Buy Side Assumes Role of FX Market Maker

Terry Flanagan

Banks are finding themselves disintermediated in FX trading by their own customers, who are taking on the onus of market making responsibilities that was formerly the exclusive province of sell-side FX trading desks.

“You don’t really have that clear-cut differential any more between buy side and sell side, because you have buy-side clients that are acting in market-making capabilities when it suits them,” said Soren Haagensen, head of e-commerce, Americas at Societe Generale Global Markets. “If you consider yourself a buy-side client, you will price when it suits you, but if the market for whatever reason doesn’t suit you to price you don’t have to. Whereas the sell side basically has to price even though it might not suit them.”

So what are banks and brokers doing to serve the needs of buy-side FX trading desks? “Everything that is possible for them,” Haagensen said. “That means providing liquidity to them via voice or electronic, depending on what the client wants and needs.”

Customers want to be able to trade in size, which means banks need to be prepared to place a larger portion of their inventory at risk. “If an organization needs to sell 45 million Polish zloty, the organization doesn’t hit nine different liquidity providers for five million each, because there will eventually be someone who goes to the market, the market moves away from you and everyone gets unhappy,” said Haagensen.

Banks, meanwhile, are ramping up FX automation to reduce costs and also avoid price manipulation risks. With volumes on the rise and continued reporting pressures, major financial institutions are making strides to ensure they have the right technology to efficiently run their day-to-day operations, said aid Rob Gray, head of sales for EMEA at Dion Global Solutions.

“Electronic trading has become synonymous with foreign exchange and it was only going to be a matter of time before this trend migrated to the wider world of FX options,” said Gray. “While there is still a way to go before the asset class becomes completely electronic, there has never been a better time for financial institutions to look for a fully automated system to underpin their FX activity.”

In general, the currencies with the least liquidity are the most at risk. “You have to warehouse a certain amount of risk, and you have to be able to execute or get out of your position, because somebody might go to market a little bit sooner,” said Haagensen.

In emerging markets currencies, liquidity is limited by the number of banks trading each currency pair. “If you don’t have a natural interest, it’s very hard to be a liquidity provider in it,” said Haagensen. “It’s harder to move the bigger amounts when liquidity is less, but market makers are certainly willing to provide liquidity.”

Even though the FX market as a whole trades 24 hours a day, not all currencies trade at all times. “If you trade Polish zloty, the best time to do the transaction is most likely when Poland is open,” said Haagensen. “You have the local banks involved, and then local natural interest in the market will also pay attention to it and therefore you can have a deeper market. If you try to do Polish zloty on a Friday afternoon in New York, you probably have a little bit of a challenge to get a large amount done.”

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