Finclub

Lee Oliver

The world's largest foreign exchange banks make a mistake, sending prices into a set of electronic platforms and inviting everyone to participate in them. Now, they want to take control back. How to find out whether Oliver, the new bank trading system is touted as the answer. Who is behind this, and whether it would be a success?

This is the most important event in the foreign exchange market, but no one wants you to know about it. Six world's largest forex bank is considering a proposal to create a new spot-trading platform exclusively for its own use.

Behind all of this vow of silence, the foreign exchange market is difficult to know exactly what is happening. Some banks say they have no interest in the proposal (at least not yet). Some say they see it. Many people point a finger at Deutsche Bank and Reuters as the driving force behind these plans (although they are not quite sure what the plan). The Germans strongly deny their intended role, while Reuters will not comment, even though some bankers say that their technology is available and ready to go.

Some things are more clear. Leading banks play a large role in creating a system that threatens to bring them more harm than good. In fact, they were sawing the branch on which sat. The proliferation of electronic trading platforms (nobody really knows how many there are) increase trade the spot market, but at the same time reduced the spreads to the bone. Liquidity is low. Nimble traders use the system to their advantage at the expense of the main suppliers of liquidity.

This plot clearly summarizes the current state of the foreign exchange market. He laced with contradictions. Its members know this, even if they do not want to admit it. They will tell you that forex - the largest market in the world, with daily circulation of more than $ 2 trillion per day. Next they will claim that he has a problem of liquidity. If both statements are true, the market should have a deep-seated structural weaknesses that adversely affect its overall performance.

Not surprisingly, the major banks, having invested huge sums of money into becoming one of the groups of true liquidity providers in this huge market, want to correct the situation. The question is: Do they take the effort to combine their own liquidity, or they just create another platform, which has little chance to change anything?

New solution

Proposed solution the perceived liquidity problem - a new platform, to which will have access only to large commercial banks. In fact, it is an attempt to restore interbank trade, which almost disappeared since the advent of electronic commerce in 1993. Until then, most large banks are usually traded with each other more, more than the market standard volume on the phone or via Reuters. Market sources say that Deutsche Bank manages this initiative.

Deutsche Bank denies that is the driving force behind the initiative, or creating a platform available only to banks and bank representative said that the bank continues to work closely with many vendors to improve the way it provides and receives liquidity.

Although Deutsche Bank would not comment more specifically, and no doubt other banks, too, an understanding of the potential problems on the spot foreign exchange market was presented Ian O ' Flaherty , the head of department of electronic commerce for the world's currencies and commodities Deutsche Bank, in the journal Euromoney in the last month. In this article, O'Flaherty said that he considered the electronic market as a pendulum, where the equilibrium point and bought side and sell side benefit. But, he added: "The new technology is introduced could swing the pendulum in favor of the buying side. We'll have to see how it is viable".

Whoever was behind it, the concept seems to have dignity, to some extent, it simulates trading platforms with large blocks of securities on the stock market. They act primarily as a supplementary rather than competitive service offered by the exchanges.

Few of those involved in rumors of banks willing to say anything, at least officially. But if you break through the law of silence Market FX, rumors are enough to suggest that the company may be on the stage of conception.

Of the eight major banks interviewed for this article, only three are ready to continue to report on the new platform. UBS said that simply has no plans to take part in this at the present time, HSBC said it was considering and Deutsche Bank denies that manages this.

One of the six main banks FX from the ranking according to a recent review Euromoney , published in May 2005, who declined to be named, suggested the following comment: "We're studying the proposal made by Reuters. How this would work In practice, it is not clear, so it would be wrong to assume that we say yes. The proposal is to create a level only for banks in the market, closed user group for the six banks. This is indicated by people from Deutsche Bank. The idea seems , is to eliminate the intermediary function of EBS. "

This is a strong statement and, not surprisingly, Deutsche Bank denies this, saying that he had no intention of trying to eliminate intermediary function EBS or any other portal, which provides it with liquidity. Reuters, which is the only real competitor to EBS, and not a lot to say on this issue.

Only the receipt of responses was as follows: "The market for FX - an extremely competitive market, and it is natural for participants to seek new ways to access the best price and liquidity of associations. Reuters supports the development of the market and happy to work to support the business objectives of its clients. However, Reuters does not comment on market rumors and could not comment on this particular initiative. "

One of the leaders of the U.S. bank located in London, said he spoke to Reuters about the proposal and that the technology to create a platform ready. Reuters, he adds, is actively polling customers about their views, to assess the viability of the project.

Head FX units of other major player said: "It all came because EBS has opened and allowed the hedge funds enter the system. It's not like many people, particularly Deutsche Bank."

He adds that the current liquidity problem in the market occurred not because EBS has opened its platform to customers through its product EBS Prime, but because the Deutsche Bank did not sufficiently distinguish who delivers their prices. "The situation [mirage liquidity] arose because the Deutsche Bank supported too many platforms - they did not think about what they do. They have released the genie from the bottle, and now are trying to drive him back."

There is no doubt that Deutsche Bank is the principal opponent of EBS Prime, but he firmly states that has a good relationship with a broker. "We work in close cooperation with EBS, to provide EBS Prime, if required by our customers," said a spokesman.

Even in this case, market sources are adamant that the bank does not like anonymous FX trade, he is not alone in this, but it seems only bank prepared to speak out. Although complete anonymity works well on regulated exchanges, credit long played an important role in the FX market to manage prices. Even if the major banks recognize the advancing of anonymity, it would seem that they are determined to delay the process.

Problem for FX is that the market is stuck somewhere in the middle: some members can trade anonymously on the major platforms, while others, especially the actual providers of liquidity, they can not. But putting all the blame on EBS seems unfair. "Deutsche Bank does not seem to recognize that EBS competes with other platforms and should respond to the threat," said the chief dealer at a British bank, referring specifically to the strong growth in the CME, as well as the threat from electronic communications networks, such as Hotspot.

EBS, at least partially opened its platform for the buying side, noticed that some of them are extremely aggressive. As a result, buys the party gained an advantage. "Anonymity should not be selective. This gives an unfair advantage for certain hedge funds. If we put a price on to the large amount someone can see it for the dollar or euro, see it - we are, and if they think We have directed the effort to turn around and move the market. Hedge funds do not face this problem. And they're not market makers - they do not provide a stream of prices ".

Justyn Trenner, chief and head of the service sector finance advisory firm ClientKnowledge, express similar views. "There is a very definite interest in buy-side participation in the platforms of market direction," he says. "Some of these parties are buying very aggressively. They are not market makers. I think inviting them, EBS is indeed the real preconditions. The business of buying, which penetrates through the EBS, may pose significant challenges for the sell-side".

This could be true, but the real problem, it seems, is that the market can be accessed through a large number of entry points. Banks will try to absorb this flow, when they can not cope with it, it will be reflected in market centers, possibly resulting in a discontinuity in prices.

Answer to this is to reduce the large number of platforms. The problem of liquidity of the market should not exist, given its vast size. If it exists, only because the market had created it. The answer seems obvious - the liquidity should be merged. But this is unlikely to be realized at present. Therefore, technology «smart order routing technology» is touted as another possible solution.

"Introduction of a new electronic trading technologies would be very beneficial to the foreign exchange market and could be directed to large ruptures performance that currently exist," said David Ogg, Head of Lava FX. "For example, banks would be able to benefit from cutting-edge solutions to mitigate the effects of discontinuities of liquidity. The most innovative and imaginative platform will be well positioned, referring to the technological needs of the currency trading community".

Looking at the U.S. stock markets, outlook Ogg would be accurate. But, given the current climate on FX, there are those who believe that the "connectors» (aggregators in the original) could actually exacerbate the problem because it will make multiple platforms more vulnerable to hostile parties.

"The market should be careful that the new technology does not exacerbate the problem of liquidity mirage. Accession of many outlets that offer the same price from the same provider of liquidity to make the risk management flow is extremely tough for liquidity providers in the future," says Representative Deutsche Bank.

Market with a turnover of 2.5 trillion $

How can the market, which according to the latest triennial review of the Bank for International Settlements had a total daily turnover on the foreign exchange market in April 2004, more than $ 1.9 trillion, have these problems? And how do they get worse, as the market becomes more?

A permanent joint committee on the currency market of Great Britain and the U.S. Monetary Committee, which met under the auspices of the Bank of England and Federal Reserve Bank of New York, respectively, recently published data showing that the market grew by 17% in London and 20% in New York for six months from October 2004 to April 2005. Market participants argue that such growth rates show the market over the previous six months, suggest that the daily turnover of the FX market is now more than 2.5 trillion $.

Despite the fact that the market is trading a large number of currencies and different products, most activity is concentrated on the "majors" - the U.S. dollar, euro, yen and pound sterling. According to the Bank for International Settlements, forward the market is approximately 50% of turnover, and spot market, which is a general concept, which most people think, considering FX, approximately one-third of . The remainder of the volume consists of direct transactions, which are a combination spot and forward deals and options . The currency pairs, the volume of transactions on the euro / dollar accounts for 28% of the market, the dollar / yen 17% and the pound / dollar 14%.

Each of the different currency segments of the FX itself represents a huge market. The daily turnover of the spot market is now worth about 800 billion dollars a day. However, despite the huge size of the market participants FX is often argued that the spot market is illiquid. It seems completely unimaginable. The main reason why this statement makes some sense, lies in the fact that FX trading is not centralized like many other markets.

Another factor is that the market has consolidated over the past seven years - 11 banks now hold 75% of turnover in the U.S. compared with 20 in 1998. In another contradiction, while this consolidation occurred, the market has also undergone significant fragmentation.

Consolidation in the banking sector is an obvious reason why market share is concentrated in fewer participants. Technology also played a role in introducing transparency and efficiency, this has resulted in a reduction of spreads that he is now almost non-existent. Erosion of margins, many banks effectively squeezed out of business. However, the positive side, technology has made the market much more accessible and certainly played a role in its growth.

Technology has allowed liquidity providers to distribute their prices further and wider and more efficiently process smaller applications. Nobody knows the exact number of places serving the Internet commerce on FX, but the estimated number of such places is between 200 and 600. Currently there is no reason to believe that this is the limit.

Such fragmentation is probably the real reason why market participants feel the need to talk about the problem of liquidity spot market FX. The question is why the FX market allowed this fragmentation?

At least part of the reason is that as spreads narrowed and began to emerge a new business model of the spot market FX. To manage a viable spot business is now required to have the ability to accumulate a substantial risk or have sufficient market share to earn on the spread. Spread could be minimal, but the size of the market means that if a sufficient flow going, the spot FX market remains a viable enterprise for the sell-side. Many banks, therefore, decided to supply liquidity to the largest possible number of platforms to attract the flow of applications.

However, the rapid spread of streaming prices led to a problem that Martin Mollett, chief dealer at State Bank of England, remarkably called a "liquidity mirage" in a speech at the Congress of ACI in London in May 2004. There are hundreds of trading platforms, but they all show essentially the same price. This gives the appearance that the FX market is much bigger than he is. If several of the platforms are affected at the same time that market participants say, happens fairly regularly, the selling party provider of liquidity is likely to inherit a great position.

Although the FX market is not centralized on an exchange, it has at its center two electronic brokers - EBS and Reuters. Over the past five years, the Chicago Stock Exchange also retooled to become a significant alternative solutions for businesses. EBS is the largest of these market centers, reported an average daily turnover of 120 billion dollars. This is extremely impressive, but the price of its screens are often given only small amounts. According to the company, the average size of transactions EBS at least 3 million $.

If the bank has just inherited a position in the $ 50 million, and then just make a deal at $ 3 million, when trying to exit the trade on EBS, it is not surprising that he expressed dissatisfaction. However, these complaints are not common, and one veteran of the market has a slightly different point of view. "There is no liquidity problem as such, the only problem (liquidity) with specific prices," he says. In addition, all traders have the habit of memorizing transactions that do not go as planned.

Whatever the true situation, some of the largest banks in FX verify who they send their prices, knowing that some of the alternative platforms, or abuse the system yourself or have customers who are abused. As a result, liquidity is definitely too low in some places, but there is too much competition between banks, so you can imagine the expansion of spreads on an ongoing basis. In fact, the opposite occurs, and the spreads are still shrinking.

Criticism cartel

Idea of ​​creating an alternative platform to provide liquidity providers of liquidity may make some sense. However, at this stage it seems unlikely that this will happen. It risks being labeled as a cartel, though, as suggested by one dealer is easy to cost, if anyone can enter, as long as they give a commitment to give prices for large sums.

In addition, people are suspicious of the motives of the German bank. These suspicions may be misplaced, and to be successful due to the bank's FX; German bank could well act altruistically for the greater good of the market.

But, ultimately, the company will likely not lead to nothing, because for the players is not clear that they will benefit from this. "It probably will not work. Why do you quote five other banks in huge amounts?" People will be more inclined to take a chance on EBS (to break up the volume), "says the head of FX units of U.S. investment bank. "Why do the strong even stronger?"