Eurex recently revealed it will impose a speed limit on fixed-income options trading from December, while it was reported in the Wall Street Journal that Cboe Global Markets was looking at introducing a brief delay on one of its equities exchanges.
Speed bumps are nothing new – many banks use them – but their potential imposition on FX exchanges has caused alarm in some quarters.
For example, Kevin Kimmel, global head of e-FX for Citadel Securities, describes the proposals by equities exchanges to implement asymmetric speed bumps as harmful to equity markets.
“They would be similarly harmful and counterproductive in the FX market, which has recently made significant progress towards limiting last look,” he says.
If speed bumps are enforced by market participants to manage their liquidity to deter loss-making order flow, remaining market participants will be left to absorb this ‘toxic’ flow, according to Point FX CEO Henry Wilkes.
“Faced with an increase in loss-making trades, they will widen their spreads, making it more expensive for everyone to trade,” he says.
Nikos Tsoskounoglou, head of algorithmic trading at ADS Securities, reckons the effect on pricing will depends on the quality of the flow.
“For good customers, it would probably make no difference, but for others it might translate to slightly wider prices or worse fill ratio,” he says. “However, I do not believe its impact would be significant.”
While any artificial constraints make a market less efficient, if they are implemented to protect the utilitarian traders and their service providers from predatory practices, the result might be tighter prices, adds Vikas Srivastava, chief revenue officer at Integral.
This is because there will be less need for defensive pricing from the liquidity providers, who just want to serve their customers.
James Sinclair, executive chairman of MarketFactory, agrees, noting that clients who tolerate speed bumps – whether deliberate or due to slow processing by the market maker – tend to be less aggressive, friendly flow clients.
“This may enable a market maker to quote tighter prices to these clients, particularly in multi-dealer platforms, such as ECNs, where the market maker does not know the true identity of the end client,” he says.
Need for transparency
A number of observers stress the need for transparency. There are legitimate uses for a holding timer in some circumstances, but those uses need to be transparent and clear to all pre-trade, says Roger Rutherford, COO of ParFX.
“It is critical that a speed bump – or a randomized matching tool – achieves its purpose of meaningfully protecting traders against bad trading behaviour,” he adds.
“Some platforms have introduced latency floors and slowed down or batched orders, but these measures are not effective and don’t deter disruptive trading behaviour.”
Brad Bailey, a research director with Celent’s capital markets division, says his concern with market structure changes such as the introduction of speed bumps is the cost to the treasurers, investors and firms that rely on tight spreads and ample liquidity.
“I would ask what the market is trying to do by introducing speed bumps: make it harder for certain liquidity providers to make markets?” he says, asking who would benefit from this move.
Zero hold time will mean that last look will mostly be used for its original purpose of protecting against true off-market trades, rather than as a money making strategy- Vikas Srivastava, Integral
Consistency would also be challenging, suggests Point FX’s Wilkes.
“As we have seen from the debate about last look, it is not easy to agree a consistent market approach or even whether the practice should be allowed in the first place,” he says.
“My sense is that this is a similar situation and the first thing the market has to do is to decide whether the use of speed bumps adds value to the operations of the market or unwanted and unnecessary interference to the natural flow of market liquidity.”
Wilkes also observes that many dealers now apply a zero hold time and operate successfully, so there is an argument to be made that this should be adopted as best practice by any market participant that wants to be a liquidity provider.
Robbert Sijbrandij, head of institutional FX trading at Flow Traders, suggests the adoption of zero hold time would be more effective, as it takes away the option to pre-hedge in the last-look window.
“This is different from speed bumps, as it will impact those orders that are not real liquidity while responding to real liquidity from end investors,” he says.
Widespread adoption of zero hold time would be effective in changing how last look is used, says Integral’s Srivastava.
“Zero hold time will mean that last look will mostly be used for its original purpose of protecting against true off-market trades, rather than as a money making strategy,” he concludes.