighting how much money allowing the banks to get away with pre-hedging and trading on a standing instruction basis has cost them.

Any time pre-hedging is required it is indicating that professional traders, using sophisticated data analytics, think the order is too big for the designated window. There is nothing wrong with that, indeed it is fulfilling one of the recommendations from the FX Global Code that potentially disruptive market orders are identified and dealt with differently. The thing is though, the benchmark fixing price and the TWAP over the pre-hedging and fixing window are often different and rarely are they to the detriment of the executing institution.

Asset managers have long been aware this is going on – paradoxically some were party to class actions and then expressly permitted banks to carry on pre-hedging. True, they did so on the back of data that was not previously available to them, but I can’t be the only one who sees the irony in this situation?

I have often argued that nothing is likely to change regarding the use of the Fix until the buy side actually decides it wants to do something about it. The benchmark provider has a transparent mechanism and calculates the benchmark according to how it should be done, and banks execute in a more transparent manner thanks to them disclosing – and often getting specific permission for – their pre-hedging activity. This activity makes them money, the benchmark provider charges fees and makes money out of it – and the buy side doesn’t really care one way or the other. It should of course, after all, if you asked a bank to work a large order on your behalf you would expect minimum slippage and an accurate “all in” price – so why don’t you want that from your fixing orders?

If the whisper doing the rounds now comes to anything, the latter aspect will change – and quickly. The frustration for me is that all of this can/could have been avoided if we had paid attention to the data. The initial FSB report noted how trading activity in the one-minute window was 10 times the average, which is why I argued for a 10-minute window in 2014/15. Since then, passive investor volumes have skyrocketed, meaning there is likely increased demand for the Fix, hence it should be longer still. At the very least there should be an independent industry assessment of how well the five-minute window can absorb the volumes being put through, especially at month ends.

If there is to be more legal drama around this then surely it will focus minds on the problem at hand. There are those that believe the issue has been solved and that there is no longer a problem at 4pm London, however I would point out that rough analysis of the January and February month-end windows indicates EUR/USD moving 15-25 points in the pre-hedging and/or Fix window. It was same in Cable and even USD/JPY saw a directional move. Yes, this reflects the balance of orders in the market, but it also highlights how they are being squeezed into a too narrow and overly transparent window.

I must confess I had thought that the moment for reform has passed when it comes to the Fix – but if there is indeed going to be serious legal questions asked of the asset manager community over its use, perhaps it hasn’t?

colin@thefullfx.com