FX: UK Treasury slams ‘evidence’-free liquidity fears

By:
Joel Clark
Published on:

Regulators and policymakers recognise the need to understand changes in liquidity but need better market intelligence, AFME conference hears.

Policymakers in the UK and internationally are actively monitoring changing liquidity conditions in fixed income and currency markets, but they need intelligence to be specific rather than generalized, said a senior official at the UK Treasury.

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Charles Roxburgh,
Her Majesty’s Treasury

"I always find that 'liquidity’ is a term used in many ways and often it comes across as a bit of a humpty-dumpty word that means exactly what the speaker wants it to mean," said Charles Roxburgh, director-general for financial services at Her Majesty’s Treasury.


"It is not that helpful to get generalized concerns that there’s a big problem with liquidity. It is easier if [participants] can give us much more specific, detailed, evidence-based examples of where is the problem, in which markets, and your insights as to what are the root causes of those problems."

Speaking at the Association for Financial Markets in Europe’s (AFME) European fixed income and FX market liquidity conference in London on February 25, Roxburgh reassured market participants the Treasury is aware of industry concerns, but he added that some instances of shallow liquidity might be a correction of pre-crisis conditions.

"Deeper market liquidity is not necessarily a characteristic of an effective market," he said. "We saw in the crisis instances in which liquidity in previously highly liquid markets suddenly dried up and it became clear that previous levels of liquidity were illusory and ultimately damaging to market effectiveness."

Excessive liquidity, Roxburgh explained, can fuel asset bubbles that compromise financial stability, but he acknowledged that insufficient liquidity can lead to sharp price volatility, damaging market confidence.

Instances such as the unexplained intraday swings in the US Treasury market in October 2014 and volatility in the German bund market last year are sufficient to give policymakers "pause for thought", he said.

More selective

Buy-side market participants complained it had become harder to get business done, particularly as banks have reduced their balance sheets and become more selective about which clients they serve.

In that environment, buy-side trading desks have had to consider new approaches, which could include making prices directly to primary trading venues, or peer-to-peer trading that avoids the need for bank liquidity provision altogether.

Stephen Grady, head of global trading at Legal & General Investment Management, said: "One of the concepts that has been shattered is the public utility of investment banks standing in the middle of markets and making a price no matter what the conditions are.

"The banks have balance sheet to preserve, so the pricing they are willing to make is going to reflect their risk appetite and risk capability, and that has implications for markets."

A reduction in bank liquidity provision creates opportunities for non-bank providers to gain market share, particularly in foreign exchange where buy-side demand for currency hedging continues to grow.

XTX Markets, formerly part of GSA Capital, has been one of the most successful electronic market-making firms and it recently recruited Zar Amrolia, Deutsche Bank’s former global head of FX, as its co-chief executive.

Speaking at the conference, Amrolia said smart technology allows XTX Markets to do up to $50 billion of FX market making per day with just one salesperson and no traders.

When the Swiss National Bank suddenly removed its currency floor in January 2015, sparking one of the biggest ever intraday market moves, XTX suspended pricing for just 20 minutes, according to Amrolia, while some bank systems were out for several hours.

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Zar Amrolia, XTX Markets

"It was our worst daily loss in terms of capital, but we were there, and we switched pricing back on a lot quicker than most banks," said Amrolia. "If you think about putting your money where your mouth is in terms of liquidity provision, I can’t give you a better example."

Non-bank market makers shouldn’t be seen purely as competitors to the banks, he added, as there are opportunities for constructive partnerships.

"This is an incredibly exciting time for financial markets, because the impact of technology is creating new market participants that do business in a different way and those benefits can be passed on to many of the banks and end-users."

However, despite the growth of alternative market makers and the advent of new trading models, concerns remain that changes in liquidity provision could adversely impact financial markets and the real economy.

According to Roxburgh, central bankers and regulators are actively committed to understanding the drivers of such changes and the possible policy responses.

"There are enough signals out there in the noise that we are taking concerns about market liquidity very seriously and we are trying to build a more detailed understanding of the causes of any problems," said Roxburgh.