The Last Look…
Posted by Colin Lambert. Last updated: July 5, 2022
Here’s a question: What’s happening in the non-bank market maker space in FX? It was noticeable during my extended trip to Europe in May that not only were less people talking about these firms, but some liquidity consumers went out of their way to say how much less they were seeing of them on the other side of trades.
It’s not all firms, XTX Markets – which has largely operated a slightly different model to the others – is still regularly mentioned in discussions, as is Citadel Securities, but beyond that the only firm garnering attention on my trip (and during subsequent conversations) was HC Tech, and that was for the wrong reasons!
I do think that some of the firms in this sector have decided that FX is just too hard to make money in, especially given how last year’s changes to the FX Global Code have focused attention on their use of last look. I also think that the tightening prime brokerage market has made it more challenging for firms with certain models. Probably the number one reason, though, is that they are focused elsewhere – even if you look at XTX, it is noticeable that the replacement for Zar Amrolia (albeit in the role of deputy, rather than co-, CEO) comes from an equities background rather than FX.
Other firms went to crypto as they found a rich seam to mine thanks to volatility, volume and the absence of banks, although given how volumes are declining and price action seems to go in fits and starts this may not last much longer. I also think that the more crypto markets took on the characteristics of equities, this was attractive to some firms – throw in the looser (or non-existent) regulation and their speed advantage with huge arbs available and you have a recipe for success.
Another factor is one I raised several times in my columns at P&L – there is only so much room for firms of this type in FX. They are predicated upon public markets, which handle a fraction of FX flow every day and the competition is fierce – so much so that without a client franchise of some sort the cost/benefit equation just doesn’t work out – especially compared with the opportunities elsewhere. Put simply, if 10 firms were battling for that piece of the FX pie, only two or three at the most were likely to succeed – and with the imposition of zero additional hold time on last look, the success rate diminishes further for some of these firms.
FX is still an attractive market to non-bank firms, but they have to be clever about how they operate – there is no more hiding behind hold times and leveraging speed.
When this theme first emerged I tended to think people were saying this because these firms had become part of the FX industry’s furniture, but that does not seem to be the case, although I would suggest that XTX and Citadel have become just that, possibly to different degrees. This should not be seen as an indicator that this segment is disappearing from the market altogether, however, for I sense that there is a new generation of non-bank firms emerging that are part trading/part market making – hedge funds without the investor base might be one way of describing them.
These firms are technologically nimble but do not rely upon arbitrage, they also do not rely upon last look and tend to be takers on the public markets more than makers, although that depends, obviously, on how volatile those markets are.
It is inevitable, as technology continues its inexorable advance, that the disruptors get disrupted, especially if their business model is one-dimensional. Equally inevitable is that new firms to the market will use the latest technology to gain an edge, that’s called evolution and it’s how we innovate as an industry.
Ultimately, to paraphrase Oscar Wilde (not sure I’ve done that before!) reports claiming the demise of the non-bank FX players are exaggerated, the sector is still there and an important part of the FX market, especially in the public arenas. What has changed, however, is that some of the names are less familiar and some of the “household” names have disappeared.
FX is still an attractive market to non-bank firms, but they have to be clever about how they operate – there is no more hiding behind hold times and leveraging speed. In many ways the non-bank firm of the future has to look somewhat similar to the FX trading desks in the banks many years ago – be prepared to quote, but also look for prop trading opportunities.
The technology is vitally important, but how it is used is even more so, and, to end with a cliché, standing still is going backwards.