The Voice of Experience

The latest in our series, which taps the minds of experienced FX market participants, sees regular contributor Ted Holloway join the debate over the buy side and its attitude to having to pay to access liquidity

I wanted to follow up on the “The Last Look” column of January 23, 2024 in The Full FX, for while there were a number of points raised with which I agreed, there were others that I thought warranted discussing in greater detail.

For a number of buy side clients the notion of paying for FX liquidity is an anathema, however the blame for this, in my view, lies with LP’s. Historically FX was a volume game, the thought process being the more you saw, the greater the chance to capture the spread, with the additional bonus of potentially offsetting market risk.

To add to this I believe the market at this time was fixated by surveys, with Euromoney being front and centre. That publication’s annual FX survey was almost viewed as the complete who’s-who of the FX market. LP’s were judged in just about every category the FX market

had to offer, and in every global time zone. Of course, this never truly told the full story, but like it or not (and I know which side I was on) its presence in the market could not be under estimated.

The problem with the survey was, however, that it was an entirely volume-orientated and LP’s built businesses around its findings. This meant the relentless pursuit of volume became paramount. FX sales desks were built solely around credits, and pricing at times became secondary so long as volume targets were seen to be hit. Clients naturally became spoilt, and the notion for paying for FX liquidity an anathema, as I mentioned earlier.

I make no apology for this history lesson, as I believe its important to understand it in the context of today’s markets.

the expectation, from those who wish to transfer risk, that it can be done without cost, is at best short sighted

Of course, LP behaviours have changed, for reasons we are aware of, and this has had the knock on effect of increasing costs via compliance and regulation and, in some cases, reduced risk appetite. If the sell side behaviours have had to change to reflect this new market, therefore, is it reasonable to expect the buy side to do likewise? Introducing costs to hedge FX exposures at a time when most fund portfolios and businesses are already under pressure is likely to be a highly unpopular move, however, I believe it is a necessary one.

I am not suggesting the market implements a uniform charge across the industry to assess liquidity. Whether an LP does or doesn’t charge for FX liquidity should remain at their discretion, however I do think that buy side clients need to get comfortable with the fact that if they want to remove FX risk from their portfolios and businesses, then those offering this service should at the very least be afforded to opportunity to make money from it.

Traditionally LP’s have been poor at assessing the overall value of their clients, and in turn, in my opinion, those clients need to gain a better understanding of the value of liquidity and risk transference. The near endless supply of portals and platforms all claiming to offer deeper liquidity with faster pricing and tighter spreads gives the illusion of plentiful liquidity, and that is often the case.

It is important to remember, however, that liquidity and risk appetite are not the same thing. The former only exists whilst the latter is in a stable condition. What happens when that stability is eroded? In times of high market stress liquidity disappears, as we have witnessed in the past. What happens if those ultimately providing liquidity deem it too expensive to continue doing so?

As I have mentioned before, the price of providing FX liquidity has increased, therefore it is reasonable for those providing liquidity and thus absorbing market risk the opportunity to make money.

I am surprised that the notion of not having to pay for FX execution still exists amongst the buy side. Yes, the sell side did itself no favours, however the markets have moved on, and are far more regulated as a result. The expectation, from those who wish to transfer risk, that it can be done without cost, is at best short sighted. Failure to address this will both lead to a greater concentration of market risk, and at times of greater stress, could lead to complete liquidity failure.