Rethinking FX market structure has already boosted volume

Published on 1 October 2021

Rethinking the market structure of FX could allow significant cost savings and risk reduction through more effective provision of liquidity. Market impact of large hedges – and even smaller trades – can have an outsized effect on trading costs through traditional channels.

As a result, say Jay Moore CEO of FXHP, a model for banks and client to use that reduces the need for credit and risk to be provided to the buy-side by the sell-side is proving a massive success with over US200 billion traded a month.

Dan Barnes: Welcome Trader TV – your insights into trading for professional investors. I’m Dan Barnes.

The way that traders execute in the FX markets is changing and evolving, particularly in terms of market structure. To discuss this with me today is Jay Moore, founder and CEO of FXHP, and we’re going to be talking about some of the changes that we’re seeing in market structure and why they’re occurring.

Jay, welcome back to the show.

Jay Moore: Thanks for having me back, Dan. Good to be here.

Dan Barnes: So you’re seeing 200 billion a month at the moment in terms of trading products. Why are investment firms using your platform so much at the moment?

Jay Moore: Last time I was on the show, we talked a lot about how FXHP has really changed, sort of the way the market structure fits together in the FX markets, particularly around the idea of separating liquidity from credit, opening up the potential for buy-side firms to provide liquidity to another buy-side firm on the other end. And when we started this we looked at the, particular for us, the SWAP space where you can only get prices from the banks that you have credit relationships with.

So breaking that tie, I think really opens up potential for savings. If you have large passive hedgers doing multibillion dollar SWAP trades on a monthly or quarterly basis, they’re speaking to their sales traders of those banks that they have credit relationships with, and that’s where they get their prices from. And at the same time, those banks may have an offsetting position with another client. They may not, and they need to go to brokers or other banks for liquidity so that they can price that client. And ultimately, it finds its way through a series of transactions to another passive hedger on the other side, potentially.

And naturally, there’s settlement risk, there’s CLS fees, there’s platform fees, there’s all of these layers of fees on every single one of those transactions. All of those layers of costs, they come from where? You and I as investors in the funds. And so what we found is that naturally people have reached out with interest in what we’re doing, from the buy-side and the sell-side, because they have fiduciary responsibilities to us as investors, right, to provide better products, lower fees, better tracking of the index. All of these things come down to performance, and performance is driven by cost.

Dan Barnes: What would you say is the demographic of firms trading via FXHP at the moment?

Jay Moore: Naturally, the buy-side. This is what we originally set out to sort of address. You know, we thought this was going to be at the very beginning a play on spreads and fees and the overall costs of a trade. And it turns out that obviously the FX markets are the biggest market in the world, and SWAPS and FORWARDS the biggest part of that market. So these SWAPS, the liquidity is enormous. And as a result, obviously spreads are pretty competitive.

When we started to speak to the large asset managers and the buy-side firms that work with us, they started highlighting a lot more of the pain points beyond spread. And those costs are operational in nature. Naturally, you’ve got a huge amount of resources that are required to get these trades done and the risk that comes along with that. Tracking error, of course, I mean, when you’re trying to match your benchmark for a particular index that you’re tracking if you are an index tracker.

And then, of course, there’s credit optimization; the fact that you’ve got a very few number of banks that dominate the market. So in order to get the best prices, you have to really take on a lot of credit risk with those banks.

But the biggest one, I would argue, is market impact. Especially with these very large, predictable, scheduled hedges that are rolled on a calendar basis. That in and of itself is a lot of information that banks have and that they need to use in order to provide liquidity. So they know that every month you’re sending five yards of Eurodollar to them and expecting price in return, they may pre-hedge that position to build an inventory so that ultimately they can provide you a price. Now, at that point, the market has already moved because the banks have pre-hedged you. You have to allow them to manage risk. You can’t expect to call a bank and say, ‘Whats your price on five yards á euro dollar,’ and they give you a price and then scramble to get out of it. These are very large trades they need to be able to manage. So the banks are stuck between a rock and a hard place with all of the pressures that we see around market impact. And so this is really the biggest concern that’s making both the buy-side and the sell-side attracted to the model that we created.

Because for the buy-side, naturally peer-to-peer trading has no market impact. On the other side of the equation, it’s banks saying, ‘Look, I know that I’m providing credit as a service. I can be the counterparty and allow my clients to spread and use more of my balance sheet for these trades without having to get in the middle of the trade from a pricing perspective.’

Dan Barnes: So then what would new users need to do if they wanted to gain similar advantages?

Jay Moore: Naturally, people are hesitant to change. New platforms, new venues, new workflows in general create risk from their perspective. Because of that, what we’ve done is fit in with workflows. Not asking the buy-side to do things differently than they have before or the sell-side for that matter. So we’ve taken painstaking efforts to really integrate ourselves into existing platforms; OMs’, EMs’ that the market use today, rather than asking people to do something different, and I think these efforts are going to bear fruit in that it’s going to create a much more familiar workflow for new users to just adopt without having to change the way they do things.

Dan Barnes: Jay, that’s been really good. And congratulations on the business success so far.

Jay Moore: Thanks a lot, Dan. Thanks for having me again.

Dan Barnes: I’d like to thank Jay for his insights today, and of course you for watching. To catch up on our other shows or to subscribe to our newsletter, go to TRADERTV.NET.