Market makers have been rethinking price algorithms since the unexpected decision by the Swiss National Bank (SNB) to remove its EUR/CHF currency floor on January 15.
Constant review of the efficacy of electronic price formation is a sensible strategy regardless of market conditions, but even more so in the wake of an event whose impact was so widespread.
|David Cooney, MahiFX|
“Market makers have no visibility on what other market makers are doing, so whether the quality of pricing overall has improved is a difficult question to answer,” he says.
“However, observable liquidity has certainly diminished, making markets gappier and more volatile, and that in itself has presented a requirement to evolve the core pricing models.”
Paul Chappell, founder and chief investment officer of UK currency management firm C-View, says: “As a user of FX markets and accessing liquidity, we would observe that it appears that the Swiss franc event has caused some change in market landscape in that in benign markets, pricing and liquidity remains as robust as before and in some instances has even improved.
“However, when markets are impacted by events – and particularly unexpected events – then liquidity drains away much more speedily than previously. As spreads widen, so market makers reduce pricing and amounts in order to protect themselves.”
FastMatch CEO Dmitri Galinov refers to data on average executed spreads of all users from the beginning of the year to show that for EUR/USD, spreads substantially improved from mid-January.
Jim Foster, deputy head of eFX trading at State Street, says the actions taken by the SNB earlier this year did not notably impact State Street’s day-to-day pricing algorithms, but adds they did highlight the importance of having logic in algorithms to cater for the most extreme of events.
|Jim Foster, State Street|
“So the natural question that market makers need to answer is, what other extreme events are conceivably possible that should be catered for in the pricing logic?”
The market ecology on January 15 had a 7% swing in favour of manual volume executed on the EBS Market platform, notes Mark Bruce, head of product at EBS BrokerTec Markets.
“Through periods of extreme volatility, some algorithms will automatically turn off to protect both extreme loss and profit-making events from occurring,” he adds.
“Following January 15, we know that some institutions have looked at the tolerance thresholds they have in place before removing automated pricing. Having said that, both bank and non-bank algorithmic traders are of great significance in providing additive volume, improving market stability.”
Bruce says that after an understandable period of widening spreads, the market has returned to normality.
“What has become significant is the acceptance and acknowledgment from the wider trading community that primary market information is absolutely critical during market stress,” he says.
“We have seen a substantial increase in clients looking to gain access to a primary central limit order book for price discovery purposes.”
MahiFX’s Cooney adds that the Swiss franc event reminded people that markets can and do break, and there should be circuit breakers built into pricing models to prevent risk growing in an uncontrolled way.
Within the first 10 seconds of the SNB’s announcement, FXCM’s system circuit breakers kicked in to stop new quotes and trading until the market stabilized.
In March, FXCM’s chief executive officer Drew Niv told Euromoney that much of the chaos and market breakdown could have been avoided had more platforms used circuit breakers.
Cooney concludes: “This is something we had incorporated into our models as we felt it was important. Preventing businesses we partner with from suffering significant drawdowns is an important part of what we do.”