The Last Look…
Posted by Colin Lambert. Last updated: June 14, 2022
Over the years there have been three main issues I felt the FX industry needed to deal with, one of those – last look – has largely been dealt with, but the other two still hover menacingly over the market, and events elsewhere in markets have served to highlight the risks around one of them.
This is not going to be about the Fix, one of the other two issues – we await the findings of the Refinitiv Benchmarks consultation in the hope, rather than the expectation of change, but that will come in its own good time (although I fully expect the firm, leaning heavily on its respondents’ lethargy, to abdicate its responsibility to the end investor and change nothing!)
The third issue over the past 15-plus years has been high/lows, especially in dislocated markets, and recent events involving the London Metal Exchange have served to highlight the risks involved. Not only are LME volumes apparently in decline as industry confidence in the exchange seems to be diminishing, but members are leaving the exchange and, more worryingly from a reputational perspective, others are taking the lawsuit path.
The FX industry has long prided itself on running an efficient ship and handling challenges in a similar fashion, so could a similar issue happen there? Well, it has of course already happened. In January 2015 the Swiss National Bank provided a masterclass in how not to exit a currency peg and the FX industry – in the immediate aftermath of the carnage – undertook a major re-papering programme. In response to the mayhem (and it was undeniably a dislocated market), the primary venue in EUR/CHF, EBS, consulted with its major clients and the consensus was, as we all know, an establishing of the daily low to 0.8500. This in spite of the market trading down to near zero (albeit in smaller amounts).
This meant a huge number of trades being re-papered and, inevitably, lawsuits. It is perhaps significant that the headline lawsuit, CFH against BofA, ended in a UK court finding for the bank, and specifically that the trades did not need to be re-papered. Looking at how quickly some have resorted to the legal system with the LME, one wonders whether the FX market dodged a bullet in 2015?
There are significant differences in market structure of course, but there are also commonalities. Neither, for example operates a circuit breaker (at least they didn’t until recently!) and both are dealing with a wider core client base than historically has been the case, thanks largely to the growth in the non-bank trading segment.
I am not with those who believe in the effectiveness of circuit breakers. Taking SNB-Day as an example, CME Group, which does operate circuit breakers, suspended the market somewhere around 1.16 if I recall correctly, and by the time the market had re-established some order it was around 1.00. Realistically very few, if any, clients could have exited their position between 1.16 and 1.00 so swift was the move, but there was a small chance they could have done – a chance that didn’t exist in a market closed by a circuit breaker.
The FX industry would be well-served by a study and change/reiteration of the rules around highs and lows so no-one is in any doubt what will happen when, inevitably, there is another flash event.
What is happening with the LME heightens the need for the rules around FX market high/lows to be revisited. The current rules may be fine, but it would be wise for somebody – perhaps the GFXC – to take a look. I happen to believe the current rules in place are generally acceptable, the problem in January 2015 was a quorum decided to ignore them, but that does not mean this is not a good time to clarify what happens in the event (likelihood) of a market disruption.
If, for example, the rule is three-to-five million units have to trade at a price on a venue of record, that is fine – but perhaps what needs to be stressed is that in a case of market dislocation, these rules will be adhered to, no matter what the consequences. The LME’s experience is highlighting what happens when a participant(s) or market infrastructure tries to interfere with the functioning of the market, the FX industry does not need to suffer the same experience.
Sadly, by re-papering trades the industry is pandering to a certain sub-set of the market that believes it’s OK to make a silly mistake because there will be no consequences. Well, there are, and they should be understood. In the case of SNB-Day, people were selling euros at a level which meant, effectively, the Eurozone as an economic model, no longer existed. Some were rescued by the re-papering, some were not; none, however, should have their fate decided by a venue or unofficial quorum, it should be decided by the rules of the business.
The LME is discovering to its cost what happens when one party tries to interfere in the market functioning by, according to its critics, taking sides. There are some who would argue the FX industry took sides on January 16 2015. Whether it did or not, the industry would be well-served by a study and change/reiteration of the rules around highs and lows so no-one is in any doubt what will happen when, inevitably, there is another flash event.