FX Last Look Needs More Transparency

Shanny Basar

The practice of last look in the foreign exchange market needs more transparency and will continue to be one of the most discussed issues this year according to Chris Matsko, head of FX trading services at Portware, a multi-asset execution management system.

Matsko told Markets Media: “Most of our clients, global tier one fund managers, believe last look is needed in the marketplace. They think it is a necessary evil to provide liquidity as banks need to cover their own risk.”

Last look liquidity in the foreign exchange market gives price makers the right to reject or delay an order before it is filled and is problematic in electronic trading as it is unclear whether an order will get filled at a given price quote. The practice created controversy when Barclays Bank reached a $150m settlement with US regulators last November for allegedly abusing last look. The New York State Department of Financial Services alleged in a statement that Barclays evaluated and applied its last look rejection protocols almost entirely in reference to the profit or loss the trade would bring to the bank based on price movements during the hold period.

Michael Campion Miller and Jason Weinstein, lawyers at Steptoe & Johnson, said in a note that this action is likely to be the tip of the iceberg and indicates there will be future investigations by the New York regulator into last look by other FX market participants, including banks, non-bank market makers, and trading platforms. They added that the regulator did not pursue charges against Barclays for maintaining a last look functionality as it recognizes it can be a generally acceptable tool to protect market makers from sophisticated automated electronic trading systems and technologies.

Chris Matsko, Portware

Chris Matsko, Portware

The note said: “The NYDFS cites a lack of disclosed transparency regarding Barclay’s last look policies and procedures or customer rejection rate information as part of the systemic fault in the company’s operations.”

The law firm recommended that market makers, including dealing banks and non-bank liquidity providers, should carefully review the disclosure provided to counterparts to ensure it is comprehensive and accurate. In addition, information regarding use of certain rejection messages and providing customers with complete and accurate data related to specific rejection rate and turnaround times should be readily available.

Matsko agreed that last look needs to be more transparent.

“The rules have to be published so they can be understood by the buyside,” he said. “Portware’s transaction cost analysis provides data that is meaningful to the buyside so they can monitor their execution – such as which banks are at the top of book and which have the highest rejection ratios.”

The need for transparency in the FX market was backed up in a survey last October which found this was an issue for 80% of respondents. In addition 85% of the respondents who were aware of last look liquidity said this was the market practice most open to abuse. LMAX Exchange, a UK-based MTF for foreign exchange, questioned 450 institutional market participants for a report, “Restoring trust in the global FX markets”.

Last June the Bank of England released a report on its Fair and Effective Markets Review which made 21 recommendations to help restore trust in the wholesale fixed Income, currency and commodity markets. BlackRock had said in response to the Bank of England’s review that the use of last look is problematic. The fund manager said: “Just as in the equity market, where centralised venues represent firm interest rather than mere indications of interest, our preference in the FX market would be to a view on the liquidity in which we can deal, even if this comes at a higher cost compared to the ‘phantom liquidity’, which can be removed at short notice. Moving away from indications of interest to streaming firm prices would be fully consistent, we believe, with outcomes that are both fairer and more effective.”

Matsko continued that post-trade transparency has improved in foreign exchange but has more room to grow. “There is a wealth of post-trade data that can be applied to the front-end to help investors make intelligent trading decisions,” he said.

He added that asset managers have become more comfortable using bank algorithms for foreign exchange and he expects this to evolve into more programmable trading using smart order routing parameters and automated execution of request-for-quotes.

“Foreign exchange will become more like equities and artificial intelligence will drive trading decisions,”said Matsko. “I expect an uptick in the adoption of artificial intelligence over the next two years.”

Feature image by Rawpixel/Dollar Photo Club

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