Forex Network London 2019 by P&L Services Ltd.

FOREX NETWORK LONDON 2019 phOTObOOK

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Opening Address & Fireside Chat

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Rohan Churm, Head of Foreign Exchange Division, Bank of England Moderator:Â David Clark, Chairman, European Venues & Intermediaries Association (EVIA)

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Trade Wars, Geopolitics and Macroeconomics – are we entering a new paradigm for FX trading?

L-R: Van Luu, Global Head of Currency, Russell Investments • Todd Elmer, Head of G10 FX Strategy for EMEA, Citibank • Megan Greene, Global Chief Economist, Manulife Asset Management • Juliette Declercq, Founder - Global Macro Strategist, JDI Research Ltd

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Has FX Become Divorced From Geopolitics? Despite the geopolitical situation worldwide becoming more volatile, FX markets have stayed relatively idle, leaving speakers at the Profit & Loss Forex Network London event to wonder what has caused this disparity.

In recent months, news of geopolitical volatility – from Brexit woes to an intensifying trade war between China and the United States – has dominated the headlines. Yet while this volatility has been reflected in many financial markets, with energy prices being a prime example, it seems to have had little impact on currencies. Todd Elmer, senior G10 FX strategist at Citigroup, argued that the reason for this is because central bank monetary policies have stayed more insynch than was generally anticipated. “Certainly we are seeing lag in FX volatility compared to other asset classes,” he said. “There had been this expectation that we were going to see a divergence in policy across the world, reflecting economies starting to take off, but we’ve had the opposite. So long as policymakers continue to pursue this extremely easy policy, I think that that is going to suppress volatility… I don’t actually envision a significant pickup anytime soon.” Megan Greene, who is a senior fellow at the Centre for Business and Government at the Harvard Kennedy School and was previously chief economist at John Hancock, noted that there are specific reasons why the volatile energy prices didn’t translate to big FX market moves. For one, she explained that energy usage has become much more efficient, meaning that oil prices need to go significantly higher in order to create a drag on the US economy now. That’s why, said Greene, when oil prices fell so low in 2015 and 2016 it didn’t provide much stimulus in terms of those prices feeding through into inflation. “In so far as growth and inflation expectations are an input into the forex markets, volatility in energy prices aren’t going to feed through the same way they used to,” she added. Taking a more micro view of what’s happening in FX, Juliette Declercq, founder – global macro strategist at JDI Research, claimed that “there’s really been an effort to kill volatility before talks between the US and China end in a deal” and predicted that once talks has been concluded volatility would catch up with the market. Meanwhile, Van Luu, head of currency and fixed income strategy at Russell Investments, said that although he was surprised by how low volatility has been in the FX markets, there is a logical explanation for why this has occurred.

“The market is clearly playing the Goldilocks scenario where the Fed has pivoted from being very hawkish to being very dovish. And in that kind of pause environment, the low volatility makes sense,” he explained. Luu continued: “In the Goldilocks scenario carry trades work very well, the developed market carry strategy has performed nearly 4% year-to-date. Low volatility is very bad for trend strategies, but I think the best set up is to have a combination of the two because then you can benefit from either a continuation of the low volatility regime or a pickup of volatility.”

The value of hedging

Given the lack of FX volatility, the question was put to the panellists about whether firms should cut back on hedging their currency exposures. Greene responded that there are a number of risks associated with such a change in approach, pointing to recent trade tensions as one in particular. Although she predicted that the US and China will agree a new trade deal, Greene said that any such deal is likely to be “fairly superficial” and that it won’t mean and end to the recent trade tensions. “I don’t think that trade will stay off the table, I don’t think a détente will last. Also, if there is a détente between the US and China that means that our trade department in the US has more bandwidth to focus on other things. And president Trump really cares about bilateral trade imbalances. So he’s going to look at countries who have a bilateral trade surplus with the US and the top of the list is Japan and Germany. This means that car tariffs and potential agricultural tariffs on the EU are all in play. So I think that trade actually remains a really big risk, in which case if you haven’t hedged then that’s a bad call,” she commented. Declercq was similarly critical of the Trump administration’s fixation on trade imbalances and predicted that a stronger dollar should drive currency hedging for firms with USD exposures. “I think trying to fix trade balances is a bit of a ludicrous idea, there’s a clear reason why the US has a trade balance deficit and part of it is the strength of the dollar. So one way to actually fix the trade balance would be to actually fix the dollar,” she said. www.profit-loss.com

Declercq agreed that any trade deal between the US and China will be largely superficial, adding: “Eventually what will have to be addressed is the strength of the dollar and whether that is done through firing power alone or putting pressure on the Fed, I don’t know. But that’s really what I would be hedging now if I was a corporation.” Luu agreed with the stronger dollar view in general, but also said that he doesn’t see room for it to go too much higher. “When it comes to hedging, I think we have an unusual situation where for dollar investors there’s a strong tailwind from hedging back to US dollars. There’s about a 2.5% per annum interest rate differential in favour of the dollar, so it seems from a carry perspective that it’s quite attractive for dollar investors to hedge back into their own currency. That’s also attractive from a risk perspective because the US dollar is a risk-off currency, meaning that when global equity markets tank the US dollar goes up. So having dollar exposure is also attractive in case of a bad scenario like that,” he said. Limited options

Comments on the ongoing trade war between the United States and China inevitably led to questions surrounding what would happen if China, the largest holder of US Treasuries in the world, began selling these assets. www.profit-loss.com

Elmer predicted that China is unlikely to try and rapidly divest itself of its US Treasuries in response to the perceived trade aggression from the US because, quite simply, it would be difficult to do so. “Historically, when we look at what China has done with its Treasuries, the shifts in holdings tend to occur tectonically. One of the things this shows is that it’s very difficult to move out of the dollar from a practical perspective because there just aren’t many better alternatives at this point. If we think about the areas where [China] can invest, there’s only a relatively small range of assets that would meet their requirements as alternatives to Treasuries,” he commented. However, Elmer also said that he expects China to begin diversifying its reserve holdings more, noting that any trade deal with the US might include a stipulation requiring China to have a stronger, or at least more stable currency, which would incentivise it to sell dollars in favour of euros and other currencies in order to ensure that its own currency isn’t appreciating on a relative basis. “That can exert some downward pressure on the dollar,” he said. “As far as the targets of where that money is shifting, I think Europe is the area where there is a lot of breathing room to add back some exposure.” Van Luu agreed, commenting that the erratic behavior of Trump could motivate countries with large reserve pools – namely countries with US military

alliances, including South Korea, Japan and Taiwan – to start diversifying away from the dollar. “I think that motivation exists,” Luu said. “The share of US dollar in international reserves is higher than is justified by purely economic reasons. The problem is, there is no really clear alternative. If Europe would get its act together, with regard to political reform and structural reform, then I think it would be a much more formidable competitor to the US dollar.”

US reserve status remains safe

Indeed, the role of the US dollar as a reserve currency became a subject of discussion during the panel session, as it was noted that the latest figures from the International Monetary Fund (IMF) show that the dollar percentage of central bank reserves has dropped by 4.5% since 2016. Despite this, USD remains the largest reserve currency by some distance and the panellists were sceptical that this position is likely to come under threat any time soon. “Yes, the dollar’s percentage of global central reserves has fallen a bit, it’s around 60% and second place is the euro at around 20%. It’s a pretty big gap, and there just isn’t an alternative. Also network effects really matter, so companies want to do business in dollars because other companies do business in dollars. And so I think the only way that the dollar will lose global reserve currency status is if the US decides it doesn’t want it any more,” said Greene, adding that this last scenario was unlikely to happen any time soon. Elmer argued that context is important when examining the US dollar’s role as the global reserve currency, pointing out that in the 20 years since many Asian countries started building up their currency reserves they’ve only managed to diversify away from the dollar by less than 10%. One thing that he did say was unusual about the recent decline in the dollar share of reserve portfolios is that it has occurred during a period of dollar strength. “What that implies is that reserve managers have been actively moving out of the dollar,” commented Elmer. “And sure enough, if you adjust the data for FX valuation and asset price valuation, the act of buying nondollar currencies has been running at historically high levels. But this is very much a marginal trend at this point, I think it shows that reserve managers are amongst the more sensitive subset of investors to political changes.” He subsequently concluded: “We aren’t seeing any widespread crisis of confidence in the US dollar as a store of value at this point. If anything, it’s been the opposite because private sector investors have been rushing into higher beta US assets even predating the Trump administration.”

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Coffee Break

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Coffee Break

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Panel 2: The Challenges of Analysing Data

L-R: Moderator: Colin Lambert, Managing Editor, Profit & Loss • Andrew Ralich, CEO, oneZero • Dr Hasan Amjad, Head of Algorithmic Trading, GAM Systematic | Cantab • John Ashworth, CEO, Caplin Systems Ltd

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The Democratisation of Data: What Comes Next? As data in the FX market becomes increasingly democratised, panellists at Profit & Loss Forex Network London debated what this means for the industry.

Although the sources of data in the FX market have remained fairly static, Andrew Ralich, CEO of oneZero, said that he’s seeing a broad democratisation of the tools and systems necessary to process this data. “Looking back five years or more, the infrastructure and software that it took to react to time series and very granular micro market structure data in real time in order to make assumptions was very expensive and there was very niche expertise surrounding it,” he said. But Ralich highlighted that in recent years, firms offering cloud platforms are offering capabilities to marshal all this data and analyse it at orders of magnitude less cost and expertise. “Although the data set being looked at might not change, the breadth of participants who have the horsepower to react to it is, from our perspective, getting wider,” he said. However, Ralich went on to make an important distinction between the democratisation of tools to analyse data and actually being able to access the data itself. “I believe that from a technology perspective, democratisation has occurred that lets firms analyse bigger, better, newer data sets. If you’re a firm participating in this space and you’re not evolving and bringing on talent that’s capable of using these new mechanisms efficiently, then you’re going to fall behind. That doesn’t necessarily mean that all the data that you can and should be analysing is accessible or has been democratised,” he explained. Indeed, John Ashworth, CEO of Caplin Systems, made the point that even if firms in the FX market could access all the data contained within it, there would often be a defined limit to the benefits of analysing it all. Yet despite this, he pointed out that Caplin’s clients often do have huge amounts of relevant data at their fingertips that they’re not using, and it doesn’t even require sophisticated analytics tools to derive value from. “I’m talking about customer data,” he said. “We have clients who, on the anniversary of a roll of a three-month forward, have a paper system to re-

mind them that the customer did the trade or didn’t do the trade with them 89 days ago. Similarly, they have stacks of data about what their customers are doing which they never look at and they never use to reprogramme spreading algorithms or tier allocations or anything like that. This is a different side to this data issue but it’s just as important in terms of the efficiency of the bank and the value that their customers can accrue.” Ashworth continued: “Somewhat controversially, I would say that the efficiencies that can be achieved by the democratisation of technology around data are dwarfed by the inefficiencies associated with the management processes to actually getting around to doing anything about it.”

No substitute for common sense

Hasan Amjad, head of algorithmic trading at GAM Systematic Cantab, agreed with the other panellists that the operational barriers around data management and usage have come down in FX, adding that they have pretty much vanished with regards to research. “But I think the problem is that what you can’t democratise is common sense,” he subsequently commented. Amjad cited the example of one trading firm which, following a ramp up of its machine learning team, produced a new strategy that performed incredibly well when it was back-tested. When this was shown to the traders at the firm though, they refused to put the strategy into production, insisting that it was too good to be true. The traders insisted that the machine learning team keep analysing the strategy to figure out what was wrong with it and, sure enough, a crucial input error was discovered. “It turns out that they had made one of the oldest mistakes in the book, which was they hadn’t accounted for daylight savings time in the exchange hours. And that’s because all these clever young people that the firm was hiring have no idea how the industry works, no idea about the business model and no idea about the specific domain knowledge that you need to look at www.profit-loss.com

the numbers that your model spits out and be able to tell if they look right,” said Amjad. The point being, he said, firms can’t simply hire data scientists to extract value from the increasingly democratised data in the market and therefore for many firms the case for in-depth analysis of the data is weakened because simply hiring data scientists with no domain knowledge tends to waste both time and money. The panellists then went on to discuss who the winners and losers will be in an FX market where data is increasingly democratised. When Amjad was questioned about whether this democratisation truly levels the playing field for firms competing in FX, he responded that there will continue to be tiers of different capabilities amongst market participants, but that they might start to find their edge in different places rather than their data. “Part of Thomas Kuhn’s paradigm shift theory states that you have this build-up of momentum to a point where suddenly there’s an explosion and a paradigm shift whereby the established tiers at that point in time collapse. In

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this case, the operational barriers and the barriers to accessing data collapse, but then that becomes the new normal and people automatically start finding ways to differentiate themselves and the tiers just appear in a new form until the next paradigm shift,” said Amjad.

Power shift

Following on from this, Ashworth made the case that in the emerging paradigm in FX, power is shifting to the firms that own the data. In particular, he pointed to the recent M&A activity that has seen large exchange groups buying OTC FX platforms, claiming that the exchanges weren’t doing this because of the current values of the brokerage revenues associated with these acquisitions, but because of the data and market footprint associated with them. However, he was also quick to emphasise the power that the banks retain simply by virtue of the credit structure of the FX market. “The bank’s position in the credit pyramid, daisy chaining from the very tiny

customer at the bottom to large, sophisticated customers at the top, is intrinsically valuable to the bank. And while disruptors in the credit space will have a different view on this, I think that it will take ages for this structure to change. So yes, the power will be with the data aggregators and yet the banks will still have incredible power, not just because of their balance sheet and their brand, but just because of the position they occupy in the credit structure,” Ashworth said. Amjad commented that, from his perspective, there are both positives and negatives from the consolidation of data amongst these trading venues. On the one hand, for trading firms like his, there is more uniformity, increased ease of negotiation and onboarding, and improved ease when working with the data from these venues. On the other hand, he said that no one wants to live in a seller’s market because as fewer people begin offering any kind of service, the more fragile and brittle the system becomes. Ralich noted that it will be interesting to see if, as the exchanges evolve their consolidation models and absorb these OTC FX platforms, they are

going to be able to derive unique and valuable insights from the data that they acquire along with them. “These exchanges previously controlled a monopoly and their businesses evolved into selling the data that came from this, which by its nature is going to have all the information available for that specific exchange or equity class. In FX, the inputs into the system, the firms that are providing liquidity into these platforms, are very consistent between them but the constituents on the taker sides of these platforms are very different,” he said. Ralich continued: “So buying 360T gets you a data set that’s very interesting about the corporate side of this world, but it’s not all-telling and that data might not be interesting to somebody else, which is unlike in the equities world. So it’ll be interesting to see how these different fragmented data sets that they’ve acquired are either combined or whether they realise that maybe there is a limit to that consolidation because fragmentation exists in this space for a reason.” www.profit-loss.com

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Panel 3: Does the Price Action of Crypto Tell the Whole Story?

L-R: Moderator: Colin Lambert, Managing Editor, Profit & Loss • David Mercer, CEO, LMAX Exchange • Justin Slaughter, Partner, Mercury Strategies • Max Boonen, CEO, B2C2

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Cryptocurrencies: Finding the Right Audience Since the price of crypto assets spiked dramatically in 2017, many have been predicting that a wave of institutional money is going to come into the cryptocurrency market, bringing with it a flood of change. However, speakers at Profit & Loss’ Forex Network London event argued that the “institutionalisation” of the crypto markets will play out differently than many envisaged and that some crypto-focused firms have been targeting the wrong client base. A fundamental reason for this, explained Max Boonen, CEO of B2C2, a cryptocurrency liquidity provider, is that there is a common misconception regarding the operations and structures of large institutional financial services firms. “People talk about a firm like BlackRock as being a large institution, but they don’t really understand what BlackRock is. At the end of the day, firms such as this get so big because they pool a lot of money from retail investors. These firms aren’t going to come into the crypto markets and try to build a business where there’s no demand, so actually the next wave of institutional money has got to come from retail demand. We must not forget that it’s going to come from the ground up,” he said. Boonen pointed out that some major cryptocurrency exchanges have launched with great technology and systems in place and yet volumes remain low because they’ve pitched their businesses to the wrong client base. “I think that they misidentified the end-user. They thought that they were going to cater to high speed prop trading firms, and those firms are going to come, but they will come to this market because there’s an underlying volume there, they cannot drive it themselves,” he said. Justin Slaughter, a partner at Mercury Strategies agreed with these comments, stating: “I think the fundamental mistake that a lot of us made was assuming that the pick up that was done by retail compared to the original techie heads was going to be mimicked by institutional players.” He added that the process of internal approval at large financial institutions to get involved in the crypto markets has also proven to be slower and more fraught than was originally anticipated. However, David Mercer, CEO of LMAX Exchange Group, which operates LMAX Digital, the institutional crypto currency exchange, expressed optimism that major financial institutions, and in particular large banks, will inevitably come to form part of the crypto ecosystem. “Every bank on The Street is utilising blockchain today. Look at JP Morgan, they have JP Morgan Coin for internal use, how long do you think it will be before that moved from being an internal coin for their own customers to an

external one? How long do you think it will be before Goldman Sachs or State Street have a coin?” Mercer argued that blockchain technology is set to revolutionise the plumbing of capital markets and that in order to deploy this technology there needs to be an asset attached to it, regardless of whether that asset is any of the cryptocurrencies that are available in the market today. Boonen, who worked at Goldman Sachs before founding B2C2, agreed that once the economic incentives are high enough, the banks will get involved in the crypto markets. “One thing we’ve already learnt is that, for a sufficient amount of money, the banks will come,” he said. Boonen added that it was widely known that when the price of bitcoin and other cryptocurrencies was on the rise in 2017 that Goldman Sachs was looking to launch a crypto NDF, and that other banks had similar initiatives underway, but that these plans got shelved once the price of these assets started reversing in 2018. He continued: “The reality is that they didn’t stop because they stopped believing in this market. I think that if the price goes back up, let’s say it goes to $10,000, then there is a business for them, and at that point in time they won’t be able to come into this market fast enough.”

Barriers to adoption

Yet, despite agreeing that the entrance of large institutional players into the crypto markets is inevitable, the speakers also identified some of the current barriers to this happening. For example, Mercer described the problems that LMAX Digital had when it engaged a major audit firm to look over its business. The firm had to limit the scope of the audit because it was unable to verify the cryptoassets being held by LMAX Digital as a regulated custodian, which Mercer claimed was nonsensical given that every cryptocurrency transaction is on the blockchain, which is itself immutable. While this creates a friction point for financial institutions wanting to participate in the crypto markets, Mercer said: “Those big organisations will eventually just have to get over that line.” Slaughter, meanwhile, said that while the traders at financial services firms might be keen to participate in the crypto markets, it’s the lawyers and compliance staff at these firms that are likely to slow things down and delay the shift from internal crypto projects to external ones. www.profit-loss.com

Although compliance is a burden for some firms in the crypto market, with Boonen revealing that at one point compliance staff accounted for 30% of B2C2’s headcount, the panellists agreed that regulation is not a key challenge. “I believe that the regulatory framework that we have in place right now works,” said Boonen. “For example, if you offer a crypto CFD then it’s a financial instrument under Mifid and we’ve got the right licenses to trade it, there’s nothing special about that product under the regulations. Once you figure out what regulation applies then it’s easy.” Mercer concurred that regulation is not a problem for firms active in the crypto markets, but highlighted that many firms have concerns regarding anti money laundering (AML) provisions. “The issue is not regulation, it’s just AML. Personally, I think it’s easier to track a bitcoin than it is a euro in your pocket. So when the banks say ‘How can I prove that a coin hasn’t been in a suitcase?’ I push back and say ‘How do you prove that this euro or that dollar hasn’t been at a race course or in a suitcase?’,” he said. “That’s actually the sticking point right now and at some stage they’re going to have to make that leap.” Boonen also highlighted AML as a barrier to the adoption of cryptocurrencies by banks, stating that they are reluctant to touch these assets because “they have been bitten many, many times” by AML requirements. “They don’t want to take the risk at the moment. But this is really something that could transform the market overnight,” he said. Slaughter contended that the problem facing crypto is not regulation, per se, but rather a general lack of technical literacy around cryptoassets. “Lawyers are trained and graded on how well they can put a peg into an existing hole, you’re not credited for novelty. You get credit for finding ways

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to establish that something is following a precedent, and for regulators it’s the same. They hate the concept of novelty,” he said. Calling back to Mercer’s suitcase full of money metaphor, Slaughter continued “You’re absolutely right. Cryptocurrency is infinitely more traceable than a suitcase full of euros or dollars. The problem is, the comparison point for AML KYC people is credit cards or bank transfers. They don’t want any dollars, but they also don’t want a reduction of the establishment they understand so well.”

Credit Still Missing

Generally, the panel argued that the necessary infrastructure is in place for institutional market participants to trade crypto assets. However, Mercer highlighted one major component of the current financial systems that is still missing from the crypto-space: credit. “Everyone’s dancing on the edge of this issue, talking about things like stablecoins, but what they’re really saying is that they don’t trust the counterparty to send them the bitcoin after they’ve sent their dollars. It’s old fashioned PVP, we need some credit there,” he said. Mercer claimed that the banks will eventually come into the crypto markets and provide this credit before adding, perhaps somewhat tongue-in-cheek, that if they don’t then LMAX will start doing so. He commented: “The banks will come and they will solve this credit issue. And if they don’t, then we will, because at the moment people are asking LMAX Digital to solve that problem for them. So if there has to be an LMAX Bank then so be it, watch this space!”

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Coffee Break

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Panel 4: Thinking Forwards – A New Market Structure

L-R: Simon Jones, Chief Growth Officer , 360T Group • Paddy Boyle, Global Head of ForexClear, LCH • Paul Matherne, Global Head of FX Forwards, BNY Mellon • KC Lam, Head of FX and Rates, SGX • Paul Houston, Global Head FX Products,CME Group

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Panel 5: Market Impact – Execution Styles that Work

L-R: Moderator: Colin Lambert, Managing Editor, Profit & Loss • Christian Gressel, Executive Director, Head of FX Algo Trading, UBS • Chinedum Nzelu, Managing Director, Global Head of Macro eCommerce , J.P. Morgan • Stuart Parris , Director of Sales, EMEA , FastMatch

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Coffee Break

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Panel 6: Credit - Is it Being Priced Correctly?

L-R: Moderator: Colin Lambert, Managing Editor, Profit & Loss • Gil Mandelzis, CEO and Founder, Capitolis • Dave Reid, Global Head FX Prime Brokerage, Deutsche Bank • Pierre-Emmanuel Pomès, Service Head for Risk & Documentation, Traiana, CME Group

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Panel 7: Liquidity – Perception vs Reality

L-R: Moderator: Colin Lambert, Managing Editor, Profit & Loss • Mel Mayne, Executive Director, Alder Capital • Peter Plester, Head of Prime Brokerage, Saxo Bank A/S • Robbert Sijbrandij, Head of FX, Flow Traders

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