The Liquidity Game


I remember having a crisis of confidence way back when it was not fashionable to do so.

I was working as an Interdealer Broker and I was wondering what the point of my job was? What did we do for the markets to pay us so handsomely? One of my colleagues turned round to me and said “We create liquidity and the whole market revolves around liquidity”. It was undeniably true: By talking, cajoling, inflating, fabricating, wining, dining, entertaining and probably begging and praying (preying?) too, the proud team at “Stuffem and Leggit” got people to do things that would not otherwise have happened! Yes, it was the late 80s or perhaps the early 90s.

Somehow that conversation has stuck with me. Today, the markets are so much better organised and regulated. E-Trading has come along and transparency has shone its healing light on everything it touches. …Or has it? 

So what has really happened? The first thing that strikes me is that my current line of work is pretty much the same as my old broking one. In the end I am still asking people to deal on a set of prices. The key difference is that they are now much more transparent and being delivered electronically. In so doing BidFX, whilst integrating and accommodating the most complicated of workflows and client demands, ends up offering an extensive choice of e-FX prices to the discerning FX trader, just as I used to do as a broker. Though today ‘best execution’ has replaced ‘best entertainment’ as the main reason most people trade with me. But am I still creating Liquidity? I think the answer to that is most probably a no:  Activity, yes but true Liquidity no.

Banks used to create liquidity through their traders who, in managing the house risk, were given generous limits with which to take positions in the market. Today, where we have not legislated that away, it’s much, much, much, smaller than it used to be. Everyone has now set themselves up to pass the buck to someone else in increasingly smaller time differentials. Trade volumes go up and liquidity appears to be everywhere but in reality it’s just churning around faster and will probably prove not to be there at all in a crisis.

So who is going to create liquidity when the next Financial market crunch comes along? There is clearly a market-making vacuum building up. We all know markets abhor a vacuum, so who or what is going to jump in and fill the void? Erm… we’ve legislated away most of those evil bankers taking risks haven’t we? Doesn’t Liquidity just occur thanks to the divine presence of e?!

Despite the claims of some ECNs, for most players FX remains a relationship driven business. BidFX has been designed with respect to that relationship, it should be thought of as a tool through which Banks deliver on their relationship commitments. Given the wider nature of banking, the speed of the FX markets, tiny spreads, huge sizes and associated risks, it is hard to imagine this relationship element really changing amongst professionals. It is therefore unlikely that the value provided by Bank sales desks to their customers will change. In fact, as speed and risk goes up, it can be argued that the value of strong relationships increase. However that does not necessarily mean that the bank should also be taking market making risks.  

It seems that there is now a market opportunity for some entity to take on some risk. The entity concerned should have access to large amounts of money, understand the nature of risk, be prepared to put their money where their mouth is and have access to good credit lines. Sound familiar? Is this a hedge fund I see before me? Well, sit back and watch the rise and rise of non-bank liquidity and their associated Prime Brokers. Some people may see this as a threat but I think not: Bank traders manage their respective houses risk, the more that they are restricted from taking on risk the more external liquidity they need. That in turn means that new sources of genuine liquidity should be welcomed.

Why? Because in the end the old broker was right “the whole market revolves around liquidity”.

Alan Dweck
Head of Sales: Asia +65 6499 9808