CFTC’s concerns about FX industry annoy pros


Paul Golden
Published on:

Comments made by the US regulator at an FX industry event in Miami in February have raised the hackles of some market participants over the thorny issue of ghost or phantom liquidity.


In a speech to the TradeTech FX conference, Andrew Busch – who was named the Commodity Futures Trading Commission’s (CFTC) first chief market intelligence officer less than 12 months ago – said the CFTC was concerned about loss of liquidity in the FX market and specifically whether some of it actually exists.

A survey conducted by the organizers of the event among traders and heads of FX at US-based financial institutions found that half of respondents viewed finding alternative methods to source liquidity as a priority.


Dan Marcus, ParFX

Busch’s views have garnered some sympathy, with ParFX CEO Dan Marcus describing phantom liquidity as a hindrance to traders that not only portrays an inaccurate picture of market depth but also results in a lack of confidence across the board as efficient price discovery and execution is unachievable.

Some electronic communication networks – to look like they are offering a deeper market – will pretend to appear like a client to other networks and republish the depth, adds Nick Dyne, co-founder of Cash Netting Services (CNS).

“In this way, the actual depth is massively exaggerated,” he says. “The increasing use of order book-based electronic trading means this is a reduced problem, but it is still a frequent tactic.”

Institutional FX Advisory Partners (IFXAP) founder Henry Wilkes suggests the FX market is in denial about the quality and depth of real liquidity.

“The forward market has probably suffered the most, with a significant reduction in liquidity as a result of regulation and the new capital requirements seriously restricting the appetite for anything longer than three-month FX risk on the balance sheet,” he says.

The sell side has an important role to play in aggregating both liquidity and data from across the market to provide not only execution quality but also important market insights for clients.

Banks should look at their aggregated data in real time – from trading venues as well as internal trading – to derive information about the flow of liquidity, spreads and other key market information, which is difficult for the buy-side client to determine on its own, suggests Matt Hodgson, CEO of Mosaic Smart Data.


IFXAP’s Wilkes and others have been quick to point out that regulators such as the CFTC are far from blameless when it comes to liquidity issues.

For example, when the swap execution facilities (SEFs) were being set up, there wasn’t enough liquidity to go around, but regulatory pressure to use multiple SEFs – to prove what a good idea it was – led to exactly this issue, notes Dyne at CNS.

Javier Paz,
Aite Group

Market fragmentation is a reality in an over-the-counter setting and CFTC’s Busch seems to forget that regulator policies since 2010 – the Dodd-Frank Act, the Volcker rule, Mifid II, Basel III – have led to decreased market making by banks, observes Javier Paz, a senior analyst within Aite Group’s wealth management practice. 

“Reduced bank liquidity equals more liquidity provided by non-banks equals more liquidity fragmentation,” he says.

In any case, market fragmentation is not necessarily a negative development, suggests Brad Bailey, a research director with Celent’s capital markets division.

“While it creates a more complicated environment where technology prowess, better tools for capturing and analysing data and deeper market structure skills are required, it also allows for more choice in execution and potentially more competitive pricing,” he says.

MarketFactory executive chairman James Sinclair accepts that fragmentation could enable adverse selection. However, the market has had much practice and experience reducing that circumstance, he adds.

“Electronic brokers almost all have strict limits on numbers of orders that a trader can submit in a given time interval and some enable randomization,” he says. “Networks monitor behaviour and put more aggressive customers in segregated pools.”

New regulation

Wilkes believes enforcing new regulation to address the issue of ghost liquidity would have a negative impact and would prefer to rely on the commercial dynamics of the market to drive out the practice with market participants refusing to use platforms that develop a reputation for poor quality liquidity.

“As a market participant, if you continue to be negatively impacted by liquidity suddenly disappearing, you have the choice to use one of the many other platforms,” he says.

Even Marcus at ParFX acknowledges that rule changes can be expensive, take years to implement and result in regulatory arbitrage, thereby limiting their effectiveness.

The solution might lie in the FX global code, which provides clear guidance on how market participants can reduce instances of ghost liquidity, suggests Curtis Pfeiffer, chief business officer at Pragma Securities.

Principle 12 in particular states that market participants should not engage in trading strategies or quote prices that compromise market integrity, cause artificial price movements or a false impression of market price, depth or liquidity, he says.

“Adherence to this principle by a broad range of market participants would be a major step forward for ensuring access to firm and executable liquidity across the entire FX market,” concludes Pfeiffer.