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EXECUTIVE SUMMARY
• The dynamics of liquidity have changed as the FX market has developed
• The consensus is that all posted prices should be two-way
• The derivatives market can destroy liquidity in the spot market
• The FX markets offer the best opportunities to deal with macro events in a way that offers the highest liquidity
• FX markets have the advantage of being capital efficient and with positions that may be readily exited
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Foreign exchange debate part one: Banks and buyside face up to market pressures
Euromoney FX debate videos
Foreign exchange debate: Learn more about the panelists
Sui Chung, Euromoney I’d like to start this second half of the discussion with assessments of the liquidity situation. Mani, how do you see liquidity levels out there in the market today, at least in the leading currencies?
MM, Sun Trading The dynamics have changed. What we see now is a reflection of different strategic positioning; the advent of high-frequency trading into FX has definitely added value to the markets and it has allowed other participants to focus on other types of trading. With regard to the banks and their liquidity, they primarily seem to be very interested in knowing whom they’re trading with, and they’ve been able to focus on that as well. Through the top FX ECNs a lot of the volume is coming from non-bank entities producing two-sided markets and in those markets banks are consumers of liquidity now. I think it’s a reflection of having everyone focus on their relative strengths as opposed to everyone trying to do everything. That’s what makes things work.
Sui Chung, Euromoney Ian, would you agree, coming from Deutsche Bank, that you were as big a consumer of liquidity as a provider?
IOF, Deutsche Bank No, I don’t think we are as big a consumer as we are a provider of liquidity. On the other point there has definitely been an increase in volumes. That has come from two areas; one is new entrants to the market, secondly the increased ability for people to hedge has driven volumes up too. The key trend of the past few years, though, has been the evolution of FX from what was once a primarily quote-driven market into an order-driven one. At the moment new market participants have definitely helped the top-of-the-book area of the order book. Beneath the top of the book, the liquidity is not as good as it was and there isn’t liquidity at every point in the market, and sometimes at the times you need it the most it’s just not there. When you find these, you get a mini flash crash; there are a lot of mini flash crashes that happen every day in foreign exchange. At the moment the market can handle those, but it’s something that’s going to be very interesting to see how the market works them out over time.
MW, Credit Suisse I would agree with Ian, I would describe the liquidity as sometimes discontinuous, so although it’s a 24-hour market the liquidity isn’t there at the same level uninterrupted on a 24-hour basis in all 100 currency pairs and all the payoffs. Also it’s usually discontinuous when you need it most. Particularly for the liquidity providers that makes it doubly difficult, and I guess that’s the challenge we all are facing.
RO, Oanda Isn’t something quite dramatic happening? If you go back a few years you would say EBS and Reuters were at the core of the FX market and then you had the big market makers as a ring around it facing all the other market participants. I argue that the market landscape is changing. EBS and Reuters are losing their prime position. The big market makers are becoming far more prominent and are a powerful independent source of price information and liquidity. So this makes the whole discussion much more subtle. A system that was once centralized has now devolved and is operating in a distributed framework. Each of the big market makers plays a prominent role in determining liquidity.
RL, UBS As far as liquidity is concerned I’d say that liquidity is there. The big market makers have been able to tweak the liquidity and some of that has to do very much with what you’re talking about with regards to the way in which the big liquidity providers are increasingly the centre of gravity. But one of the issues that we face is when the market does lurch. A lot of that has to do with liquidity illusion, whereby people take a central feed, in some cases EBS, and they spit this out to a vast range of clients. When those consumers interact with the central pool it creates ripples and discontinuous movement, and I think that has been exacerbated.
All posted prices should be two-way
RO, Oanda My contentious statement is that it’s a complete mistake to allow people direct access to the market without forcing them to post two-way prices. A market where you can just show one-way prices is open to abuse, even tactical abuse. The reason is very simple. When you see a one-sided price you don’t know if that’s just a very attractive price or the guy has some other information that you don’t have. The only way to prevent that is if you force people to show two-way prices. If it’s narrow you know he has no other information; if the spread is wide but one side is attractive you know he has a particular set of information.
IOF, Deutsche Bank If you were forced to show the other side, to a degree you can shade it, but now you’re able to just really show one side, and you have the active funds coming in on the ECNS just showing one side, and that makes the whole system very unstable.
