Pragma Securities has released an interesting piece of research, investigating the liquidity conditions of the FX market. Contrary to some assertions, the study finds that major banks continue to offer top on the line FX liquidity.
A debate across the industry has been opened as electronic communications networks increase their market share and some major banks pull away from the market. Pragma’s findings suggest that the remaining banks are the more competitive FX liquidity solution across different market conditions.
Pragma’s research was conducted over two years and included the bilateral streams of seven banks. According to the findings, even through market turmoil, banks have maintained their provision of competitively priced liquidity.
During the period of the study, three market events have led to banks withdrawing liquidity – the Swiss National Bank crisis, an NZD flash crash in August 2015 and the GBP’s flash crash in October 2016. On average, banks widened their spreads wider than ECNs for about 3 minutes a day.
Aside from the banks, the study used data from EBS and Reuters on the seven most liquid FX pairs— AUD/USD, GBP/USD, EUR/USD, NZD/USD, USD/CAD, USD/CHF, USD/JPY.
Last Look Barely Used Outside of Extreme Events
While banks have the right to review orders and subject them to a ‘last look’, Pragma finds that institutional clients trading systematically and algorithmically got close to 100% acceptance rates.
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The study finds that banks very rarely withdraw from the market outright, but they could do it effectively by making their quotes uncompetitive. At the same time, while trading via an ECN, liquidity providers are exposed to adverse selection from more informed traders, which results in wider quotes, that make up for the adverse selection.
Non-Bank Liquidity and Algorithmic Trading Perks
Commenting to Finance Magnates on the rise of non-bank liquidity providers, the Chief Business Officer at Pragma, Curtis Pfeiffer, said: “While non-bank liquidity providers have an important role to play in terms of making the market, we expect banks to continue to account for a substantial portion total liquidity for the foreseeable future.”
“Looking at the Bank of International Settlements figures, banks’ share of total spot turnover has dropped over the past few years, but they continued to account for a very important 43% of the market in 2016 and are holding steady around 40-45%. Our research also shows that, despite pressures on banks’ risk tolerance and capital controls, banks are continuing to fulfill their role as necessary liquidity providers,” he elaborated.
Extreme events such as the SNB crisis in January 2015 have shown that banks can reprice trades at dramatically different rates to their clients.
“Unexpected market events are going to remain part of the trading environment, but algorithmic trading technology has an important role to play in helping traders navigate these periods of intense volatility,” Pfeiffer explained.
“For example, an algorithm can spread execution out across the volatile period, reducing risk by providing an average price vs a single point in time execution for a non-algorithmic order. And if that algorithm has access to multiple streams of liquidity it is even better, as they will be more insulated against the risk of vanishing liquidity,” he concluded.