PROFIT & LOSS EVENTS 2015
FOREX NETWORK
NEW YORK MAY 28, 2015
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PROFIT & LOSS FOREX NETWORK • NEW YORK 2015
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PROFIT & LOSS FOREX NETWORK • NEW YORK 2015
Opening Address: “Best Practices in FX” Michael Nelson, Assistant General Counsel and Senior Vice President, The Federal Reserve Bank of New York 4
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Conference Moderator: Colin Lambert, Managing Editor, Profit & Loss www.profit-loss.com
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Panel One: Shaping the Future of the FX Market
Jamil Nazarali, Head of Citadel Execution Services, Citadel Securitie Chris Concannon, President & CEO, BATS Global Markets Sanjay Madgavkar, Global Head of FX Prime Brokerage, Citi
Jill Sigelbaum, Global Head of Foreign Exchange & Alliances, Traiana Joe Conlan, Global Head of FX Sales, INTL FCStone Markets, LLC 6
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Cost of FX Trading to Rise as Firms Continue
Jill Sigelbaum The FX industry is being forced to re-price risk, which could potentially lead to higher costs for end users. Speakers on the opening panel of the day at the recent Profit & Loss Forex Network New York conference, ‘Shaping the Future of the FX Market’, focused heavily on how this re-pricing of risk is creating new cost pressures that are shaping the industry. “January 15 was an event that you can’t ignore if you’re a statistician, you can’t ignore a 38% move in a major currency, so you have to see that the perceived risk of doing this business has changed. I think that there’s a trickle down impact where right now you’re seeing the banks that are the major credit engines for this business re-pricing credit, and in some cases rationalising whether they want to do business with certain clients at all,” said Joe Conlan, global head of FX sales at Intl FCStone Markets. The panel appeared in agreement that it is impossible to margin for an event like the Swiss moves on January 15, but it was suggested that firms need to ensure that they adequately price the risk of any given transaction into the fees that they charge, which may mean re-pricing customers in some instances. Asked whether the growing interconnectedness of the FX could cause more sharp price moves in the future Jamil Nazarali, head of FX execution services at Citadel, responded: “I think that there’s been a very dramatic change across the industry regarding 8
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Joe Conlan
Chris Co
how market making firms price risk and that’s a positive development for the FX market. It’s difficult to say with any certainty whether this will have an effect on volatility because this phenomenon has occurred in other markets. It’s not unique to FX.” Sanjay Madgavkar, global head of FX prime brokerage at Citi said that “the revenue and risk relationship is becoming a lot more clearly defined for providers” of PB services. He added that not only are credit providers looking at how much risk they are exposed to in contrast to the revenue they receive from clients but that they are also focusing on their fixed costs. “More attention is now being paid to fixed costs because if you half the size of my business, my fixed costs will only go down by 10%, so it’s becoming more and more clear to market participants in my business that scale has become critical,” he commented. Liquidity is also another area identified by the panelists where a change in the willingness of firms to warehouse risk is subsequently forcing changes in pricing. Madgavkar said that he’s seeing an increased participation from buy side firms in providing liquidity to the market and, although he believes this to be a healthy thing overall, the market still needs more risk capacity. “What I think that we need is more risk absorption capacity in the market place, more risk-capable
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Re-Pricing Risk
oncannon
Jamil Nazarali
Sanjay Madgavkar
market makers as opposed to market makers that have a more transient view of risk,” he commented.
For example, at Traiana we are currently focused on facilitating the synchronisation of credit monitoring with the way that execution has evolved.
Chris Concannon, president and CEO of BATS Global Markets, responded to this point by stating that there’s no economic driver for many market makers to want to take on this risk. He claimed this if market makers have clients trading voice who are looking for larger sized trades then they’re more likely to provide true risk capital, but for firms that have clients providing liquidity in electronic form at very tight spreads the economics are not as favourable for risk taking.
“Similarly, new regulations result in changes to post-trade workflows, creating operational risk for the industry. By leveraging Traiana's expertise in complex post-trade workflows, clients can concentrate on growing their businesses while Traiana manages their post-trade risk and reporting requirements,” said Jill Sigelbaum, global head of foreign exchange and alliances at Traiana.
“The technology solutions that we have today only solve the one to five million execution level, they don’t solve trading in large blocks. Large blocks are just going to get harder to find liquidity for, and as algos start to develop those blocks will get chopped up into smaller orders, and once that happens that large block liquidity is never coming back,” he said. Unsurprisingly, the panelists also discussed how regulatory changes are introducing new risks to the market, exacerbating this need to re-price FX services. “Regulation is still a front and centre item, a lot of people thought that they would be able to implement regulatory infrastructure and then be done with it but that’s an ongoing cost,” claimed Conlan. “What we see is that as changes in execution occur in the market, there is an inevitable case of catchup, from both operational and credit perspectives.
Concannon agreed that operational risks are pushing pricing up and that technology might hold the key to reducing them once again. ”I think that operational risk is a real risk and we’re seeing it every day and because people are starting to price that in firms will start building technological solutions that solve that risk, meaning that you can effectively lower your price by adopting technology that eliminates the risk,” he said. Despite this, Concannon predicted that the cost of doing business in FX is going up. “Margins are coming down across the board, the spread that people are capturing and the risk that the large banks are willing to put on and warehouse has gone down and when that happens people start question where their frictions are. Price ends up being a major friction because you have the price of execution, the price of clearing, the price of CLS and all these frictions mean that the margin is going down and the cost of business is going up,” he said. www.profit-loss.com
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The P&L Debate: Do We Need Fix Alternatives? Philip Weisberg, CFA, Global Head of Foreign Exchange, Thomson Reuters Chip Lowry, CFA, Senior Managing Director, Agency FX Services, State Street Global Markets Andrew Maack, Head of FX Trading, Vanguard www.profit-loss.com
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Bank Withdrawal From 4pm Fix Heighten The banks’ reluctance to participate in the five minute WMR Fix window is causing increased volatility during the window, according to industry experts. Speaking at Profit & Loss’ Forex Network New York conference Andrew Maack, head of FX trading at Vanguard, said that he believed that the changes to the WMR Fix methodology have overall been positive, but that the 4pm window has become more volatile to trade in since it was expanded from one minute to five. “There are a lot of reasons for this, one being that the sell side is, quite frankly, nervous to even participate in that five-minute window. Now you tend to have a lot of execution algos running, maybe they’re simple TWAP algos running over that five-minute window, but the sell-side banks are not necessarily coming in to interact with that flow because they don’t want to be involved in that timeframe at all. “I think that this ultimately creates a lot of volatility around that time. You tend to have a lot of VWAP algos that are moving the market in one direction and not a lot of resistance on the other side and this can create air pockets at that time period,” he said.
“The residual is always going to be a problem, but in many cases it’s predictable what direction the residual is going to be. That’s an opportunity for those market participants that have flexibility built into their trading strategies to be able to position themselves in the direction of the likely outcome of that residual,” said Phil Weisberg, global head of FX at Thomson Reuters. Asked if the Financial Stability Board (FSB) might ever consider mandating how this residual is traded if the FX industry does not produce an effective solution for doing so by itself, Weisberg responded that he thought this would be unlikely. “I think that the solutions that lever the existing market infrastructure are the most likely to be successful and that’s what firms are getting on with right now. I don’t know that the FSB would ever empower a market utility to trade out the residual because the people who manage the money have to be able to choose the best way to manage that residual. That is the personal decision of the asset manager and it may vary depending on what type of fund they are managing or the contract that they have with the asset owner,” he said.
Chip Lowry, senior managing director, agency FX services at State Street Global Markets, added that the extension of the WMR window is less significant than the change in behaviour that has occurred around this Fix. “Whether or not the five-minute window is appropriate, the behaviour of market participants has changed, that’s obvious. People think that we just went from a one-minute window to a fiveminute window, but we did not. We actually went though a wholesale change in how firms pre-hedge risk before the window. No bank today wants to prehedge risk for fear of being labelled as front running their client, so there’s a lot of fear on the sell side,” he said. Maack also said that the banks are hesitant about the use of more sophisticated algos during the fixing window. “If we want to use a more opportunistic algo that, if it sees flow going one way or the other irrespective of time, might be able to be more aggressive or more passive depending on what side it’s on, banks don’t want to have you running those algos in that window because they’re concerned that it might appear to be a 'beat the Fix' type algo,” he commented. The panellists then turned to discussing whether the market will be able to find an effective solution for managing the residual flows that are not matched up during fixing windows. 16
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Andrew Maack
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ning Volatility
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Panel Two: The Technology Food Chain
Christopher DeWinter, Managing Director, Managing Director, Head o Gil Mandelzis, Chief Executive Officer, EBS-BrokerTec Eddie Wen, Global Head of Macro Ecommerce, J.P. Morgan
John Shay, Partner - Transaction and Technology Services, Virtu Fina 18
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Eddie Wen
John Shay
Can FX Technology be Scaled Across Although some elements of FX technology can effectively be scaled across fixed income and commodities business lines, there are limits to how similar these asset classes will become, according to panelists at Profit & Loss’ Forex Network New York conference.
direct manner with counterparties. This means that there is a behavioural quotient that is discussed and agreed to, there are acceptance rates and response times that are agreed to, there’s minimum tick increments that you can describe and trade, and we view it as the next natural step for these fixed income markets to take,” he said.
John Shay, partner – transaction and technology services at Virtu Financial commented that his firm had taken some of the better attributes of its FX business and applied them to its fixed income one, most notably in US treasuries. He said that this is because US treasuries, like FX, is a liquid, transparent product that trades on well-known and established OTC platforms.
Icap, which owns EBS, recently decided to merge the business with its fixed income platform, BrokerTec. Speaking on the panel, Gil Mandelzis, CEO of EBS BrokerTec, explained that this decision was made because there “are certain aspects of each market that are highly transferable from one asset class to the other”.
“As an electronic market making firm that is looking to take spread out of certain trades the existing platforms do allow us certain limitations, and like we’ve gleaned from FX there are wonderful opportunities when you trade in a disclosed and
However, despite claiming that electronification is coming “in a very meaningful way” to parts of the fixed income market and that it is probable that some parts of the US treasury markets will behave more like the current FX market within five years, Mandelzis said
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Gil Mandelzis
Christopher DeWinter
Asset Classes? that this electronification might not happen at the same pace or in the same exact way as it did in FX. Eddie Wen, global head of macro e-commerce at JP Morgan, said that although it’s tempting to view some products as being very similar once they go electronic, from a bank perspective there are unique challenges with regards to uniformly applying electronification across asset classes. For example, the different asset classes have traditionally existed within different product silos in the banks and therefore FX, fixed income and commodities all have their own governance, trading system and strategies and the nature of the ecommerce effort can vary significantly between each one. Over the past 12 months Wen says that JP Morgan has implemented changes to reorganise its business structure under one new JP Morgan
Execution Services unit so that it can take a more holistic view of the electronification of these asset classes. He warns that there are still challenges for the banks in terms of divergent technology stacks in each asset classes, as well as the differing speed of the evolution of each market. “Although a lot of the technological infrastructure that you build in one area conceptually looks very similar in other asset classes, when you have to wedge it into the other infrastructure that’s already there, you’re going to find that there are things that just don’t fit,” he added. “In principle, we’re all heading down the same path in each asset class, but at different paces. I think that eventually we’re going to see that a lot of the investment, learning and scale that you build in one business can actually be applied across the other asset classes, but only once a number of markets structure challenges are ironed out.” www.profit-loss.com
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Panel Three: What Next For Swap Execution Fac Laurant Paulhac, Managing Director & CEO, ICAP SEF Scott Fitzpatrick, CEO, Tradition SEF Paul Hamill, Global Head of FICC, Citadel Institutional Solutions
Mike Du Plessis, Global Head of FX, Rates & Credit Execution Servic 26
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Laurant Paulhac
Scott Fitzpatrick
SEFs: An Unlikely Success Story? Although market experts at Profit & Loss’ Forex Network New York conference disagreed about whether Swap Execution Facilities (SEFs) should offer post trade anonymity without a regulatory mandate to do so, there was broad agreement on the panel that the introduction of these venues has been a success. The issue of post-trade anonymity on SEFs has been a hotly debated one, with Profit & Loss previously reporting that many market participants feel that the lack of post-trade anonymity on SEF central limit order books (CLOBs) has deterred the buy side from trading on these platforms. But on the dealer-to-dealer (D2D) side, SEF operators are unlikely to offer this post-trade anonymity unless required to by regulators, because their core client base – the banks – largely want to retain post-trade name give ups. “It’s very important for our banks to know who is on the other side of their trade. Losing that information would be taking away their ability to touch and feel what is going on in the market place,” explained Laurent Paulhac, managing director and CEO of Icap SEF. Subsequently, he said that the reason Icap SEF doesn’t offer post-trade anonymity is because to do so would change the way that its current trading community operates. “I don’t necessarily agree,” responded Paul Hamill, global head of FICC solutions at Citadel Institutional 28
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Solutions. “If you’re in a market where you’re willing to put a live price on the screen, there’s no need to know who you’re trading with. I think that it’s unclear what the rationale is behind claiming that the banks need this special piece of information.” Mike du Plessis, managing director, global head of FX, rates and credit execution services at UBS, added that many buy side firms will only begin participating in CLOBs when they feel that they are getting the same treatment as the banks. “It does concern me a little bit when I hear a platform operator talking about one side of the market needing a particular type of touch or feel. The experience that we’ve had so far is that when clients get to access that market place, they too love the touch and feel of it and it’s important that we take steps going forward to ensure that both clients and dealers get the same touch and feel, because right now it doesn’t feel like they do,” he said. Despite this, Scott Fitzpatrick, CEO of Tradition SEF, commented that even the introduction of post-trade anonymity by a D2D SEF would be unlikely to lead to a sudden rush of buy side firms wanting to sign up to that venue. Additionally, he noted that competition amongst the SEFs would make it hard to introduce such a change unless it was mandated by regulators. “We grew up as D2D platforms and that’s still how we generate the vast majority of our revenue. We also operate in a very competitive market place where clients can choose from a number of
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Paul Hamill
Mike Du Plessis
different SEFs to trade though. Although there’s been talk of voluntary anonymity, unless this change is driven by regulators, it’s unlikely to happen,” said Fitzpatrick.
Paulhac attributed the overall erosion in swaps trading volumes to market conditions and the cost of capital rather than strict changes to the swaps market structure.
However, the thought of regulators further dictating how the swaps market should operate also appeared to be an area of concern for the panelists.
He pointed out that in the US market, roughly 5060% of swaps are now executed on SEFs and that 20-30% of the notional volume of Icap’s swaps business is conducted electronically. As Icap did not trade any swaps electronically 18 months ago, he said these statistics are evidence of the success of these trading platforms and the evolution towards electronification.
Paulhac explained: “We’re not against anonymity, and in some cases it may make sense, but we want to be thoughtful about the process.” Similarly, Fitzpatrick argued that any regulatory change needs to be implemented in a controlled manner that doesn’t disrupt or bifurcate liquidity in different types of order books. “I think the point that Scott makes is very important,” said Hamill. “If regulation is implemented that enables loopholes, then it could force trading to move away from these venues, resulting in further fragmentation and more complexity, which no one wants.” Despite disagreeing on the issue of post-trade anonymity, the panelists all made the case that the introduction of SEFs has been a success, despite some of the negative press that these venues have received. “With some of the debates that go on and the lack of patience you see being played out in the press, you have to remind yourself that we’re just over 12 months into mandated trading on SEFs for some products, so the market’s still in a fledgling state and will naturally take time to evolve,” said Fitzpatrick.
Hamill agreed that these figures showed that SEFs have been a success in terms of achieving regulatory goals. “While the SEF regime is still imperfect in a number of ways, ultimately this is about liquidity and customers’ ability to consume liquidity. There’s now more competition and greater choice in the market as a result of SEFs and it’s very hard to see that as a bad thing,” he said. “A buy side client can go into an order book and trade in a pool of liquidity that they were previously excluded from, that’s a huge step forward that’s come out of these changes,” added du Plessis. “We’ve also seen improved workflows, clients can now operate in the swaps market in a very similar way to how they operate in FX, cash equities or the listed derivatives space. We’re seeing a very rapid pick up in the desire from clients to unify their workflow. Why? Because they too have significant cost restraints, and while the move to SEFs and central clearing is part of the reason behind these costs, the solution lies there as well.” www.profit-loss.com
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Panel Four: Disruptive Tech Alan Schwarz, CEO, FXSpotStream Bapi Maitra, Global Head of FX Bank Sales & FX Institutional e-Sales, Citi John Miesner, Head of Sales, GTX Dmitri Galinov, CEO, FastMatch
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Panel Five: Dimensions of Risk Craig LeVeille, Executive Director, FX Products, CME Group
Jodi Burns, Global Head of Regulation & Post-Trade, FX, Thomson R Patrick Philpott, President, Americas, DealHub David Holcombe, Head of FX Product, NASDAQ
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as, Societe Generale www.profit-loss.com
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Reputational Risk Driving Changes at the Banks Concerns about reputational risks are driving changes at the banks’ FX departments, according to speakers at Profit & Loss’ Forex Network New York conference last week. “When I meet with front office executives they’re deeply concerned about the reputational risk associated with the FX fines and this reputational risk is driving a desire for real change at the desk level because these banks are worried about the impact that this crisis could have on what are sometimes multi-decade client relationships,” said Kiran Narsu, senior vice president of commercial sales at Digital Reasoning. Narsu also highlighted that this reputational risk is also a growing issue for the individuals within the bank. Often these are FX desk heads or senior executives outside of the compliance department who are being required to personally sign-off on a wide array of potential alerts, the vast majority of which are false ones. The concern for these executives is that this compliance burden is consuming a significant portion of time that could be spent running their business and that, despite not being a compliance specialist, they could be held liable for having reviewed an email that a future investigation unearths as being related to malpractice. “We’re increasingly seeing the personalisation of reputational risk. One firm we’re working with calls it a wholesale transfer of risk to the senior executives on the front line,” he said. Matthew Kulkin, a principal at Squire Patton Boggs, noted that the reputational risk being suffered by the banks is spreading beyond their FX departments. “There’s a price that’s paid reputationally when you have a settlement and there is a headline about a bank paying hundreds of millions of dollars in fines. But at the same time there is a SEC Commissioner issuing a speech condemning the waivers, there are politicians on Capitol Hill talking about the fines and so that reputational risk is spreading beyond the FX desk and attaches to the brand more generally and that comes at a serious cost,” he warned. Much of the reputational damage suffered by the banks has stemmed from the chatroom transcripts released by regulators, showing FX traders at different banks colluding around the 4pm London Fix. But despite some of the conversations being very obvious about the traders intentions – one line of the transcripts reads “If you ain’t cheating, you ain’t 38
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trying” – Narsu said he is not surprised that the current bank surveillance tools failed to raise red flags to compliance staff. “This behaviour wasn’t caught because the environment and culture of compliance wasn’t consistently established within these firms,” he said, adding that there was also a technology failure where the current systems only took samples, used keywords and didn’t have the analytical capabilities to discover the damaging communications taking place within the banks. “Imagine hundreds of traders chatting hundreds of times per day, sending thousands of emails over a seven- or eight-year period and you’re looking at huge data volumes that are very difficult to analyse in a time construct that makes sense for a compliance analyst. So firms have resorted to sampling to get through it all,” he added. Narsu said that he believes that the banks have “got the memo” and are now striving to improve their surveillance tools and compliance practices at a systemic level. However, Kulkin warned that the banks aren’t the only ones improving their surveillance tools. “Talking about the role of surveillance, you can’t forget that the regulators in Washington are growing increasingly sophisticated in their use of technology,” he said. It has recently been revealed that US authorities missed huge sets of data when analysing the 2010 Flash Crash simply because at the time they didn’t not have sophisticated enough technology to consume all the data that was theoretically available to them. Kulkin pointed out that since 2010 the US authorities have attempted to rectify this with DoddFrank creating the Office of Financial Research (OFR), which is partially designed to work on data standardisation, the Commodity Futures Trading Commission (CFTC) setting up its Technology Advisory Committee (TAC) and the Securities and Exchange Commission (SEC) creating Midas, which publishes large amounts of market data. Additionally, he noted that there are bills pending in Congress focused on improving data quality and standardisation and that in the derivatives markets swap data repositories are required to report trades as soon as technologically practical. “There’s always going to be this cat and mouse game between what the regulators can do and what the market is doing but the regulators are catching up,” he said.
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