FEATURE
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of a general trend that has become evident in the post-financial crisis – that liquidity-taking banks are now being more sensitive to their liquidity providers overall qualities rather than simply judging them on price alone and on a deal by deal basis, says Martin. “I think the financial crisis caused everyone to take a deep breath and reassess exactly what they are trying to do when it comes to FX. Tere was a realisation that relationships are important.”
Relationships matter
Te growth of algorithmic-driven trading models has enabled dealers to quickly analyse multiple prices and execute accordingly but, on occasion, this has involved neglecting the longer-term and more qualitative aspects of the relationship between liquidity providers and liquidity takers, says Martin. “If you put price aside from a moment, there are other things you want from your liquidity provider. For example, you want them to back you once you make a deal with your customer. Ultimately these banks distributing bids and offers are importers and exporters and the one thing that loses them customers is when a displayed price is no longer available because the market has moved against them.”
Te re-evaluation of the relationship in FX liquidity management has led to some give and take on both sides – the liquidity takers have agreed to use a longer time horizon when judging their liquidity providers rather than on a deal-by-deal basis and to not simply go with the lowest price on offer. In return, the liquidity providers have agreed to back their clients trading activity even when the occasional deal may lose them money. And this has had an effect on the types of technology used in liquidity management. “Tere is now a greater level of sophistication involved in the pricing models and the liquidity management systems,” says Martin. “Te aggressive, alpha generating algorithms are out and the intelligent, cognisant algorithms are in because they are able to absorb much more information aside from simply price.”
Martin has also noticed the increased presence of multi-asset traders in the FX market and the effect this is having on the development of trading technology and tools. “In the past we had clients come to us in different silos based on asset class but those classifications are becoming more blurred. In FX the corporates at the bottom of the food chain are multi-asset by definition because they are entering the
56 | april 2011 e-FOREX
FX market in order to facilitate another transaction. And at the more sophisticated end of the market, the various triangulations strategies are joining together different asset classes and this is now affecting liquidity providers in the FX market,” says Martin.
It is also affecting the vendors who supply the liquidity management systems, says Martin because those that only operate in a single asset class will find it difficult to adapt to a multi-asset class environment should the participants increasingly seek to use one system to cover multiple asset classes rather than the asset- class specific approach that has prevailed up to now. “I think if you are just an FX platform, then you have a lot to worry about. To develop a new version of the technology and bring it to market is relatively trivial but to develop the ability to add a whole new asset class to your platform is a massive job.”
Challenges with upgrading
For Harry Gozlan, founder and chief executive of SmartTrade, the biggest challenge for FX participants in the liquidity management space lies in upgrading their systems and the complexity involved when migrating from their current system, which may be five or more years old to a more powerful new system equipped with all the latest trading tools and metrics. “Tey are not starting with a blank sheet. Te difficulty is that there may be some of the pieces already in place such as auto-hedging rules or pricing engine but to get everything harmonised and ready at the same time is a huge undertaking,” says Gozlan.
“Te only possibility is to implement the solution one component at a time and ensure that you take a very open approach to the development because there are often different protocols involved. Tis gives banks much more flexibility for the future which is important because much of this technology is still in an evolutionary stage. Tis is also true of the securities market where a new state-of-the-art product arrives and you need new components to work with it, be that software or hardware.”
So what kind of principles are involved in the development of the latest liquidity management systems? According to Gozlan, the method behind the metrics is much as it always was. “In the classical sense it is all still about extracting maximum value with minimum risk and all of the various metrics – real- time positioning, auto-hedging rules and real-time
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