FX: Solution emerges for ‘last look’ information leak
FastMatch’s leak/sweep protection order – designed to address market manipulation fears – has received a cautious welcome, but it’s not clear its benefits will be felt equally by market makers and takers.
FastMatch introduced in May the leak/sweep protection (LSP) order type, which it says enables market makers to protect themselves on the platform when an aggressive taker sweeps across markets.
LSP is also set up to protect clients from revealing order information to makers unless that order results in a trade.
By using LSP, market makers are effectively ‘outsourcing’ last look.
Last look is the practice used by banks to pull a price from a platform after a customer has placed an order, introduced as a defensive measure to deal with toxic flows that outwit traders.
Dmitri Galinov, CEO of FastMatch, describes LSP as a positive development that resolves the information-leakage issue associated with using last look where order information is disclosed for uncompleted trades.
Alex McDonald, CEO of the Wholesale Markets Brokers’ Association, has referred to last look being used unfairly when market makers stand aside from trading on a bid or offer that they have made with the intention of price discovery rather than market making.
The notion of levelling the playing field for market makers and takers is a positive one, says Bryan Seegers, director eFX pricing and execution at ADS Securities.
“Giving the client the ability to protect their order from being traded against and guaranteeing anonymity in the event the trades are not completed, as well as protecting liquidity providers from being ‘run over’ should translate into a better trading experience for everyone, assuming the liquidity provider is able to monetize the flow,” he says.
According to James Watson, CEO of ADS Securities, the LSP concept is sound and should be focused on larger order flow and protecting clients.
David Mechner, CEO of Pragma Securities, adds: “Interestingly, FastMatch also appears to be offering the service as a technology provider on a service bureau basis, which means that banks can outsource last look in the context of direct disclosed bilateral trading – thus not requiring the taker to have a prime broker, and not introducing brokerage and prime broker-related expenses into the equation.”
Henry Wilkes, founder of Institutional FX Advisory Partners, suggests that change is required to alleviate any misconceptions about individual proprietary platforms’ use of last look and how this can be manipulated to the advantage of market makers.
“It will be difficult to achieve this if the proprietary platforms retain control of the whole trading process and have the ability to reject trades based on their own rules and criteria,” he continues.
“I would therefore welcome an independent venue taking control to ensure that the process works for both the market maker and the market taker, providing it does not add too many extra layers of connectivity, complexity and costs for the former.”
James Sinclair, CEO of MarketFactory, refers to LSP as an interesting development and accepts that price makers must ensure they do not make use of information from deals not done if they wish to maintain their customers’ confidence – doubtless we will hear more of this as the global code of conduct evolves.
One of the principles of the code is that confidential information obtained from a client, prospective client or other third party is to be used only for the specific purpose for which it was given.
However, Sinclair also suggests LSP should be regarded as an aid that addresses a specific set of circumstances rather than a replacement for good behaviour.
ADS’s Seegers observes that the success of LSP rests on the assumption that the full ticket is being sent as a full order amount.
“The majority of venues are used specifically to sweep the market or to trade out of difficult business, which is why the venues are used instead of sourcing liquidity direct from the provider,” he says.
“The vast majority of clients that execute on these venues are doing so across multiple venues/sources of liquidity, which increases the odds of market impact and ultimately, results in minimal flow being executed.”
Pragma’s Mechner notes that FastMatch’s implementation allows the price maker to choose whether LSP will benefit only the maker, or whether it will also prevent a trade if the price has moved in the maker’s favour during the hold period.
“That flexibility makes it attractive to a wider group of makers, but without symmetry it provides takers with a relatively narrow benefit in preventing information leakage around unexecuted orders,” he says.
“It doesn’t really address one of the core issues with last look, which is that it introduces adverse selection that degrades execution quality.”
One provider of FX market data says the key issue with LSP orders is how the price referencing works, as it is the reference price that drives subsequent actions.
“The key question is whether the protection aspect of the product can be deliberately triggered,” he concludes. “Given that every LSP order type we have seen operates against a rate derived from the platform or – worse still – the market maker itself, the concept of protection is illusory.
“It might be a better idea if the reference rate couldn’t be affected by the market maker either directly or through the platform, but like many of these products, that might reduce the overall attractiveness of market making into the product.”