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FX markets positioned at familiar tipping point

First Published 22nd September 2014

TradeTech FX focused on how industry is overcoming major challenges - weak performance, electronification, latency, and regulatory impacts.

PJ Di Giammarino, JWG Group

PJ Di Giammarino, JWG Group

"There's a lot of discussion about how to make better use of technology in operations, but I still think we are going to be here another two or three years."

London - There are a number of reasons to anticipate an upswing in FX markets after some five years of overall sideways performance.

To some extent, generic, or beta, FX strategies - value, carry and trend - have led to this weak performance, but going forward factors that result in more risk could boost the market.

Gordon Ibrahim, senior portfolio manager at BlackRock, told some 250 FX market participants at last week's TradeTech FX conference that the last two to three years show a positive trend.

"We've seen…an upward trend towards more diversification, so (a higher number of pairs) being uncorrelated," he said. "This means that FX is trading on more idiosyncratic factors. This may be growth, interest rate momentum, carry, but it is certainly an encouraging sign for FX investors."

As swap rates diverge, for example, the US dollar trend may pick up after choppy, sideways movements that challenge trading models. The dominance of the USD trend is such that it can explain more than 50% of the moves in FX.

This potential upswing is occurring in a market transformed by the boom in electronic trading and, much like the equities markets, technology that underpins trading has made the shift from competitive advantage to must have.

There are two main responses to the latency concerns that accompany this transition. Fergal Toomey, chief scientist and founder of Corvil, an IT data analytics firm, said that on one side, companies are making sure that systems are optimised for latency with the best technology. The other response is to create a level playing field by, for example, implementing controls for speed at trading venues.

Either way, the importance of monitoring latency has arrived in FX markets and the key, said Andrew Rossiter, global head of IT at ADS Securities, is to look carefully at price latency to determine bottlenecks.

He added that the cost of becoming a liquidity provider is coming down. "It is an expanding market (and) we are continually talking to new sources of liquidity," he said.

Unsurprisingly, the race to zero is attracting criticism and a rethink of order execution models.

François Bonnin, CEO and founding partner of John Locke Investments, said that the competitive advantage of being faster has not only become a more dubious prospect in recent years, but that high speed traders are drying up liquidity as market makers are scared off from displaying big quantities to avoid being hit.

He recommended a 'frequent batch auction' solution, which would result in groups having sealed bids and offers matched in 10-auctions-per-second increments.

Audience questions revealed some skepticism over whether this could become an industry-wide solution backed by mandates. But considering the success of IEX in the eyes of the buy side as a response to HFT in equities markets, the idea could have a role within exchanges or as a separate venue.

If trading faster is an inevitable development however, so too is using technology to try and trade smarter.

Information round-table discussions on algorithmic trading, systematic strategies, and the liquidity environment in FX markets that support those kinds of trading were packed. And in a separate talk, genetic algorithms were considered for future potential.

One of the panels highlighted the ways in which FX was following in the same footsteps as equities markets. And right behind, fixed income is next in line on the same path, said Andrew Young, Colt Capital's sales specialist director in the Capital Markets unit.

The potential across asset classes is certainly getting noticed, but Young also noted that when he speaks with firms "everything is regulation". It's at the point where the way to increase budgets is to make sure requests are justified by compliance and regulation requirements.

Speakers on a panel focused on regulatory impacts said that increased transparency is welcome, but it's difficult to ascertain any other good news until there is clarity on incoming rules. Major points of contention have to do with product definitions and harmonisation between jurisdictions.

"Ultimately, if you look further down the line, you get a market that is more transparent, easier for people to trade in, particularly at the liquid end of the curve," said Bloomberg's global head of FX and commodities electronic trading, Paul Tivnann. "But if you don't get (regulations) right, the net effect of getting them wrong is that liquidity can migrate."

Alex McDonald, CEO of the Wholesale Markets Brokers' Association, said that the good news is "second order" - such as efficiency of capital, conduct and technological development . But he denied there is any direct benefit of regulations such as Dodd Frank in the US or MiFID II and EMIR in Europe.

Closing the conference's first day, JWG Group's CEO, PJ Di Giammarino, said the discussions sometimes feel like "Groundhog Day", referring to a film starring Bill Murray in which a weatherman relives the same day over and over again.

"There's a lot of discussion about how to make better use of technology in operations, but I still think we are going to be here another two or three years," he said.