Liquidity, regulation and the FX Global Code – Non-bank FX in 2021 and beyond

As 2020 – a year that will undoubtedly remain etched in the memories of many for a long time to come – draws to a close, Richard Elston, group head of institutional at CMC Markets, explores the key themes he sees emerging across the non-bank FX community in 2021

The FX Global Code is nothing new. Can you explain why that’s on your mind as you look to 2021? 

Richard Elston: The Global Code played a key role in allowing the industry to lay down standardised rules of engagement. This approach enabled operations to continue without regulation stifling the efficient operation of the market. However, most projects of this scale take time to move from inception to fruition – and this case has been no exception. The narrative dates back to at least 2015 so, at the outset, the code was agreed between central banks and some of the largest global institutions. Many of these acted as the key providers of liquidity, but that market itself has been through some comparatively dynamic change in recent years. With the emergence of a new wave of liquidity-makers – and the ability to sign up to the Global Code now being more open – I believe we will soon see being part of the Global Code as a prerequisite to doing business at scale. 

 

So, is CMC Markets able to sign up to the global code?

Richard Elston: We already have – although, when we first started looking at becoming a signatory, the path was far from clear when it came to companies such as ourselves. There was a lack of clarity over whether firms making liquidity with derivatives could apply, however, our own product roadmap, combined with what seems to be changing perceptions across the industry, allowed us to put forward our case and we were accepted back in November. Given the role we are increasingly playing as an institutional liquidity provider, we feel confident that this will help bolster our position in this arena. As many of the legacy institutions that helped formulate the code become more selective in who they work with, it’s falling to the next wave of liquidity-makers to deliver this service. We see our signing the code as a key differentiator in what could become a rather congested market.

 

You mention a growing number of liquidity makers. Where are they coming from? 

Richard Elston: As the traditional providers of FX liquidity have retrenched by being more selective, there has been a need to ensure smaller banks, brokers and funds still have fair and efficient access to wholesale currency markets. The upshot has been a proliferation of non-bank liquidity providers. I think it is fair to say CMC Markets has positioned itself well in this space – we’ve been fostering those valued tier-one relationships for years and, by combining this with our critical mass of internal flow, we have now established ourselves as a true liquidity-maker. While technology plays a key role – we employ more than 100 full-time developers in-house – success here is just as much about having the ability to quote consistently good prices with meaningful market depth. 

 

Given that you mention technology, do you see financial technology-oriented liquidity providers disrupting the market in 2021?  

Richard Elston: In a word, yes. But, while some fintechs are playing a role in liquidity provision, I don’t believe the market will see anything like the same level of disruption as occurred with the prime-of-prime brokers a few years back. While you need a robust and scalable technology stack, you also need the native liquidity along with all the attributes such as solid regulation and a weighty balance sheet that make you an appealing counterparty for major institutions. Given these natural barriers to entry, you can’t simply position yourself as a non-bank liquidity provider by pulling together a series of off-the-shelf components, setting up with minimal financial backing and then going down the route of liquidity recycling. With the inherent execution, risk management and compliance shortcomings, anyone attempting to take this approach would likely fail any due diligence and certainly wouldn’t easily be able to comply with the Global Code either. In turn, that offers another layer of credibility to both the code and its signatories. 

 

At the start of the year, you discussed the evolving regulatory backdrop for the industry. Do you see the Global Code playing a role here?

Richard Elston: I think care needs to be taken to delineate between the restrictions applied at the retail end of the market with those faced by institutional businesses. CMC Markets is in that select group that has to look at both sides of the equation. However, to recap, there’s a definite levelling-up of the requirements being imposed by what could be considered the ‘tier-one regulators’, with the latest iteration coming from the Australian Securities and Investments Commission, which has recently imposed strict leverage limits on what can be offered to retail customers in line with what has already been rolled out across Europe. Moves such as this have a positive impact on end-to-end market quality, but the self-policed watermarks such as the Global Code stand to play a far more significant role at the institutional level. 

On this theme, it’s worth pointing out that many onshore brokerages with retail exposure – especially larger players – have been able to adapt their offering to customers, mitigating much of the initial downside caused by regulatory change. However, this also shifted demand to offshore brokerages and onshore regulated managed currency funds – again two parties that will always be looking for liquidity providers. It seems this market will never stand still. 

 

What about the regulatory reporting burden. Do you think that will evolve in 2021?

Richard Elston: I believe change has to occur – especially in Europe. Currently, there’s little consistency across the single market and, as a result, we are seeing national regulators making different requests of the brokers they oversee. In turn, each broker is interpreting these demands differently and, while we have the ability to tailor reports in any number of ways, questions have to be asked as to how much more value could be generated if a single uniform structure was developed. 

There are now perhaps some early signs of convergence being observed here – regulators obviously have visibility across multiple firms, they co‑operate with counterparties in neighbouring jurisdictions and many brokers are in turn reporting to multiple authorities. By a process of trial and error it seems the industry – at least in Europe – could start to find more common ground here, making it easier and quicker for the brokers to deliver the information the regulator wants at the first request and without any unnecessary extra data.

 

Is there one other theme you could see taking a dominant role in 2021?  

Richard Elston: There’s a perpetual quest for lower latency, and arguably the path here has been smoothed by that growing adoption of the Global Code, combined with some significant technological innovation. There’s a wide range of factors that need to be taken into account here as liquidity providers have a legitimate need to protect themselves against rogue operators – or ‘toxic flow’. 

The idea of ‘last look’ neither provides a level playing field nor delivers that much sought-after ambition to reduce latency. As such, liquidity providers will increasingly demand better visibility over the provenance of the order, allowing them to make risk-based assessments as to whether the trade itself is being made in good faith. As the legacy liquidity providers have shown the market already, the route to success is as much about quality as it is quantity.  

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