Forex Network Chicago 2017

CHICAGO FOREX NETWORK

PROFIT&LOSS

SEPTEMBER 27-28, 2017

Contents: Are Markets Mispricing Geopolitical Risks? ..............3 Which Regulations Will Have the Biggest Impact? ....5 What is the Reality of Liquidity in FX? ........................7 What is the Best Measure of Execution Quality? ....10 Will FinTech Change the FX World? ........................12

Profit & Loss Forex Network Chicago September 27-28, 2017 The Westin Chicago River North, 320 North Dearborn Street, Chicago

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Profit & Loss forex Network ChiCago • Day 1

Profit & Loss forex Network Chicago focused the first of the two-day conference on themes ranging from geopolitics to regulation to Liquidity, execution and fintech. Conference attendees formed working groups along the five main topic areas, with the first focus group looking at geopolitics, whose main findings can be found below.

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are Markets Mispricing geopolitical risks?

n the US, it seems like every day brings a new Twitter-based risk event, but looking at the wider world, is the FX market looking at daily events or taking longer term views when it comes to market moving geopolitical developments? The working groups that convened focussed primarily on the US’s recent turn toward de-globalisation, the ascension of China, threats from North Korea, an expansionist Russia, and to a lesser extent, Brexit.

The Geopolitics working group was led by topic leader Collin Crownover, senior managing director, head of currency management and FICC research at State Street Global Advisors, and supporting working group leaders Greg Anderson, global head of FX strategy at BMO Capital Markets; Richard Cochinos, executive director, UBS; Simon Derrick, chief currency strategist at BNY Mellon; Steven Englander, head of research & strategy at Rafiki Capital Management; and Robert Savage, CEO at CCTrack.

“The biggest market moving geopolitical developments this year are not the stuff you read about every day,” surmised one of the topic leaders during the session recap. “The story is about China doing a lot better. It’s looking a lot more stable and like it’s on top of policy a lot more than anyone expected at the beginning of the year,” noted one working group leader.

But others pointed to wild cards such as North Korea. “If you think about more trading oriented risks, such as the North Korea situation, if North Korea lobs missiles over Hokkaido, the reaction by China, Russia or Japan is going to be immediate. We then have to decide if we want to fade it – which has been the trade – or if this is going to lead to Armageddon,” the leader continued.

Whether it’s the US president’s daily tweets, anticipation of how hard or soft the Brexit negotiations will be, as well as renewed threats by North Korea, fatigue emerged as the most likely factor in potentially mispricing geopolitical risks. “Obviously, if you keep tracking North Korea or Brexit without a major blow-up, you might get tired of positioning for it,” noted a topic leader.

The group also blamed policymakers for introducing an element of moral hazard through QE and zero or negative interest rates.

“In 2008 and 2009, the biggest crisis was of expectations getting too skewed in the negative direction, and that’s why you saw experiments not only in the US, but that extrapolated globally,” ex3

plained a table leader. “Now we’re in an environment where expectations have been driven so far, that there’s been a backstop in terms of the risk in markets because of very loose policy – whether it’s QE programs or the ultra-low rates we have globally – which has dampened down the natural fear response in markets.

To a certain extent, that behaviour takes time to unlearn as well.”

The panellists noted that central banks have been getting more aggressive of late, a point they agreed should be considered in pricing risk. “The politicisation and cycle of central banking is an underappreciated risk. Central banks know they can speak and the market will listen – they’ve built up a lot of credibility – but we all know that one misstep and that can disappear quickly,” added another.

Robert Savage

Geopolitical Hotspots

Turning the conversation to geopolitical hotspots to watch, the working group leaders shared the top risks that each sees in the year ahead.

In Europe, Russia stood out for signs of its expansionist aspirations. “The top risk as I see it is Europe, with the particular risk being that people are not focussing enough on the Baltic states.

What happened in Crimea is a sign that Russia is expansionist and will try to create further political unrest there. My concern is that Russia always tries to distract attention away from where they’re really trying to make a move – and I’m worried that they’re going to start making moves up around Eastern Europe and the Baltics,” said one of the table leaders.

Given the recent hurricanes across the US and an earthquake in Mexico, geological threats were also raised as underappreciated risks. “Until three weeks ago, we were having a very benign geological environment. It’s impossible to predict the implications of hurricanes and earthquakes, but a volcanic eruption in Indonesia created a mini Ice Age. So those risks are impossible to predict and markets are probably complacent about them,” said another table head.

Adding to this, de-globalisation can amplify such threats. “Supply chains form an underlying inflationary risk,” noted another

Greg Anderson

Richard Cochinos

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table leader. “Looking specifically at NAFTA, the relationships we’ve taken for granted about our supply chains are underlying in inflationary risk. One of the lessons we may learn from hurricane disruptions is that supply chains are a bit more fragile than we understand, and if we start seeing inflation and dependence on Mexico and Canada, it makes our negotiations with them, with this new administration, a bit more awkward and difficult. That de-globalisation impact is something we shouldn’t underestimate. When NAFTA occurred, that was actually the turning point for globalisation. That was when Europe started to think of the idea of the euro, where there was more of a push for a global order. The global order disrupting itself and separating goes back to the fears about Russia linked to the Crimea, but because of nationalist impulses here in the US and the threat of inflation that it has, we’re underestimating other pockets of inflation around the world.”

Policy uncertainty itself was also raised. “The thing I worry about most is what’s happening over the next two to three years at the key central banks? The Fed’s getting gutted, but there’s a very clear plan in place. In Europe, however, it’s a completely different story. Where I worry is that the ECB is losing five key members over the next two years and there isn’t a plan laid out – what to do with the balance sheet, what to do with the program, how quickly to wind it down, or even what to do with the asset holdings that the ECB has now – so we could end up with a very, very different ECB in the next two to three years. That’s by far the biggest risk as I see it,” said another.

The Middle East and oil was also seen as an under-priced geopolitical risk. “Where I don’t think the markets are pricing anything in comes down to the Middle East and oil. The reason for this is that the implications we tend to believe is that global growth is on an upswing, that we’re in a very bullish and expansionary late cycle, but still an expansionary mode for most devel-

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oped countries, and oil continues to press to the topside. If that ends up being a hotspot geopolitically, you get oil price spikes. If those are sustained, that’s something not priced in to anyone’s growth expectations or policy expectations at this point, so that’s a key market risk that causes a lot of fluctuation in the short end of the rate curves.”

As the US pushes towards de-globalisation, China is expected to fill the void. “We live in a world where one major power is withdrawing from international participation, pulling back its leadership role politically, economically, trade-wise – and on other side of the world, there’s an emerging major power that wants to grab that role as much as it can – you can think of them as having had a 20- to 30-year plan, but now there’s this window of opportunity to fill this gap that’s being left by the US. China is working on international financial transactions, but certainly, the One Belt, One Road initiative could replace the US in that part of the world,” a table head said.

“For China, the next couple of years represents the best opportunity they have to grab influence and prestige on the global stage – and their incentive is not to disrupt things, not to have a financial crisis, not to have a recession, not to let a debt issue fester or become a major issue. The incentive is to keep things going, so they can look like an island of stability. China had been perceived as unstable, but the US president would view it as a success if the US is less involved with the rest of world. So, it’s possible we end up with a better outcome in Asia out of self-interest by China. That self-interest is real and they have the opportunity there to accelerate progress in a domain that’s very important to them through the One Belt, One Road initiative,” added another.

Overall, the group formed a consensus that while the market may not be fully pricing in geopolitical risk, it’s moving in that direction.

Simon Derrick

Steven Englander

Collin Crownover

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Profit & Loss forex Network ChiCago • Day 1

turning to the topic of regulation, the regulatory working group discussed which rules will have the biggest impact. Below are their key findings.

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which regulations will have the Biggest impact?

he regulatory working groups on Day 1 at Profit & Loss Forex Network Chicago covered a number of issues facing the industry – from MiFID II to data privacy, SEF regulations, the Global Code and FinTech.

Lisa Shemie, associate general counsel, CBOE Global Markets, led the team of working group leaders, which included Justin Slaughter, consultant, Mercury Strategies; Allan Guild, head of execution services and GFX regulatory change, FX & commodities, HSBC; Stephen Berger, managing director, government and regulatory policy, Citadel; Dino Kos, executive vice president, CLS Group; and Jessica Sohl, general counsel and CCO, HC Technologies.

At the time, late September, MiFID II was weighing heavily on the minds of many market participants, and the concern was that there were still plenty of unknowns about a rule that would come into effect in January 2018. The consensus was that regulators were providing little clarity, and confusion reigned. Based on the experience of Dodd-Frank, the working group expected another year before anyone would understand what MiFID means and if they’re accurately implementing the rules.

The unbundling rules in particular, was driving the most confusion, primarily for asset managers. One of the working group leaders noted, “In the absence of knowing what the rules are, and given the risk aversion of institutions in recent years, the tendency is likely to be to shut down certain activities or certain client groups where firms are unsure of what to do. In absence of certainty, you shift into risk aversion mode and if your compliance staff and lawyers are not sure about what the rules are, the default position is: just don’t do it.”

But another table leader suggested that the process is going more smoothly in Europe, taking the view that while Dodd-Frank may have been a painful process, the changes ended up being less impactful on clients than expected and believed MiFID II would go down the same route.

Another working group leader suggested that the various authorities would be lenient with firms showing a good faith effort to be ready by January, and wouldn’t be handing out enforcement actions on day two.

The main concern voiced around MiFID II was not so much preparedness as what it means for the industry. “The costs are 5

tangible today – everybody’s incurring costs in terms of preparedness and compliance, while the benefits remain more elusory. It’s a well-intentioned piece of legislation in terms of attempting to make markets more transparent, more fair, more open and competitive. But there are certain technical calculations around which instruments will be subject to which transparency requirements and when, and a lot of those transparency requirements won’t actually apply to most products until those calculations are recalibrated in June of 2019.

So, for the first 18 months of MiFID II, this whole new transparency regime that’s being touted as a big improvement, won’t actually be there. So we’ll have incurred all the costs of preparing for it, but won’t actually be able to see the benefits from it til halfway into 2019,” the table leader continued. “Alas, all regulation is a tax and tax is paid up front, while any benefits that may occur happen much later.”

In the UK, legislation around data privacy entered the conversation, as it comes into effect in May 2018, and will affect multinational banks. Although few knew much about it, the rule will require a bank salesperson to obtain consent to have a client’s data, and will have to delete it if the purpose changes without consent. “A lot of infrastructure will have to be built to accommodate this. It has flown completely under the radar and is something UK regulators have been trying to raise awareness of,” the table head said.

Turning to fintech, the working groups explored how regulators are likely to view the sector. “Are they going to be implementing new rules that apply to all asset classes of which fintech is included, or will they segregate into a fintech sector?” asked one table head.

“Right now, regulators want to be supportive of this nascent industry. It’s new, it’s hot, and it hasn’t caused any big problems yet. But regulators don’t have a plan in terms of how to deal with it yet. The OCC has its charter system, the CFTC has its Lab. A lot of people are talking about ways to create sandboxing, or to create hotlines or use the technology themselves, but nobody has a strategy,” the table head said.

“Regulators are in listening mode at the moment, but I think we’re going to see action on this either through No-Action let-

Jessica Sohl

Lisa Shemie

Justin Slaughter

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ters or possibly some very baseline regulations in 2018-19,” the table head added.

On the SEF front, the working groups discussed how the CFTC was likely to overhaul regulations. One table leader expected fine-tuning of SEF rules, but didn’t see Title 7 of Dodd-Frank being repealed. “Expect more flexibility from the CFTC, which is expected to make it easier for non-mandated asset classes to join, rather than mandating more asset classes,” the table leader said.

“There was initial resistance to having prime brokers join SEFs, as they were unwilling to take on their clients’ behaviour under SEF rules. Now CFTC seems open and eager to solve the resistance PBs had in joining SEFs, which demonstrates the agency’s goal of promoting trading on exchanges generally,” the table leader continued.

While discussions about implementation of the Global Code of Conduct for the FX industry continued to be dominated by views on last look, the working groups looked at the impact of the Code on the market, who was likely to adhere, when, and what the impact might be.

Amongst the buy side participants, working group leaders reported positive approaches, but noted that many felt that with all the legal and compliance responsibilities this sector faces, the Global Code is lower down the list.

“If you are a buy side firm without a large client base, that doesn’t trade with a central bank, are you going to slow down your MiFID II work to put resources into the Global Code?” explained one table head. “They will get to it at some point, but it’s a timing question for buy side firms.”

Two positive aspects the working groups came up with was a focus from market makers on transparency and an understand-

Jessica Sohl

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ing that the client wants to understand the trading protocols they are engaged in – such as how prices are provided, what that means to them, what the obligations are to the market maker, and vice versa.

The second aspect was that of market colour. “A few years ago, all market colour almost stopped. Market makers were reluctant to provide any information, but the Global Code sets out principles about what’s appropriate and inappropriate to provide. That has reached a far better equilibrium as a result of the Global Code,” the speaker noted.

The working group leader asked why those on the buy side, who may find compliance with the Global Code, should feel attestation is necessary, since market makers doing the right thing ought to be a given.

“MiFID is a regulation, a specific set of rules that have an enforcement capacity. The Global Code does not – it’s a set of principles that are not only flexible, but can be implemented in different ways at different firms. At the same time, the Code is telling us broadly what kind of behaviour we should all have as market participants, but if bad behaviour doesn’t change, then the Global Code will be translated into a regulation with much more prescriptive requirements and an enforcement capacity,” suggested a table leader.

“Crashes and crises bring new regulations,” added another table leader. “If the Global Code prevents an FX-style, miniLehman or mini-flash crash, that will reduce the chance of regulation being handed down.”

“We can have a global set of principles looked after by a global FX committee, but we can’t have truly global regulation, so it’s in all of our interests to make it work,” concluded another.

Allan Guild

Dino Kos

Allan Guild

Stephen Berger

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Profit & Loss forex Network ChiCago • Day 1

the Liquidity working group discussed the depth and composition of liquidity in the fx market today.

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what is the reality of Liquidity in fx? he liquidity working groups on Day 1 at Profit & Loss Forex Network Chicago looked at the depth and composition of liquidity in the FX market.

Tim Cartledge, global head of FX and head of product, NEX Markets, served as team leader; joined by Mark Bruce, head of FICC, Jump Trading; Sean Cleary, global head of FX sales, Hotspot; Stephen Flanagan, global FX e-commerce risk manager, JP Morgan; Takis Spiropoulos, head, global e-commerce solutions group, CIBC; and Joe Conlan global head of FX sales, INTL FCStone.

The definition of liquidity varied amongst the working group panellists. “If you’re trying to execute ones and twos in commoditised currencies, G7, I don’t think there’s a problem – prices are available and distribution of liquidity is probably the best it has ever been. If you’re trying to do 10s in the anonymised markets or 30s in the disclosed space, then there’s definitely a lack of liquidity providers and a lack of availability of pricing there. So, it depends on how you define it,” one table leader noted.

“One of the things we discussed round the table is what liquidity is, because these days everyone’s views on liquidity are so different. My view is going to be different than any other liquidity consumer’s or provider’s view of the market. Some people are probably inundated and have too much liquidity, while other parts of the market are probably struggling – and that’s due to credit constraints or your profile as a participant,” the speaker continued.

“Liquidity is really a function of many things,” added another table leader. “If you try to break it down into what actually determines liquidity, there are a number of issues. For example, when you try to hedge amounts in more exotic currency pairs at difficult times of the day, there are many factors at play – from what technology you use, how many LPs you have, whether you are trading on anonymous or disclosed venues, what your credit relationship is, and whether you have the right tools to continuously monitor your business so you can assess if you’re making money or not. Another factor is who the client is that you’re dealing with – is it a single touch customer – a simple transactional relationship – or is it a multitouch customer with deeper relationships, so you’re more 7

willing to take losses. So, at different times of the day, and depending which factor comes into the forefront, liquidity can be an issue.”

According to Cartledge, discussion round one of the tables looked at whether liquidity is better today than it has been, but noted that the group couldn’t come up with an answer. “Quite honestly, liquidity today is very confusing,” agreed a table head. “There’s fragmentation and a lot of technology costs involved in accessing the depths of liquidity. Just look around a spot desk any time of day – I tried to cover 10 euros and the whole market moved on me. Meanwhile, in the electronic space, I nod my head and say wow, that went pretty well over there. In actuality, you are seeing mini moves. People are saying there’s a lack of liquidity, but if you really analyse some of these sharp moves that we’re getting, there’s a lot of liquidity that’s trading in these quick moves. I think technology has advanced to the point where many, many market participants are well armed and very quick to react to different moves in the currency space.”

Echoing the view that for smaller size, finding liquidity is relatively easy in the major currencies, another table leader added that once you get into those larger sizes, that’s when the problems start. “Part of this could be related to fact that profitability of FX trading has decreased so much that for an LP to take on a large position, the P&L swing could be so wild it could be a make or break for your day in terms of making money or losing money, so there’s fewer people willing to take on that risk and that is what’s causing some of the issues for those larger trades,” he said.

Another panellist suggested defining a liquidity provider. “If you round up 100 people in a room, you may get 50 that say they’re liquidity providers, but the reality is that there’s a ton of recycled liquidity out there of people that take prices, redistribute those prices, maybe they add some spread or maybe even don’t, and they will call themselves LPs,” he said.

“There’s only a handful, maybe it’s five or eight, of real pricegenerating LPs and I do think the market’s becoming aware of this. So, one of the liquidity issues is that there appears to be a lot more than there is, because a ton of it is recycled out,

Takis Spiropoulos

Tim Cartledge

Joe Conlan

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and then last look creates a domino effect of there not being as much as you thought there was.”

This comment led to the question of whether the market has reached a peak in terms of the number of liquidity providers.

“I think we still have too many,” replied one of the table leaders. “As the market becomes increasingly competitive, market makers will become very bespoke or boutique, whereby the largest may have a full suite of product, then we’ll have some niche guys – maybe some guy that can do size very well, or has a good EM or Commonwealth franchise – but I think the days of everyone saying, ‘I’m a full suite LP’ and there being 50 of them just has to go away.”

“It depends on your franchise and the different banks around the world that have a different client franchise,” added another panellist. “There’s every opportunity to service your clients and become LP to them, it gets much more interesting when it comes to hedging and having international relationships or banks hedging with banks or with non-banks or anonymously through ECNs, and that’s where I think the level of sophistication that’s required is quite a bit higher than it used to be, and it’s going higher and higher all the time. So, the barrier to entry to create an ECN from a technology perspective is not that high, but the barrier to entry to create a franchise, keep it and service your international, large corporate institutional clients is getting harder, because you need more tools, more sophistication and the right technology.”

“Is relationship trading still alive and well?” asked Cartledge.

“Since the SNB event, we’ve had a period where more and more, people are returning to old-style relationship trading,” noted one table leader.

“It’s important to distinguish between normal market conditions and times where you have market dislocation,” added another. “In normal market conditions, there’s quite a bit of liquidity – you can afford to trade with multiple counterparties. But there are very few people that will be there in times of market dislocations and the people that will service you during those times are the ones you really need to have a very good relationship with.”

The discussion turned to whether the market is becoming less of a free-for-all, with more structure to it “rather than just aggregating a bunch of rates from wherever you can get them and banging away at them”.

“Without a doubt,” replied one table head. “We’re in the process of almost going full circle. A few years ago, the market was almost on a centralised exchange with most trading taking place on either EBS or Retuers. Then we went through an evolutionary phase where everyone was going down a relatively simplistic and dumb aggregation method where you’d just sweep the entire market and run everybody over, which only lasts for so 8

long. Then there was a realisation that, that wasn’t the best way to do execution, and now, if you look at the ECNs, your biggest asset probably is the ability to understand your data and liquidity management, as well as the ability to understand your customers. Now, most ECNs are going down the full amount route, most try to limit LPs in a sweep, so people are becoming increasingly intelligent about how to execute.”

“The one challenge I do find in the market today is that – while top of book is great in most currency pairs, EM as well – as you begin to delve deeper, the cost of how to access 100 million euros becomes quite challenging, because even firm liquidity isn’t firm. How fast the market can react today means the playing field is getting level. The challenge now is to begin looking at how to harvest the liquidity out there. While many clients are utilising algo trading, TWAPs, what we’re finding is that when clients want to get out of a position, the risk transfer price is still there. The challenge then becomes how to access liquidity on full risk transfers, but I think it’s a very good environment that we’re in right now.”

“The days of dumb aggregation are gone,” agreed another panellist, “but that requires investments in specific areas. For example, you need a market data strategy, you need to be able to capture the data, then you need the analytics tools to analyse it, create various profiles, run sensible risk over a period of time, and you need the quants to be able to do it, as well as the reporting, talking to sales and traders. I’m not sure all banks are in this position and it’s going to get harder and harder in the future, because it’s always getting harder to make money in this space, it’s getting more competitive. So, if you don’t have those basic abilities, you aren’t going to be able to grow the franchise.”

Turning an eye to flash events, the panel noted that large moves such as that following the SNB announcement and Brexit vote occurred during illiquid hours or in a nervous political environment. “If we have significant gapping with no liquidity, then I think that’s a bigger issue for the fundamental structure of the market. I think it creates a lack of confidence, puts LPs under pressure, and makes everyone look more closely at market structure. The events where the market is going up and down 10-15 ticks during an uncorrelated non-event, but every point is traded throughout – that’s just part of normal life now – there’s not as much liquidity in size. I think we’ll continue to see moves of a couple ticks back and forward, then back to normality. If every price point trades, that shouldn’t be viewed as flash events, I think that’s the new normal.”

Cartledge asked whether that new normal is being aided by how central limit order books are being used?

“CLOBs have come under tremendous pressure the last couple of years – there’s been a gradual erosion of liquidity from

Stephen Flanagan

Mark Bruce

Sean Cleary

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centralised marketplaces. I think they’re all doing the right things – the frequency of data coming down, the transparency around central limit order books, the general acceptance of firm liquidity being a better source of liquidity – which is helping people move back to CLOBs. But I don’t think we’re going back to a utopian world where everybody trades FX on one exchange. We’re a long way from that,” said a panellist.

Another added: “During times of market dislocation or flash crashes, there’s an imbalance of market participants. Because they happen in such a short period, the natural flow of hedging that comes from corporate treasurers is not there, so who really is there? It’s banks, non-banks, maybe some hedge funds – people that want to create alpha. Meanwhile, the natural business that provides liquidity to the market at those times is not there, so when something happens, people recognise it and start trading one way so you’re going to have a crash and that’s a fact of life. You just have to have the technology, the speed and right risk appetite and controls to get through it.”

“For those of us that traded through the ‘80s, we’ve had the flash crashes that we describe today in the e-world, we’ve had these forever,” added another. “We’ve had many events with 200-300 point moves, but the key to these markets today is that they do recover – like dropping a rock in a pond, the water closes back up. Most of these events that we’ve seen, we’ve also seen the market regenerate. I think the technology gains we’ve made, as a result of these things, has all been very beneficial in ensuring that the next market event we see is more orderly.”

In closing, the topic leader summarised the discussions: “The FX market today looks to be a higher quality market with a smaller number of players delivering liquidity, but higher lot liquidity, better conduct, and the markets are resilient, but even after incredible stresses, it comes back and it’s a bright utopian future for FX!” 9

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Profit & Loss forex Network ChiCago • Day 1

addressing the question on everyone’s minds, the execution working group analysed how best to measure execution methods. Below is the discussion from the working group session.

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what is the Best Measure of execution Quality?

he execution working groups on Day 1 at Profit & Loss Forex Network Chicago attempted to tackle questions around the best measure of execution quality.

The working group leader, Alex Dunegan, CEO, Lumint, led the post-working group panel discussion with fellow table leaders Doug Cilento, global head of execution, AQR Capital Management; Ian Daniels, head of eFX sales EMEA, NatWest Markets; Kevin Kimmel, global head of FX, Citadel Securities; David Mercer, CEO, LMAX Exchange; and Alex Shterenberg, head of eFX trading Americas and global head of FX algorithmic execution, Bank of America Merrill Lynch.

Each of the panellists noted that in discussing the best measure of execution quality, the working groups had a good cross section of the market – buy side, platform providers, non-bank market makers and banks – and each found a disparity in approach from each of those participants.

One panellist explained that his working group ranged from those having very sophisticated approaches that were very clear on objectives – knowing what they were measuring and what they were trying to do from either platform or market maker side – while for the more average buy side FX participant, it was clear there was still a lot of education needed and still quite a narrow view on best price and how they evaluate it.

“One consensus we reached was that there is no best measurement,” said another panellist. “We all know we have to try to measure best execution, not just best price, and that it’s client specific, but it’s really about educating the client base and getting data to them.”

“We also had a very good cross section – a TCA provider, platform, bank algo provider and a couple of buy side clients – everyone looked at it from their own angle,” noted another table leader. “What we found is that best execution means different things to different people. The algo provider gets the trade at point of execution, and has a good handle on how good execution is – they have a lot of benchmarks and metrics to analyse it. But the whole lifecycle of the execution matters and more transaction costs are concentrated before the execution point for some clients, so best ex and TCA should cover the whole lifecycle of the trade from inception to execution, and when it goes to the platforms, how it interacts with LPs on it.”

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“The whole lifecycle point is a really critical one for the buy side,” agreed another panellist. “There’s a growing awareness of that going back to whatever the original decision point is that creates the need for the FX trade – whether it’s active trading or if it’s a byproduct of something else they’re doing – but it seems to be a bit of a ‘Catch 22’ from a data and technology perspective for those buy side participants to be able to measure that and understand how crucial that is.”

“We talked about that as well,” noted the previous panellist, “and one thing that came out was that the buy side has a lot of recent regulations mandating new processes – best execution, recording trades, time stamping – and while a lot of clients treat this as a box ticking exercise, what we found at our table was that a lot of clients are genuinely interested in improving their execution and they’re taking advantage of the tools that came about because of regulation and the current market environment, and even those that purely do it for box ticking also benefit – a rising tide lifts all boats.”

Delving further into the concept of the full trade lifecycle from the buy side perspective, another panellist noted, “An extremely important takeaway from our table was that there’s no single measurement and it really comes down to your alpha profile – what’s your benchmark and how do you determine it? It’s really a conversation between the trader and your PMs.” “Our table went through some scenarios that looked at what the banks see from clients, and it really brings home the point that education is needed, because now that we have these tools and have conversations like this about mark-out analysis and revaluations, you have clients that are making judgments and decisions off it, but they may not really understand what the statistical significance is and how much data they need to make decisions. It’s great that we’re talking about it, and great that we have the tools, but there’s a lot of education that is still required,” another panellist added.

“That’s a good point about the algos, we talked a lot about that at our table,” said another table leader. “Part of bridging that data gap, from the buy side perspective, means that while they can trade electronically and get richer data around time stamps and fill rates and all the richer data that comes out of that process, you can’t compare that to the vast quantities of data

market makers have at their disposal to build those models.

Hearing how a market maker builds their algos and how they manage their trade book, it highlights a weakness on the buy side because, even if they have a great model, they don’t have access to that deep data to be able to take that type of approach.”

“That’s dead on – that’s our biggest challenge,” said another panellist. “The challenge for us is to get more data and to work with our banks that have data on their algos and how their algos work will certainly help us.”

Turning to banks and liquidity providers, the panellists discussed whether these firms are getting more requests from clients for both data and liquidity provision.

“We absolutely see a lot of those requests, and are getting more than ever before,” replied one of the panellists. “Also, even though data has not been readily available to all clients, if you look at the data available today, there’s a lot more than there used to be. It’s not all transparent, but the tools are a lot more sophisticated now – there are independent TCA providers and the banks themselves are happy to help you analyse the data and provide you with reports. So in some sense, it’s easier to be able to achieve best execution on the buy side now than it ever was.”

“The difficulty with algo execution is to get that data set. It takes a long time to actually prove whether bank algos work or don’t work – you either have to do a lot of algos and trial them yourself or you can go to an independent TCA provider – but you

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still need to have a good critical mass and that’s always a conundrum for some clients,” said one of the table leaders.

“Providing TCA is a way LPs can differentiate themselves,” suggested another. “One thing I was very surprised about on our table was going back to quality of data. I actually didn’t know that for a lot of end users there is an actual lack of data quality. For example, one of the buy side at my table said they have four bank LPs and that’s their data set – so the spreads they’re getting from four bank LPs is their data set – and they’re measuring best execution and benchmarking, all based on data from four bank LPs. That’s a very limited data set. It’s also completely self-fulfilling – you don’t even know if you’re getting good liquidity to start with – so I think one of the most important trends we’re talking about, and it’s a larger discussion, is that independent TCA or LPs providing more data is highly important because I can’t imagine even trying to measure best ex based on such a small sample set. How do you even know if you’re getting good prices?”

While great data is certainly an advantage, it opens up a burden of choice from a buy side perspective, said the topic leader, who noted questions around which algorithms to choose, and understanding how they are evolving and knowing how to evaluate them. “Best practice would dictate that independent TCA goes a long way, but it seems to be a bit of an algo arms race to keep up with how things are changing in the marketplace, how things are changing at providers and what, as a buy sider with limited data and limited time, I make the best choice.”

“Our group broke this down into two larger, distinct categories: a) you have to have the right liquidity pool (and that’s a whole category to measure in terms of whether you have the right liquidity and is that the right liquidity for you); and b) once you have the right liquidity pool, are you executing appropriately? We debated both aspects, but came to the conclusion that they’re similar and related, but two different things – you can have both, but you can’t do one well and not the other,” said another panellist.

“This came up in our group as well,” said a panellist. “An independent TCA provider said there are multiple banks that provide TWAP algos that are trying to achieve the same goal. There’s a time period that they have to execute linearly, but there’s vast differences in the performances of the different algos from the different banks, and much of it has to do with the liquidity that these algos have access to and how well they minimise market impact on signalling. Another thing that came out on our table was that a big part of this liquidity discussion is whether there’s good internalisation, because it helps minimise market impact, it also helps minimise transaction costs.”

Evaluating algos proved challenging for the buy side. “If I’m an algo user on the buy side,” one panellist asked another, “and come to a conference where everyone tells me I should start 11

using broker algos, how do I evaluate them? Are you seeing customers evaluating you based on one trade in one currency? How do they get the sample size? How do you have that conversation where you say this is one trade, here’s how the algo works?”

“That’s a great question,” replied the other panellist. “One trade isn’t going to help you evaluate a provider – you need a much bigger data set. For clients who trade with a provider a lot and use a lot of algos, they receive aggregate reports – monthly and quarterly reports showing their performance. They are also provided with their performance compared to their peers for algos that are similar to what they’re executing – similar sizes, similar currency pairs, similar times of day – and they can see if they’re doing better or worse than similar users on the platform.

Of course, third party TCA providers help a lot because that’s their purpose.”

“That’s sort of my point,” continued the first panellist. “You’re doing a lot of education – and you have to – otherwise the buy side may make snap decisions when they’re looking at one thing or one data set and making trade decisions based on it. I just think it can be a dangerous situation.”

“Education is the key,” replied another panellist. “You’re giving someone another tool for their execution toolkit, so they need to know how to use that tool. It’s an ongoing education process that doesn’t stop after they use the first algos. We prefer to provide as much education as possible, because someone’s taking execution risk from you and they need to be aware of that fact.”

The panellists then tried to address what they saw as the perfect state of execution. What they found during the table discussions was a huge gap between what the average buy side firm is doing and what’s optimal. “Optimal” meant continuing to get

more data, ever-evolving analysis, running different tests, looking at different aspects and using data visualisation tools.

“It seems to me there’s an opportunity for an algo aggregator here,” noted one of the table leaders.

“Every LP, every venue, needs to agree on a set of metrics. At our table, we discussed having standardisation. We should be able to calculate per trade, per customer, per currency pair – it’s all basic arithmetic – bid/offer spread, market impact, price variation, hold time. If we all measure them and issue that data, then it’s a good starting point.”

The panellists agreed there could be more standardisation.

“My ideal state is where everybody has some form of standardisation, but I think that there will always be some form of customisation. If everybody has a way to measure liquidity, apples-to-apples, then we could have transparent discussions around that. That’s where I think the market is starting to move towards,” said one.

“We’ve focused a lot on algos today, but there’s a whole segment of the universe that’s not necessarily using algos, it’s more manual behaviour,” added a speaker. “There’s a lot of TCA around algos, but we also need a better understanding of the other forms of execution.”

Overall, the attention being paid to quality of execution made the panellists optimistic about the future of execution measurement in FX. “Although some of it is very difficult, in the end, I think a lot of tools will be created that will help clients analyse their execution and at the same time, raise the bar for banks and other providers to provide better service – people will be receiving orders, not because someone took them to the Super Bowl once a year, but because their execution is really, really good,” said another.

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PROFIT&LOSS

Profit & Loss forex Network ChiCago • Day 1

the topic for the fintech segment looked at how technology would continue shaping the fx world. the working groups looked at a number of new technologies and shared opinions on what the most important developments would be.

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will fintech Change the fx world?

he FinTech working groups on Day 1 at Profit & Loss Forex Network Chicago looked at a range of technology ventures in the works, and tried to pinpoint those that could be game changers in the years ahead.

Jeff Maron, managing director, financial markets division, IHS Markit, served as the topic leader, along with table leaders Steven French, head of connectivity and messaging, NEX Optimisation; Anton Katz, head of trading technology, AQR Capital Management; Phil Weisberg, member, Matzliach Capital; Rick Schonberg, then head of product development, Currenex; and Franck Mikulecz, managing director, FXCH Ltd. Panellists tackled fintech from three key development areas: cloud, distributed ledger and AI. So, what do these technologies mean to the industry and how are people applying them?

There were differences in approach. One working group leader reported getting into a generational discussion about “how technology is impacting us and the millennials behind us”. “As we look at the next generation coming in to trade in the FX market, what do they bring with them as a way to interact with others?” the panellist asked.

Meanwhile, another table leader noted that although fintech is a “nice, buzzy term”, it doesn’t actually represent anything new in and of itself. “Technology has been a layer of finance forever.

What we are calling fintech today has to do with technology that can improve upon what existing technology does, but to do it better and add value. The ultimate effect of technology depends on where can it be deployed that opens a market that didn’t exist previously,” the table leader said.

Another panellist countered that fintech truly is a leap. “Distributed ledger, AI and machine learning, are all relatively new technologies, but they are at very different stages of adoption and maturity – and there are huge differences between buy and sell sides in terms of both the implications and the hurdles,” the panellist said, “and we are seeing this primarily on the sell side.”

Looking to address why the sell side is having difficulty getting to that stage, the panellist said, “It’s easy for them to decide where to have data centres and manage processes. But that’s where one of the disconnects are – and it’s all about perception.

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“There’s a perception that you’re able to protect your data when you own data centres – when you have data collocated to you – but that’s been proven wrong. You still have regulatory burdens, so there’s a couple of mind-sets that need to be changed if you want to adopt the technology.”

The Cloud

Turning to the cloud, one panellist said his group discussed two areas: data in the cloud and computing power, which he called very high value-add.

One of the problems, according to one table leader, is the knowledge base of those in risk and compliance at banks. “Who understands what the cloud is? The bank tech guys do, but risk and compliance may not. So they’ve been asking the legacy questions, such as which country is the cloud hosted in?” he said.

“We were talking about the cloud as an enabling factor,” said another table leader. “I don’t think you could do machine learning and AI at anywhere near the rate of adoption that we’ve seen in last couple of years if the cloud wasn’t there to facilitate it – you need a huge amount of data, the ability to go through and start analysing it, and you need to have it in a place you can rapidly assemble and disassemble. You don’t need to build an entire legacy data centre to support that.

“If you go back to people that like saying no to everything and try to explain to your risk and compliance officer that ‘I need to take all this data from a client – yes, there’s some central bank flows embedded in here, and yes, some client names are embedded – I’ll just put it on the cloud, crunch the data and then put it back. It’s lost on them,” the table leader added.

“The cloud has created a dis-economy of scale that favours smaller companies,” suggested another panellist. “Larger companies have policies in place that can prevent people from doing things in an arguably safer way. This is empowering many small companies in our industry, because when people leave bigger organisations, they find they can buy storage and compute power today without raising $20 million to start things. So it has been a great base layer enabler. What we haven’t seen yet but will do, is

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that as applications grow up and sit on top of the cloud, and we are just seeing the beginning of this, these smaller businesses that have been empowered can run 100 times faster than legacy businesses, and they can get there in a short amount of time – they can do 20 years of work in a year.”

“A lot of people have big expectations around fintech,” noted another panellist. “They’re saying the cloud and cloud adoption takes up about 20% of their time, while blockchain takes up 70% and the rest is AI. The cloud and AI has helped a lot of institutions already, while blockchain has provided the fewest solutions.”

So is blockchain just a lot of hype? Starting off by quoting Bill Gates as saying, “’People underestimate the amount of change that happens in 10 years and overestimate the amount of change in two years’”, another panellist said, “The tough thing about blockchain is that it requires an entire transformation of how you think about who owns the value in an ecosystem and it reduces the value in the traditional players and puts it in a decentralised or distributed form. We’re all used to trusting a government or a bank to take care of problems you may have like a lost credit card.

But with these distributed procedures you have to trust the protocol, because you can’t call the protocol. It’s a generational level of thinking. If you’re in your 20s, you might not trust authorities, but you’re far more likely to be receptive to distributed trust and the lack of there being a controlling entity. So, I think it’s unlikely the entities sitting at the top of this economic food chain – because they’re the trust brokers – will relinquish trust to these distributed solutions, but I do believe that these distributed solutions, 10 years from now, will be the underpinnings of a lot of work that will be non-differentiable in our industry.”

Turning to another panellist, the topic leader asked whether distributed ledger/blockchain is hyped or real? “Overhyped? Probably.

Hyped? Probably not,” the panellist answered. “There’s actually some real stuff out there now – the rubber is starting to hit the road. Our group broke fintech down into three categories: change a process that’s there today, just swapping out the technology – call it proof of technology – or linking up disparate processes and making them more streamlined. But what’s the big thing, what’s the game changer, the quantum leap? We weren’t sure.”

Another panellist suggested blockchain won’t touch the day-today business of FX in the immediate future. “Nobody in our group thought that by the end of 2018 there would be significant initiatives that would be widely used, although there are a lot of hopes put on small initiatives that would satisfy a small bucket of participants. But it sounded like at least five years away, maybe more.

We thought the hype is not unjustified, but the concrete results won’t come soon,” said the panellist.

Another panellist noted that the Depository Trust & Clearing Corporation (DTCC) is moving its trade information warehouse, where 13

credit derivative swaps are stored, from an IBM mainframe to distributed ledger by June 2018. “So stuff is happening, but how many will use blockchain as a transport layer and how many will actually use it when you look to smart contracts is a very different story. We should know the answer later this year or next year,” he noted.

“We’ve been involved with blockchain for the past two-and-ahalf years. Blockchain isn’t new and there’s been various levels of implementation. There’s definitely traction. Your example of DTCC is a good one. One of the major players is understanding there’s a cause for concern and disruption and they’re implementing a case for it. We’re recognising that as well. Do we think it’s important and crucial to development and think it will disrupt? There’s very little question that it won’t. But the timing is a real question. All the companies we survey are showing a lot more maturity, but are still some ways away – 2018 is very aggressive – but I think we’ll see first cases disrupting slivers of our industry within three years, with wider adoption towards the 10year line,” said another table leader.

“It’s interesting what’s driving that change at the DTCC. It’s cost-driven, it isn’t a function-driven thing. Single name credit derivatives are not as popular as they once were, they started with a very high cost base. Fundamentally, I think people underestimate how much cost is going to be a driver. Every firm represented here has a back office and an army of people reconciling trades that add no real value to the underlying business operation. There’s no reason that can’t all collapse if there’s a golden copy of the trade record and the financial incentive to do that should be to take your back office cost and reduce it by a factor of 10 and see how many points of margin you get and see how much that does for your stock multiple if you’re a public company, and it should be a no brainer. But the incumbents that are sitting on top of the stack are not incented to take advantage of that,” noted another panellist.

So where are the friction points in FX where fat can be cut out and solutions found for a stated problem that might pull from the cloud, AI or distributed ledger?

“Our group looked at this more in terms of an evolution than revolution. So, for example, AI can help reduce the number of staff needed for the mundane part of the business, but won’t completely revolutionise the market,” said one.

“One key thing that came out of our discussion is that you really want to tame the conversation around AI. It’s about perception. People think that if I just AI this black box that nobody understands, just feed it information, it will come up with a magical answer. But it’s not at all the case. It really takes hard work to implement machine learning algorithms – it takes hard work to feed the right data in the right format to them. Still, humans are in charge of the data that the machine learning algos are looking

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at, so in a way, they’re providing their own bias into that conversation. So, we’re talking about something we understand fairly well and control very well, but it has very real limitations,” said another panellist.

“We’ve seen successes in some areas – compliance, legal – on a reasonably large scale that a lot of people don’t necessarily talk about, but a lot of the cases brought against the industry for collusion or manipulation, a lot of people’s emails and texts were processed using machine learning programs where people went through 10% of the data and said, ‘this is a bad conversation’. One of the press releases said, when trying to look for collusion, they found people congratulating each other. They didn’t necessarily need to find evidence of a crime, but it was machine learning that came up with those instances of people congratulating each other. So, behind the scenes, talk about enforcing global codes of conduct is an example of where it’s already behind the scenes as a pretty powerful force in the industry,” a table leader added.

Going back to the generational shift, another table leader noted that skill sets in the dealing room have changed dramatically, which is “organically creating organisations that are actually able to evolve forward using technology”.

“We lose sight of the perspective of people born in the cloud,” added another table leader. “For us, it’s a new thing, but for people in high school, their life is in the cloud – that’s how they manage their relationships. There’s no notion that it’s risky or something bad, but would think a very large, trusted company like Equifax is a thing you don’t really want to trust. So I think we’ve had a bit of a delay in the normal chain of people moving through companies, because of the financial crisis, which stacked up people – maybe people’s careers lasted five to 10 years longer than they’d planned on. As soon as that filters out of the system, I think we’ll see a lot more risk taking, but that next generation of people coming into our industry are going to think about what we were doing as risk taking, and what they’re doing as riskless.”

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