PROFIT & LOSS EVENTS 2015
FOREX NETWORK
CHICAGO SEPTEMBER 24-25, 2015
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Conference Moderator: Colin Lambert, Managing Editor, Profit & Loss 12
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Introductory Remarks Adam Cooper, Vice Chairman, FXPA; Senior Managing Director and Chief Legal Officer, Citadel LLC www.profit-loss.com
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Keynote Address CFTC Commissioner Christopher Giancarlo 14
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Giancarlo Calls for Reassessment of “Flawed” Swaps Rules CFTC Commissioner Christopher Giancarlo has called for the Commission to revisit the MAT and swaps trading rules in a speech delivered at Profit & Loss Forex Network Chicago.
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iscussing the “platform-controlled process” of Made Available to Trade (MAT), CFTC Commissioner J. Christopher Giancarlo noted that a SEF may certify a MAT determination to the CFTC after considering one or more of six factors and that consideration by the SEF of any one of the factors is sufficient under the rules. Giancarlo pointed out that the CFTC reviews the SEF’s determination, but may deny the certification only if it is inconsistent with the Act or regulations. “It is doubtful, however, that the Commission could find that a MAT submission is inconsistent with the CEA or Commission regulations because neither the Act nor the regulations contain any objective or quantitative criteria on which to base a MAT determination,” he said. “Nevertheless, once deemed available to trade, these swaps must be executed on a SEF pursuant to the limited execution methods permitted by CFTC rules for ‘Required Transactions’, that is, they must be executed in an order book or in a request for quote system in which a quote is sent to three participants operating in conjunction with an order book. “The MAT process, in combination with the CFTC’s limited execution method approach, is problematic for several reasons,” he added. “It forces swaps to trade through a limited number of execution methods even where a product lacks the liquidity needed to support such trading. “Since the MAT process is platform-controlled, a nascent SEF attempting to gain a first-mover advantage in trading liquidity may force certain swaps to trade exclusively through the SEF’s restricted methods of execution before the appropriate liquidity is available to support such trading,” he continued. Giancarlo also noted that this approach has “created an unnecessary tension between the clearing mandate and the trading requirement”, adding, “The determination of whether trading liquidity in an instrument is sufficient to calculate initial and variation margin to permit central clearing is a wholly different analysis than whether trading liquidity is appropriate for mandatory trade execution through an order book or RFQ system.” Highlighting concerns raised by a roundtable hosted by CFTC’s Division of Market Oversight to discuss the MAT process, Giancarlo said that participants “argued persuasively for the establishment of a process that would require consideration of objective, quantitative criteria, public comment and Commission approval before a swap is subject to mandatory SEF trading”. Whilst noting that he was “very sympathetic” to the concerns raised at the roundtable, Giancarlo also declared that the choice between a platformcontrolled or a CFTC-controlled MAT process is “a false choice”. “There would be no need for the flawed platformcontrolled MAT process if the CFTC did not limit in
the first place the SEF execution methods for swaps subject to the trade execution requirement,” he stated. “If SEFs and their customers had the flexibility to transact swaps through the ‘means of interstate commerce’ that best suited the liquidity characteristics of the particular swap product, then there would be little resistance to conducting all swaps on SEFs as ‘Required Transactions’. In fact, there would be no reason at all to maintain the artificial dichotomy between ‘Required’ and ‘Permitted” Transactions’. Giancarlo argued that it is “imperative” that the CFTC take the opportunity to correct the “inflexibility of the CFTC’s swap trading rules”, adding, “failing to do so will not make the harm go away”. “It is increasingly clear that Organised Trading Facilities under European swaps trading rules will not be similarly hidebound in methods of trade execution, nor will swaps platforms in Singapore or Hong Kong,” he added. “This mismatch between CFTC and European rules may well be the basis down the road for another ‘equivalency’ standoff similar to the currently prolonged dispute over central counterparty recognition. “Such a wrangle would not be in the spirit of global regulatory reform or in the interests of healthy and efficient markets…it is crucial that key regulators across the globe coordinate the timing and consistency of the mandates. Anything else will perpetuate global swaps market fragmentation.” Giancarlo also told delegates that while CFTC staff has initiated “some small efforts to improve the rules” following his white paper issued in January, “Unfortunately, the CFTC’s actions to date have fallen short overall of the changes needed to truly improve swaps trading. The CFTC’s tweaks of the swaps trading rules in the last seven months, mostly in the form of staff no-action letters, have failed to fix the underlying issues with the trading rules. “Last month, I released a Six Month Progress Report that reviews in detail the CFTC’s measures to date and assesses the degree to which they ameliorate rule flaws,” he added. “The Progress Report’s title sums it up: Incomplete Action and Fragmented Markets. “The CFTC must make a more concerted effort to fix its swaps trading rules in accordance with the letter and spirit of Title VII of the Dodd-Frank Act in order to align its regulatory framework with the distinct liquidity, trading and market structure characteristics of the global swaps markets,” Giancarlo stressed. “If not, US swaps trading and liquidity will continue to suffer and Congress’s goal of promoting swaps trading on platforms and pretrade price transparency will not be realised. “Furthermore, as mentioned, the CFTC will have a difficult time achieving equivalence with European and other foreign swaps trading regimes, which are not following the CFTC’s prescriptive approach to swaps trading.” www.profit-loss.com
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Climate Change
Over the past two years, the nature of liquidity has changed – both in t Forex Network Chicago conference explored whether changes in vola
Steve Flanagan, JP Morgan • Jim Kwiatkowski, Thomson Reuters • David Mercer ,L
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ome blame regulations, others say it’s a natural progression, but few dispute that FX liquidity conditions have changed with increased volatility being the measure. While a host of factors have impacted bank behaviour in the FX market – from Basel III capital controls that have led to reduced leverage ratios and a pullback from credit provision, to the conduct fines that have led banks to a more cautious approach to trading – the impact of the Swiss National Bank’s surprise move on January 15 highlighted the fact that the market has changed in ways not previously realised. Better technology and risk management policies are leading to a concentration of market share amongst a tighter and tighter niche of select banks. Likewise, credit and pricing pressures are impacting clients, particularly on the lower end of the spectrum. Is the diversity of the marketplace therefore under threat? “The diversity of the marketplace is beginning to shrink,” said Stephen Flanagan, executive director and global e-commerce risk manager at JP Morgan. “If we just look at how credit has been re-priced, it has forced a change in the composition of the traditional type of flow in the market,” he said. “This is a constructive and positive development, but there are a lot of questions as to what is the most effective way forward.” Jim Kwiatkowski, global head of sales, FX at Thomson Reuters, suggested that regulations have been a driver for change, these haven’t fully been realised. “Since 2007, we’ve been talking more 16
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about rules in foreign exchange than ever before, and we’re just now beginning to see the impact of these rules coming into play,” he said. “The Volcker Rule had a material impact on liquidity. There has also been a big focus on conduct, but the rules that govern that conduct have not yet been written, so I think what we’re probably seeing is a great deal of concern and conservatism by banks trying to be on the right side of what will eventually be the conduct rules. Those two things combine to have large amounts of liquidity that was available through prop trading and through more aggressive business practices not being there anymore. So the market structure change that our customers are seeing is less availability of liquidity for large size trades, and I think that is something that’s here to stay.” That said, greater availability of technology enables more participants to enter the market in liquidity provision roles, Kwiatkowski continued. “Some regional banks can be more effective market makers than they’ve been before. Also, we’ve talked for years about alternative market makers and now these firms are acting as a greater force in the market. “But the macro environment is obviously impacting everything, as it always has in foreign exchange. Recently, we have had some new and scary events with the Swiss National Bank. The volatility that resulted raised the cost of capital significantly, which in turn drives further structural changes,” he said. Again though, the big banks not making a lot of capital available for all customers means that not every customer is able to get the order done that
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terms of its provision and consumption. Panellists at Profit & Loss atility are permanent or changeable.
LMAX Exchange • Sean Tully, CME • Phil Harris, EBS BrokerTec they would like to get done, he added. “So ultimately, all these factors come together and what we’re seeing is a market that has the big banks continuing to be the major force, but behaving differently, and smaller banks trying to pick up some of the slack, but maybe not being able to do it, and a lot of wait and see in respect to regulation.” But not everyone felt the industry has seen structural change. “Actually, within the last two years there has been no structural change,” said David Mercer, CEO, LMAX Exchange. “That’s the reality. There’s been a lot of talk about it, but I think as a market we need to get on with it. There’s a lot of working groups being put together, but they're not actually effecting change – and there needs to be change. If the market in this room doesn’t get together and decide and implement it and continue to be self-regulating, the regulators are going to impose rules that won’t work in FX. It stands for us to get on with it and effect change,” Mercer said. While there haven’t been extraordinary structural changes at the forefront, we have seen a number of firms leave the prime brokerage arena, and others are increasing their costs, noted Sean Tully, senior managing director, financial and OTC products at CME Group. “There’s a fundamental underlying structural reason for this, which is the increase in Basel III capital requirements, in particular around the leverage ratio, and we’re only at the beginning of that trend. The increased cost of capital will impact the entire FX marketplace. But, said Tully, the biggest concern currently is the
Fundamental Review of the Trading Book (FRTB), a Basel initiative to overhaul capital rules. “The FRTB may actually have an additional impact that will be even higher than what we’ve already seen,” he said. Phil Harris, head of EBS Market at EBS BrokerTec, looked to the buy side as a driver of change. “While there has been innovation at EBS in many areas, one can argue that there hasn’t been significant market structure change in general, but the customer behaviours have evolved and are evolving. You don’t have to wait for rules and regulations to be written, you can invest and expand your franchise to make the most of the changing behaviours of your customers. The FX industry has spent many years speaking about what change the regulatory authorities are going to institute in our industry in its entirety, but there’s plenty of opportunity for businesses to expand and invest into changing behaviours now.” Flanagan pointed to the wide array of execution venues available for an example of client preferences. “The foreign exchange market offers a great deal of choice. There are exchanges, platforms, primary markets, and secondary ECNs, as well as an abundance of bank platforms. So every customer makes his own choice on how to execute – and they are driving the transparency that everybody’s talking about, because they demand it.” With banks sending prices out to a multitude of venues, how does one determine true liquidity? Let’s discover what real liquidity is in the marketplace, suggested Mercer. “I think there’s a www.profit-loss.com
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PROFIT & LOSS FOREX NETWORK • CHICAGO 2015 lot of liquidity out there, and it has probably never been a better time to be a customer, but the reality is that there should be a cost for it and I think liquidity right now is too cheap,” he said. “Put simply, if you want greater transparency, you’re going to have to pay for it, and if someone has a large order to go through, if they choose to execute on a plethora of venues, they're giving up that right to anonymity, they're giving up their right for the market not to see that information. “But let’s be honest, liquidity has been damaged this year. There’s no doubt that if you went to all firm limit orders there’d be less liquidity out there, but it’s supply and demand, it will find its right level, and there should be the right price for liquidity and the right price for those risk takers who provide liquidity 24 hours a day, five-and-a-half days a week,” said Mercer. But liquidity is not the same for every customer. The primary market is very liquid, but not all customers access this market – either because they don’t want to pay the price or they don’t do enough business, explained Kwiatkowski. “In addition to the banks, we do a lot of business with corporates and asset managers, and we know that the liquidity conditions for them are different than for a regional bank, which is different than for a large bank,” he said. “There are more choices available to customers right now than ever before, whether or not there’s greater liquidity in each of the platforms is debatable and that depends on the day – January 15 probably didn’t have as much liquidity as many people would’ve liked. But the best way to satisfy the needs of the overall market is to continue to provide firm liquidity to those who require it; bilateral liquidity to the many customers who still want the service orientation of the FX market rather than a central limit order book; and anonymous ECNs that include both firm and last look liquidity, which is still essential to a piece of the market. Not every client will choose each one of those venues uniquely; depending on market conditions, market participants may choose to move back and forth from one venue to another. Our view is that market participants want choices suited to their evolving, different trading needs.” But Flanagan noted that a sharp market move is not by itself a definition of a lack of liquidity. “It could be more of a description of evolution of where we are today in a systematic fashion. More people are executing today via automated models, so it could be the speed at which transactions are happening that is causing moves, it’s not as if there is not a lot of liquidity,” he said. In addressing concerns about such conditions as occurred on January 15, when banks were said to have withdrawn from providing prices, is there a real problem in terms of customers being able to get out of positions? “A lot of liquidity providers pull out over numbers,” replied Mercer. “But I would say the best liquidity providers on the Street don’t pull out over numbers. In fact, the top LPs’ axe is that they price over a number. The SNB was a market dislocation which none of us have ever seen, but let’s not look at this skittish move in a thin market and say that it’s going to be like the SNB again – it isn’t. The best LPs will price over a number, but there’s a price for that.” 18
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There are also lessons to be learned from that day, and a number of venues and players have put new controls into force as a result. “We are constantly evolving and expanding our market structure to ensure safe and robust markets for our customers,” said Tully. “As a result of this process, we’ve changed some of our rules to reduce the monitoring periods for FX circuit breakers from five minutes to two minutes.” Swaps If swaps represent nearly half of the FX market – could the real liquidity problems lie ahead in this market? “I would’ve thought so,” said Mercer. “Other asset classes have struggled more than FX has to put forward dates on e-platforms or exchanges. Look at fixed income, it has taken a long time for it to get there and the longer out you go, the harder it’s going to be and they are OTC products. But I think the short end of the curve is going to have plenty of liquidity and it can certainly be traded, exchange style.” “We've witnessed the forward market become very electronic, and I think the trend will continue, so that’s an area of expansion,” added Harris. In the exchange space, the interest rate market has lived through a lot of the problems that the FX market – in particular on the bank side – is about to go through, noted Tully. “The interest rate derivatives market already addressed the supplemental leverage ratio and they're preparing for the new FRTB capital rules. In the interest rate market, banks and other major participants clear transactions and face a single counterparty. That’s really better for the banks, because they then get to net all of their client positions down. That massively reduces the amount of capital required, and therefore banks can provide more liquidity for their clients and better service and better pricing in tighter markets. “But it’s not just about the clearing, it’s also about the additional tools that the marketplace has developed on the interest rate side and the FX market may migrate this way to address the same problem,” Tully continued. “In the OTC swaps market for example, you’ve had the huge build-up of MAC [market agreed coupon] swaps, which are very standardised swaps, so dealers can collapse their positions into a fewer number of line items, low notional and therefore low capital requirements. From the clearing side, we have built things called coupon blending – or unilateral compression – and also multilateral compression. We've seen a migration towards standardised instruments and a huge increase in the growth of the futures marketplace relative to clearing, as a more efficient way to represent risk under the new rules. “So a lot of the tools and services that have been provided to the interest rate market may be used by the FX market over the coming years, especially if we have Basel IV,” he added. Harris agreed: “I think that we’ll definitely learn from other markets. We’ll see the good things that work in listed futures, equities, data and analytics playing a bigger role in the day-to-day FX market. But I think that the net effect of this is that the big get bigger.”
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“The Impact of Capital”
Andrés Choussy, Managing Director, Head of Derivatives Clearing Americas, J.P. Mo Managing Director, Global Co-Head of FXPB, UBS 20
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organ • Sanjay Madgavkar, Global Head of FX Prime Brokerage, Citi • Terence Oh, www.profit-loss.com
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Networking at the Coffee Break
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“A New View of Execution Qualit
Jim Cochrane, Director, Analytics, ITG • Andrew Maack, Head of FX Trading, Vangua BATS Global Markets • David Mechner, CEO, Pragma Securities 48
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ard • Bill Goodbody, Senior Vice President, Foreign Exchange, www.profit-loss.com
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“Liquidity Partnerships”
Kevin Kimmel, Chief Operating Officer, Citadel Execution Services FX • Alan Schwar • John Shay, Partner - Transaction and Technology Services, Virtu Financial, LLC 50
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rz, CEO, FXSpotStream • Takis Spiropoulos, Head of e-Solutions Group, CIBC
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Challenging the Old Guard Will new entrants continue to challenge the large ECNs in FX?
Dmitri Galinov, CEO, FastMatch • David Holcombe, Head of FX Product, NASDAQ • John
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rofit & Loss Forex Network Chicago looked at the combination of growing regulatory requirements, customer disillusionment and the changing cost pressures on financial services firms that appears to be shifting the landscape of the foreign exchange market. While change means opportunity, the panel discussed whether it is possible, or even desirable, to topple the established order in FX. Dmitri Galinov, CEO, FastMatch; David Holcombe, global head of FX product, Nasdaq; John Miesner, head of global sales at GainGTX; and Harpal Sandhu, CEO, Integral Development Corp, engaged in spirited exchanges. The session started with the panelists being asked to give their views on what they saw as the major changes in the market over the last three years and what they believed were the drivers behind these moves. A wide range of positive opinions were given including the effect that new entrants into the space have had on fragmentation and liquidity, the different ways that these new entrants look at and help customers to handle specific risks, to the way increased regulation imposed on the industry post52
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January 15 is framing business. Customer demands, an ever present theme throughout the conference, were also highlighted and the ways that their ever-evolving needs were helping to drive the business forward. “The customer is becoming much more informed and is demanding more from the new entrants. As long as the new entrants are servicing those client needs, they will succeed, survive and stay in the area,” one panellist noted. On the flip-side, the panel were in broad agreement that bad service and the inability for these new entrants to adapt would have serious consequences and force these companies to either consolidate or “close their doors”. One panelist also pointed out that the viability of newer, smaller venues would be directly impacted by the increased cost of trading in the new regulatory background with firms having to hire more compliance officers to keep up with the growing regulatory burden. The panelists were also in consensus about the positive values that ECNs bring to the market compared to single-dealer platforms. Their views
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n Miesner, Head of Global Sales, GTX • Harpal Sandhu, CEO, Integral Development Corp ranged from the flexibility of ECNs with their wide range of tools available to the customer, the increased transparency on price and volume flows, to the superior data sets that ECNs can provide over the single-dealer space. One of the panelists also noted that the customer has the ability to post bids and offers in ECNs, not something that you are able to do on many singledealer platform, saving the customer the bid-offer spread. ECNs also offered the customer the opportunity to use algos to break up larger, potentially market moving orders into smaller, more tradeable chunks, enabling them to transfer risk immediately and keep trading costs down. “It may take a couple of years, but ultimately ECNs’ success will be driven by cost conscious customers,” it was argued. The ability to be far more proactive in the case of “bad apples” and the flexibility to pull these accounts from the customer stream, helping to reduce bad market behaviour, was also given as another positive benefit of using ECNs. The discussion then moved on to the value, good or bad, of disruption within the market and the
benefits, if any, for the client. Again the panelists broadly agreed that the competitive effect caused by the newer entrants would force incumbents to adapt to the new landscape, through technology or pricing models, or risk losing market share – “disruption is analogous to competition, it’s healthy.” Discussion then turned to the issue of fees and transparency and what, or who, could force any change. A slight difference of opinion from the panelists on this topic with some arguing that customer power would force greater levels of transparency and a more-level playing field on fees, while one panelist believed that banks would not accept a one size fits all approach due to different levels of customer business and needs. Rounding off the session, the panel was asked where they saw the market in two to five years’ time. One pointed to the continued advancement of technology and the associated benefits for the customer, while the others all pointed to clearing as the next big hurdle that the market needs to overcome. The majority view was that the current CLS system was too expensive and that the industry needed to work together to force change. www.profit-loss.com
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Re-Pricing Risk in Foreign Excha
January 15, 2015 clearly showed that some firms had significantly mis National Bank unpegged its currency has further forced firms to re-eva Robert Savage, CCTrack.com • Marco Baggioli, ADS • Soren Haagensen, SocGen •
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anelists at Forex Network Chicago sought to establish an up-to-date consensus on how risk should be monitored and viewed through the prism of higher volatility in FX markets. Marco Baggioli, COO, ADS Securities London; Soren Haagensen, head of e-commerce, Americas, Société Générale; Isaac Lieberman, founder and CEO, Aston Capital Management; and Marc Millington-Buck, head of international FX business development, Moscow Exchange started by providing their general thoughts on risk and how it should be applied to customers. A wide range of opinions were offered up including making sure that customers fully understood the risk they were looking to take on, that they could afford to take on this risk and making sure that their infrastructure was robust enough to withstand any major incident. 54
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The panel said that in-depth customer analysis and credit assessment were critical in this process before deciding what credit lines, leverage or charges were applied to each customer. Tenor and concentration of portfolio risk were also highlighted as essential when applying metrics to customers’ needs. Pre-trade checks and financing also found support from the panel. According to one, a lot of prime of prime brokers that didn’t have pre-trade funding in place before January 15 have left the business, while the prime broker space was also seen to be struggling to make money at the moment especially with the additional infrastructure and IT costs involved. One panellist added that due to the many PBs exiting the space, there were a lot of PB “orphans” in the market, customers who have been left
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spriced FX market risk, and the continued volatility since the Swiss aluate how they perceive and price this risk. Isaac Lieberman, Aston Capital • Marc Millington-Buck, Moex behind and been unable to trade due to their size. The panellist said that PB fees should in fact go up to reflect the service they give clients, although the panel didn’t believe this would happen. Asked if raising prices would help to mitigate risk, one panellist noted that given prices, margins and barriers to entry, the bid-offer spread would naturally widen to account for these costs and that these wider spreads on offer actually provide a much more realistic price point for clients to trade on. One panellist said that over the last 10 or 20 years people priced risk around the mid-point, but since the Swiss National Bank event, people are now pricing risk around the extremes as these extremes will repeat themselves. While the market participation has grown, fewer and fewer people were prepared to take on risk leaving the
market vulnerable to out-sized one-way moves. Pegged currencies were also highlighted as carrying a bigger risk than liquid, floating currencies, not on a daily basis where price action remained minimal, but when the currency is unpegged the market disappears leaving the customer either unable to fully get out of a position or wearing a large loss. Discussion then moved onto the current state of liquidity in the market. Customer flows were still seen as one of the major sources of liquidity with other market participants acting as time-buffers between these customers until the market found a natural equilibrium between buyers and sellers. The improved relationship between HFTs and banks was also mentioned with the former now seen as an important cog in helping to distribute risk around the system. www.profit-loss.com
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Petra Wikstrom, Global Head, FX Execution & Alpha Solutions, BNP Paribas • Jill Sig Patrick Philpott, President, Americas, DealHub • Ed Mount, MD, Head of FX Electro
Regulation vs Technology: What’
The FX industry faces a plethora of risks. Understanding how to mana best to address these? Profit & Loss asked a panel of experts at Fore
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n the world of spot foreign exchange, correctly gauging changing market regimes can be key to appropriately managing risk. While risk management systems and procedures can work most of the time under normal conditions, how do firms position correctly for a runaway algo or unexpected macro event? Some of the market dislocations seen during 2015 – in particular, the unprecedented 30% move in the CHF in January – make the market question what has led to such instances of gapping, the likes of which hasn’t been seen before. As volatility sunk to lower levels in recent years, the industry was quick to deploy technology in the race for volume, which may have resulted in some firms taking their eyes off of some of the more nuanced pieces of risk management, in particular, tail risk. When an event such as the SNB’s move in January causes huge price gaps, and market makers pull 56
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back and clients have difficulty exiting positions, what should be the role of the market maker and how can these firms protect themselves when providing this market service? “We have to acknowledge that we don’t live in a normal distribution world and we have to be equipped as market makers to understand that these are not normal distributions and our machines need to react to those conditions or at least have overrides that protect us from those conditions,” said one of the panelists. “We have to be prepared for unexpected market events and are obligated to ourselves as risk managers to accommodate that,” the speaker continued. “We can’t only operate under normal distribution and when something big happens, just walk away. Some participants do just walk away, and that’s actually where clients need us the most – so we are obligated to address those tails. “It’s important to understand when the market has
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gelbaum, Head of Foreign Exchange, Traiana • James Sinclair, CEO, MarketFactory nic Markets, Nomura Securities International
’s Causing Market Dislocations?
age risk is the biggest challenge facing the industry today, but how ex Network Chicago for their views. changed from being price sensitive to position sensitive. During mini-flash crashes, we immediately change to being position sensitive. People want to get out of their positions and they are less motivated by price – it’s actually an opportunity for market makers to stand in there and make a price that reflects the risk – you have to put something out there that lets people get out of the risk, because if they don’t, they may not come back,” the panellist said. Gapping Many have asked what is causing the large market dislocations we’ve seen in recent months? Petra Wikström, global head, FX execution and alpha solutions, BNP Paribas, said: “We have to remember that we came from a period of very low volatility and spread compression for quite some time – 2013 was
notoriously low volatility. At the same time, the electronification of the market continued to increase, but that was far outpaced by the growth in the number of electronic trading venues offering FX liquidity. So as we started to see increased volatility, and big macro events such as the Bank of Japan coming out with quantitative easing or January’s SNB move, one of the major things that we saw was the thinning or decreasing of order book depth, which is actually one of the important factors that could relate to these additional risks we see today.” So are these market dislocations going to occur with increasing frequency? “It’s a question of managing the risk,” replied Wikström. “As the regulatory landscape evolves and with the changes from an electronic perspective, we could be in the midst of a transition as we move towards even more transparency. But it’s really all about being able to process and gather as much information as www.profit-loss.com
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PROFIT & LOSS FOREX NETWORK • CHICAGO 2015 possible in terms of volume and monitoring order book depth.” Perhaps part of the risk management challenge lies in the definition of liquidity itself. James Sinclair, CEO of MarketFactory, suggested that it is. “Liquidity is, by my definition, the lack of market impact when you transact a given size. If the market impact is great, then that is an illiquid market. So while you may be able to transact a huge amount of volume, it can still be an illiquid market because the market moved two big figures – that’s an illiquid market,” he said. “The market is definitely more illiquid than it used to be, but I feel it will correct itself to some extent over time, because there is a real demand by end customers – people really want to do business in this market and that means we have continuous markets. Accordingly, the market will solve this problem – if not by the traditional means that we have today – then by new entrants in this market. These new entrants may be new players, but they may also be clearing models that restore steady continuous markets, because there is end user demand from real money and from corporates, and this vacuum will be filled,” he added. Regulatory Impact What role are regulations having on market liquidity? “Regulation is having an impact in terms of banks establishing smaller risk limits – they are not holding as much risk as they used to and they’re not holding it for as long. So the consequence of that is that people are liquidating risk quicker and that contributes to the recycling of that actual risk until
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that final customer is found – that’s important for us to remember,” noted a panellist. If banks are unwilling to take on the levels of risk they previously did, who will be the market makers of the future? “If the current players are not prepared to take the risk, somebody else will – there is a market demand and it will be fulfilled,” said Sinclair. “It may be new players, but it may also be clearing models. We may be beginning to see some of the banks spur spinoffs that are outside the bank and therefore not subject to the same rules. It may be non-banks or other participants with strong balance sheets that come forward – but it is a need that will be filled.” Patrick Philpott, Americas head of DealHub, a Markit company, suggested that clients will be looking at a narrower subset of liquidity providers. “Clients using FX for commercial purposes will still get priced by market making banks – it’s bilateral and it’s disclosed. But there’s much more focus on analysing all of your liquidity providers, all of your ECNs, all of your hit ratios, and making decisions ruthlessly based on that information – deciding who is giving the best value and determining where they are getting done,” he said. “The reason we have these new participants and buy side clients that want to make prices is the need to supplement the traditional bank market makers who have smaller appetites in general, along with shorter time horizons,” one of the panelists noted. “On a related note,” added Wikström, “we also see an increased interest and appetite from the buy side to take on more automated execution strategies, to seek reduced market impact and
CHICAGO 2015 • PROFIT & LOSS FOREX NETWORK costs. It naturally depends on the underlying rationale of the trade. For example, if it’s a time sensitive alpha fund, it might be more prudent to pay the risk transfer, but if it’s passive hedging of an underlying equity flow, there may be more appetite when it comes to larger sizes to spread the order out over time, which needs to be risk managed over the course of the execution.” “The way you choose to execute can create different kinds of risk,” added Jill Sigelbaum, head of FX, Traiana. “The FX industry has evolved to offer custom liquidity, so depending on the client type, one receives different liquidity. The market also offers custom execution – voice, electronic, algo, etc. What has happened is that each unique pairing of a client’s custom liquidity with each execution style creates a unique set of risks that need to be addressed.” “Some types of execution create more credit risk, and that has to be mitigated. Other types of execution create more operational risk, because someone’s executing 100 trades instead of five. Although both types of risk exist, the industry has been forced to create a flexible risk mitigation strategy and rely on state of the art risk mitigation technology to address these complexities. Each participant must follow the chain of events for each type of flow and make sure each box is ticked and each type of risk is solved for. It’s very important to look at every client type and not only the liquidity that you’re customising for them, but the way you’re customising the ability to execute transactions and follow the risk chains,” she said. Risk is far more than just credit risk, it’s market risk, it’s legal risk, it’s operational risk, reputational
risk, agreed another panellist. “As we automate things and use technology to solve some of our issues, the control framework that we have around automated risk management and automated trading becomes as important as the ability to trade in microseconds. How do you keep the runaway algo from going awry? I don’t think we have a standard set of rules or guidelines about that. So how do we define those unknown risks, how do we sit down and build a control framework the industry can be comfortable with so we don’t have real disasters? These mini-flash crashes are almost victimless compared to if one of these banks has another Euro/Swiss style incident. The pressure will just get worse and the rules will come in prescribed by the regulators, not by us. “We have an ideal view of how things should work, but we have systems and architectures that are immovable, and we have budgets dedicated to technology that are not necessarily going down, because more and more of it is dedicated to maintaining these legacy systems. Meanwhile, the innovation budgets are shrinking just when we need them the most. So it’s a very difficult balancing act, but it makes a lot of room for third party providers for outsourced expertise,” said the panellist. “Banks today can’t even talk to each other about how they are handling different events, because it might be seen as collusion,” added Philpott. “There’s a very different mindset that permeates trying to deal with these situations that is not helpful. It would be much more helpful for peers to be able to ask ‘what are you seeing and how are you handling this?’, but they can’t right now.”
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“The Future of Financial Services S. Michael Moro, Chief Operation Officer, Genesis Trading • Daniel Hodd, Citi• Nick Marketing Officer, Digital Asset Holdings 60
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s: Bitcoin or Blockchain?” Solinger, Head of Product, Chief Marketing Officer, Traiana • Daniel O'Prey, Chief
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The Profit & Loss Think-Tank: Th John Ashworth, CEO, Caplin Systems Ltd • Ralitza Fortunova,Director, Head of Fore and Corporate Development, Tradair 62
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e Future SDP
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“CTAs and Volatile Markets” Scott Brusso, Director FX Sales, ICE Futures U.S. • Glenn Graham, Principal, Golden Point Capital • Mike Harris, President, Campbell & Company
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