Trust, Transparency, and Success

Is there a relationship between success, trust and transparency? Eva Szalay takes a look.

It intuitively feels right that the more successful – as well as complex – something is, the more transparent it has to be for it to be trusted and therefore used? Alas, academic research on the issue suggests otherwise.

A study on the issue found that somewhat surprisingly more transparency does not necessarily translate into more trust, or in other words, customer usage. In fact, Richard T. Thakor, assistant professor of finance at the University of Minnesota Carlson School of Management, and Robert Merton, professor of finance at the MIT Sloan School of Management, found that there is very little to support the common view that by being open companies can gain new customers.

Thakor and Merton say that “empirical evidence on the issue is mixed” and there is little direct causal link between transparency and trust. “Indeed, anecdotal evidence suggests that greater transparency need not be associated with greater trust: some of the most trusted institutions often disclose less information than their less-trusted counterparts,” they conclude.

This has relevance for financial markets and FX in particular, partly from a regulatory perspective. Consider the raft of disclosure and transparency-related requirements that came with MiFID II. Or efforts from the Global FX Committee to offer guidance on the issue. Regulators are pressing for more visibility, granularity and disclosures than ever before in the hope of increasing trust in service providers and as they seek to protect customers. Thakor and Merton’s research suggests that this might be a flawed approach, however. Based on practical experience, it appears that clients positively flock to providers who refuse to be transparent, just like the study says.

A flashback to the famed whiteboard trick that derivatives sales desks used to convince customers about buying a pile of toxic debt, (all about dazzling clients with complexity and obscurity). The latter’s response? I love the complicated equation on that board, it’s so clever! I tell you what, I don’t need to know what’s going on or any further information, thank you very much, where do I sign?

Human nature seems to be prevailing in the world of FX too. The ongoing regulatory conundrum around platform perimeters is a neat example, albeit the Footnote 88 episode and a few other instances are similarly instructive.

The FX platform landscape is bafflingly complex as it stands today – like, at the heart of a currently-raging debate is the meaty question: what is a platform? It’s possible to trade currencies at dozens of providers that operate under labels ranging from software as a service to technology provider through to execution management systems. There are also the platforms, of course; ironically, the segment that appears to be doing the least well when judged on volume metrics.

Even when liquidity pools are on the same regulatory footing, the information freely available to the public about volumes, performance metrics (roundtrip times, full amount, matching engine activity etc) is widely varied. While Euronext FX publishes a whole host of information about volumes and roundtrip times for example, there isn’t a peep about either from Bloomberg.

Look at any of the UK, US or BIS turnover surveys that break down execution channel – the multi-dealer platforms, most of whom are regulated in some shape or form, are in the minority when it comes to the preferred method. Even taking the multi-dealer channels that publish volume data into account, it is clear there is more going on away from prying eyes. In the US, which handles around 17% of global FX volume, the last FXC survey indicated over $225 billion going through the MDP/Aggregator channel, where as a look at those volumes published by those venues indicates they do around $70 billion – or around a third of turnover.

Our academics reckon that transparency doesn’t translate into trust, instead it substitutes for it. When there is a lot of information, there is no need for customers to make a leap of faith, but when we look at disclosures from MTFs, there is little evidence of a rush of customer activity, which appears to be building more and more momentum in the darker crevices of the market instead.

All of this poses a few questions: why do traders appear to prefer obscurity? Could it be that what regulators prescribe as necessary for gaining customer trust, just doesn’t actually make business sense? And why is this happening, because clients seem to prefer mystique and complexity above having all the information?  Or, maybe it’s because it’s cheaper (at least on the surface) to trade at places where the regulatory costs are missing from the client bill?

Sunshine is said to be the best antiseptic, but is it as good for business? Maybe not.