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e-Forex recently asked TraderTools CEO, Yaacov Heidingsfeld, to provide insights into how the provision, distribution and consumption of liquidity may be altering the way the FX market has traditionally functioned and to assess the wider consequences:
1. In what ways is liquidity still a function of and driven by relationships, and what are the implications of this for the future of electronic FX trading?

FX is always going to be a relationship-driven market and liquidity-streaming banks are always going to prefer streaming to counterparties they know, versus anonymous counterparties. By knowing who the counterparty is, and what their requirements are, in terms of size, pairs, and frequency of trade, the profitability of that relationship can be better measured and monitored.


2. In what ways does the quality of FX liquidity vary and does this reflect a move towards a multi-tier market where some participants are considered preferential to others?

Quality of liquidity is measured by the width of the spread and the quantity of the pairs quoted. The more transparent – the more a counterparty trade is preferential.


3. What defines whether a firm is a genuine market-maker as opposed to a recycler of liquidity provided by others, and does this actually matter?

Market makers are defined as those who make bids and offers and take risk onto their books. If you’re a market maker, you do not know if you are going to make a profit on every trade. Generally speaking, a “recycler of liquidity” is just adding a spread and lying off the risk simultaneously. By definition, their behaviour and trading requirements are different.


4. What impact could new OTC market regulations have on the availability of liquidity in FX?

In my opinion, in the Spot market, there will be none. In the newly regulated markets, like Swaps, many issues have not yet been fully fleshed out, so that will have an impact on trading volumes initially. How trades are going to be offset over different SEF’s is one example. Capital requirements in order to be a SEF and continue to make markets will be another.


5. What impact would you expect the possible Financial Transaction Tax to have on FX liquidity and on underlying customer needs and their willingness to trade?

To date, FX Spot has specifically been excluded. There are proposals for the additional exclusion of FX Swaps, Forwards, Options and NDFs. Obviously any tax is going to raise the cost of doing business, and could have the impact of discouraging member country’s businesses and funds from trading. It should be noted that to date, only 11 EU countries are part of this proposal.


6. What benefits would introducing best practice guidelines for liquidity aggregation provision have for all market participants?

I applaud EBS’s CEO for taking the lead on this issue and publishing the first Best Practice Guide for Aggregation. Customers and aggregators that follow the guidelines will guarantee complete transparency from the perspective of liquidity providers and re-distributors. Transparency leads to better pricing. Understanding how market participants are compensated for flow going through their systems aligns vendors and customers more practically.


7. What are the dangers of regenerated liquidity across multiple venues where takers are viewing the same source of liquidity through multiple venues?

I believe you are referring to what the industry calls “phantom liquidity”. Phantom liquidity can result in the liquidity maker getting lifted, or executed against, on multiple venues simultaneously thus resulting in a larger risk position than was originally anticipated. This phenomenon can lead to wider spreads in the original quotes to compensate for the additional risk.


8. Can the application of new technology alone overcome most of the problems associated with so called “phantom liquidity”?

By itself, I don’t think so. Liquidity providers are responsible for making prices in the quantity they are comfortable executing. There are additional improvements from a technology perspective that can alleviate some of the problems, but it will take a cooperative effort by those making prices and technology providers to combat this problem. Let’s not forget “last look” is another tool in the liquidity streamer’s arsenal, commonly used as a “governor” for quantity.


9. Do non-traditional market-makers really add liquidity and if so, how?

Non-traditional market makers are becoming more and more of a factor in our industry. In the sense that they are not 24/5 in their quoting and have no real “moral obligation” to make markets in good times and bad, the liquidity they offer has “no feelings”. These market makers are not concerned with predatory behaviour. They are making a two-way market based on models invented to trade.


10. Some currency pairs trade at much wider spreads on traditional e-systems than manually or over single-dealer systems; is this a benefit for the dealers or their customers and how might this change in the future?

I think this a pure relationship-pricing issue. When the streamer of liquidity doesn’t know who he is making a price to, or if that streamer is being charged by the distributor (i.e. ECN or aggregator), the price has to be wider to cover the additional risk or associated cost. This does not occur on single-bank platforms or on platforms such as ours, where streamers of liquidity have complete transparency as to the identity of the customer. And because there is no fee charged to the liquidity provider, no additional spread is required.


11. FX is still a hugely fragmented marketplace with an increasing range of venues and liquidity sources. How does this complex liquidity landscape change how FX market participants  need to price and manage risk? 

Pricing risk involves knowing the maximum amount of risk at any given moment in time and the ability to “value at risk” multiple standard deviations of the current market prices. Greater transparency (regarding liquidity makers and takers, as well as pricing and venues) is imperative for effective competitive pricing.  


12. Do you expect access to liquidity in FX to become easier or harder in the future and what effect will this have on the overall growth prospects for the market?

Access to liquidity will become easier as technology continues to improve and standardize. Greater transparency, which improves spreads to customers, is also an important factor for continued growth. The single caveat is the draconian, expensive, regulatory change associated with the Spot FX market.

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