In a break from the recent past, the drama in foreign exchange this year could be found in courtrooms, meeting rooms and boardrooms – rather than gapping markets – as the industry grappled with the sins of the past and fought strategic battles over its future.
Some of this spilled into public in May, when the industry published its global code of conduct but danced around the contentious issue of the so-called ‘last look’ window, a brief pause granted to a liquidity provider after a quote has been accepted by a customer. The window exists so a dealer can refresh a price in fast-moving markets or ensure the client has enough credit line to complete the trade, but could also be used to withdraw the quote and trade ahead of the client.
The original version of the code, published on May 25, said only that trading by the liquidity provider during the last-look window was “likely inconsistent” with good practice. But that wasn’t good enough for many market participants, including XTX Markets, which had been using its seat on the Bank of England’s (BoE) foreign exchange standing committee to press for bolder reforms.
“There are some liquidity providers still utilising 100 milliseconds of last look when the primary market is updating every five milliseconds, meaning you can see 20 price updates within that last-look period. In what way is it a latency defence mechanism when you can see 20 price updates?” asks Jeremy Smart, head of distribution at XTX Markets.
XTX Markets – this year’s winner for both currencies and streaming flow market-maker – didn’t stop at behind-the-scenes advocacy.
“We’ve always had a three-pronged approach: educating our counterparties to try and explain what is going on, creating competitive pressures and contributing publicly to any regulatory comments,” says Zar Amrolia, co-chief executive at the London-headquartered firm.
One of those competitive pressures has been the firm’s move to zero-hold times, a step that effectively eliminates last look for those trading with XTX on a bilateral, disclosed basis – the hold time isn’t zero, but is so short that data from primary markets such as Nex Group’s EBS Markets and Thomson Reuters Matching refreshes first.
We’re helping to frame the market changes coming as a result of the global code, and we have been very vocal in that process in terms of what we’d like to see to help restore trust and further transparency in marketsJeremy Smart, XTX Markets
“You need a maximum of two price updates to make a judgement if using it as latency protection, so we don’t see why people need to employ extra hold time. I understand the need to do regulatory and credit checks, but 100 milliseconds is a ludicrous amount of time to do that,” Amrolia says.
Switching to zero hold time has made it harder for XTX Markets to make money on a trade-by-trade basis, Amrolia admits, but has more than made up for that shortfall by attracting more customers. The firm’s bilateral volumes with clients are up 50%, making that business as important as its proprietary market-making and anonymous interdealer business. XTX, which had 20 direct clients this time last year, has catapulted that figure to 100 and believes it can double the customer base again in 2018.
“The jump in volume and clients has got a lot to do with people realising that having a zero hold time shows a clear demonstration of our commitment to transparency and fairness, which gives us extra weighting at times within people’s liquidity pools,” says Smart. “It also means people shine more of a light on the behaviour of others in that liquidity pool. Those not offering the same type of liquidity are given lesser weighting or removed altogether, so it’s had a positive impact.”
An executive at one forex trading platform says other liquidity providers are starting to change their own behaviour, too: “There are a plethora of last-look times in the market today, but they have started to become more transparent. XTX is at zero hold time and banks have also begun reducing their last-look times as a result. We still have a long way to go but this is already having an impact on the market.”
In November, the Global Foreign Exchange Committee, made up of representatives from central bank working groups – including the BoE group Amrolia sits on – tweaked the code to make it clear market participants should not act on information seen during a last-look window.
“We’re helping to frame the market changes coming as a result of the global code, and we have been very vocal in that process in terms of what we’d like to see to help restore trust and further transparency in markets,” says Smart.
To get its prices to clients XTX has a distribution team of five people globally, including Smart. This includes one person in New York in the firm’s recently opened US office. They use a variety of methods to distribute prices, including direct connections, a third-party vendor or even sometimes via an electronic communications network (ECN) such as FastMatch, Hotspot and Currenex, which allow users to create individual liquidity streams for clients.
“We have got the message out there about how we price, what differentiates our pricing, and that has been received very well,” says Smart. “In addition, we have made a push around transparency, the importance of holding risk and zero hold time. This has added to people’s understanding that XTX is a major market participant whose liquidity they need to be able to see.”
Those clients predominantly consist of retail aggregators, systematic hedge funds and regional banks. This reflects a shift in strategy from last year, when XTX was aiming to go after business-to-business clients by providing liquidity to a number of top 15 banks.
It is absurd that clients do not know the basis on which they are charged various spreadsZar Amrolia, XTX Markets
“That portion of our business has dialled down, which has both been deliberate and also a natural feature of competition, as we are competing more for their own direct clients. Clearly the nature of the relationship has changed somewhat,” says Smart.
XTX’s long-term ambition is to break into the real-money space, but that is seen as a more complex challenge. At the moment, the company reaches those clients indirectly through the liquidity it provides to forex dealing desks.
“For those smaller banks taking our feed, their role is providing their clients with liquidity and credit services. Many of them have a model for holding some risk in forex and hedging. In general, we provide liquidity into those institutions because they can touch clients directly that we would never be able to touch, either for credit reasons or because they are outside the typical scope of the prime brokerage-type relationship, such as mid-market corporates,” says Smart.
While its zero hold time initiative may have proved successful with direct clients, applying the practice on ECNs would be suicidal, the firm claims.
“We would like all ECNs to move to zero hold time. If as a risk-holding liquidity provider you end up facing a high-frequency trader over the ECN, then it doesn’t make sense to go to zero hold time when they can easily trade on a price they know has already been updated. We’re able to control the liquidity and trading experience when we trade directly with the customer and can agree a protocol between us, but we simply can’t do that when we trade anonymously over ECNs,” says Smart.
By being transparent with customers you can show you are a risk-holding firm and have intelligent discussions on how they can improve their spreads and how liquidity providers manage their flow tooZar Amrolia, XTX Markets
Another commercial pressure XTX introduced this year is ‘XTX-ray’, a post-trade analytics (TCA) tool that allows clients to measure the cost of rejected trades, the fill rate and market impact of their trades, among other data points, with XTX.
“It is absurd that clients do not know the basis on which they are charged various spreads. Spreads they are charged are a function of the trade acceptance logic, how they execute and their market impact. So by being transparent with customers you can show you are a risk-holding firm and have intelligent discussions on how they can improve their spreads and how liquidity providers manage their flow too,” says Amrolia.
XTX claims most TCA tools are geared towards algo execution – which makes up 10% of the market – unlike XTX-ray, which includes risk transfer business as well. Smart is particularly pleased clients are able to measure the cost of trade rejects, which can sometimes give distorting results, he says.
“In the past, people viewed the cost of rejects as how much was rejected, meaning it could be OK to have a 98% fill ratio with a counterparty. However, those 2% of rejected trades can be very expensive if you still have to trade, and when you come back to market to do the same trade, the market has already moved, so clearly that is a cost the client bears to the benefit of the liquidity provider,” he says.
This could be down to a liquidity provider using last look and potentially cancelling important trades during the last-look window and then trading based on client interest in the market.