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COMMENTARY: Look again
Risk.net this week published the results of its investigation into the last-look policies of banks and non-banks operating in the foreign exchange market – finding nearly a quarter of the top 50 forex liquidity providers don’t make their policies well known.
Last look is the period of time during which a liquidity provider receives an order and – before execution – conducts price and credit checks. Banks argue the method can help them detect ‘toxic’ order flow, and last look was initially envisaged to shield market-makers from volatile price movements and the speed advantages of high-frequency traders. Those that employ the execution style also say pauses in timing trades can lead to improvements in spreads.
But the practice has become tainted and mired in controversy. Critics say slowing execution may allow dealers to see more price movements with the purpose of rejecting trades that move away from the bank or locking in more profits if prices move towards the bank. It is under particular scrutiny in relation to agency execution in which trades are conducted through algorithms that source liquidity from multiple venues and providers – because clients may be unaware of the practices used in those pools.
Some banks have faced regulatory sanctions for misusing last look in order to grab extra revenue.
In 2015, for example, Barclays was fined $150 million by New York regulators for its use of last look – reversing out of trades to boost its own bottom line.
Credit Suisse in 2017 received a $135 million fine from the same regulator to settle allegations that its traders engaged in forex misconduct. That included failing to disclose to clients when trades were rejected because of last look.
Deutsche Bank, meanwhile, was taken to court by Axiom Investment Advisors, which accused the German bank of implementing delays to reject trades that would have benefited clients. However, in a twist to that case last year, a US district court judge dismissed the possibility of a class action. The court acknowledged evidence that some clients were properly informed about the practice and that price checks, on a net basis, benefited clients despite resulting in more orders getting declined.
The 2017 global code of conduct sets standards for trading in the spot forex market. Under its Principle 17, firms are expected to disclose the length of last look and hold times. But Risk.net was only able to find this information for less than half of the top 50 liquidity providers. In addition, only 28% of the top 50 publicly disclose how long last-look checks take.
In addition, the disclosures of non-bank liquidity providers have been shown by Risk.net to be even worse as a group compared to banks. Contrasting six non-banks against five of the largest forex dealers, just three of the top six non-bank liquidity providers – compared with all five of the top dealers – had public disclosures across areas such as pre-hedging, hold times and use of rejected order information.
This week those six non-banks felt compelled to respond – publicly calling for the practice of last look to be scrapped and substituted with firm pricing.
It could be argued that trading venues should play a greater role in enforcing standards. Some have already imposed restrictions on last-look checks, although venues are reported to be reluctant to become the “policemen of the code”.
However, it will also be incumbent upon the Global Foreign Exchange Committee, comprising central banks and private sector participants that oversee the code, to respond to these issues. The GFXC has already achieved much. According to Risk.net, for example, nine out of 10 of the top 50 LPs are signed up to the code. But could more be done?
STAT OF THE WEEK
Required client margin held by Citi’s swaps clearing unit surged 8%, by $2 billion, to $28.3 billion over the three months to end-June. Citi remains the futures commission merchant with the largest share of required margin across all reporting firms, at 27.1%, up 40 basis points quarter-on-quarter. Citi fastest-growing FCM.
QUOTE OF THE WEEK
“Hopefully this committee can survey current practices and come up with ideas that would foster innovation and derivatives products that would help people manage risk, and lay off risk, that are taking a few steps beyond just broad weather-related derivatives” – Rostin Behnam, commissioner at the Commodity Futures Trading Commission, on the formation of a subcommittee dedicated to understanding and managing risks posed by climate change to the financial system