LONDON: Work is moving forward on a new way for the foreign exchange market to set its “fixing” benchmarks, senior bankers say, after another week of revelations in the row over alleged market manipulation which has rocked the industry.
While there are substantial barriers to altering the fixing system — which is used to price trillions of dollars’ worth of investments and deals — the bankers say it is increasingly clear that an electronic-based solution is feasible.
This could seek to match off and then resolve automatically the huge volumes of orders put in around the fixing with minimal human intervention, making foul play more difficult.
Many also expect the scandal to hasten the demise of voice-based trading, whose model of dealers and brokers talking on several phones to multiple clients and banks at once has been a defining image of the industry for decades.
Participants in the world’s largest and least regulated financial market are scrambling to make trading more transparent and resistant to wrongdoing.
In response to the perceived role of complicated derivatives in fueling the financial crisis, regulators have sought to push as much of that market’s trading as possible onto exchanges. Banks and others involved in the more straight-forward cash foreign exchange want to head off any such aggressive push by regulators in their industry, which they say would bury them in red tape and push up costs.
By coming up with a solution for the fixing, the industry hopes it can keep its bespoke, self-regulatory model which it says is a major factor in a steady fall in costs of currency trading for business.
However, it also has a worried eye on investigations by regulators, not expected to conclude until next year, and a G20 working group due to make proposals for reform in November.
The manipulation row, which has seen more than 20 senior traders suspended or placed on leave, centers around charges that dealers from a handful of the biggest banks colluded to move currency rates.
In a market worth $5.2 trillion a day, the “fixes” have long offered set times of the day when asset managers do a lot of business to give them an identical daily reference point for both the value of funds and foreign exchange conducted that day.
That focussed large volumes of transactions around a particular time of the day. That has been a headache for the banks, but also may have been an opportunity for a relatively small number of players executing the biggest fund orders to work together and share information to establish which way the market would swing ahead of time.
The question now is how to change that system to eliminate that exposure to “human” corruption, no easy task in a market that is conducted in multiple locations, jurisdictions and platforms.
Several senior industry figures, either in charge of or with a past running banks’ electronic operations, told Reuters it was impracticable for currency spot trading to be put on an exchange. But they say a solution to the fixing itself was less problematic.
“There may be a service provider that would provide the means of doing fixing on a third party venue where people could put in orders to be matched on an electronic system and whatever is left over could be executed by an algorithm,” said the head of e-commerce with one of the banks being looked at in the probe.
“There are platforms coming to us and offering us that kind of service. If they can attract critical mass that would be an interesting proposition.”
Bankers say that business done at the fixing has already fallen off, suggesting asset managers themselves may be finding different ways to do their deals.
The Financial Stability Board’s FX Benchmarks Group — led by Australian central bank markets chief Guy Debelle and the Bank of England’s Paul Fisher — reports back to the G20 in November on work to make the benchmarks more transparent and reliable.
The forex market has a plethora of platforms acting as intermediaries between the banks and other major financial firms and the mass of smaller investors or companies.
Platform managers agree the infrastructure to run the fix on a more electronic basis exists, although there remains a structural issue of how orders are lodged and who could know about them.
“We are working toward a system where we can dark-pool orders so that the element of manual trading during the fixes is completely taken off,” said a senior official at one of the largest foreign exchange trading platforms.
In stock markets, dark pools keep intended bid and offer prices invisible and the price at which shares change hands is revealed after the trade is done.
One big problem is the concept of “slippage,” a market term referring to the movement in market prices a large order, normally broken up into smaller pieces, will cause as it runs through. A computer-driven solution to those orders left over after the fix would face the risk of a big event in markets changing prices too radically to allow execution of the rest of the leftover orders at roughly the fixing price.
“I could come up with the necessary technical solution in a matter of a few weeks,” says the head of one London-based platform. “The key issue for me is where and how the order is submitted.”
Another problem is the legal fallout. References to fixings are written into millions of contracts worldwide and those would need to be changed to reflect any automated solution.
“There have been discussions with clients,” says another senior e-commerce management source with a large bank. “Some say yes, in theory we can use algos instead of a fixing.
“But then you have a lot more things that need to be dealt with. Some say, ok but we still have to give a reference price to subsidiaries around the world.”
Market participants say the banks were initially unwilling to introduce the fix over a decade ago but were forced into the arrangement by asset managers, some of whom are now among those saying they may have lost out.
“If the fixing went away, I don’t think the trading desks would be unhappy with that,” says the first e-commerce chief. “It has become so competitive that the margins on the fixing execution that the banks make is negligible.”
Many players believe that the fixing row will accelerate the move to mechanize most foreign exchange transactions seen over the past decade and make the voice dealing desks at the heart of the fixing row a thing of the past.
“Definitely there will be a further shift toward electronic trading,” says the second e-commerce source.
“I don’t see any bank closing its spot desks but they will continue to invest in electronic trading. It is already the case that everything under a certain size is priced automatically by an algo under a trader supervision. On euro-dollar that might well be for anything below about 50 million dollars.”
Funds themselves are also thinking twice about whether the solution proposed by some academics of putting all trading on a central exchange would be cost effective. Bankers say it simply is not feasible and would just make transactions more expensive.
“Asset managers need to understand this market is a very transparent one, where bid/ask rates are very tight and the electronic platforms do a good job and there is plenty of competition to provide the best prices,” says Howard Jones, a partner at RMG Wealth Management who is also a former trader.
“They should not leave orders to the last moment for indexing their portfolios. Through these (regulatory) enquiries, we stand the risk of overregulation which could dry up liquidity, reduce activity and lead to more volatility.”
The head of another fund managing $50 billion in assets, asking not to be named, concurred.
“If you push these “fixing” trades toward exchanges there is a concern that it will genuinely drive up costs of doing business,” he said.
“Asset managers and funds will have to put up collateral which is mandatory for clearing on exchanges. Imagine a large Asian central bank having to put up collateral. It will definitely drive up costs.”