It no longer pays to be the reference rate

By Darren Jer | Mar 27, 2014

Basel is a city we hear of throughout our careers in FX.  We know it as the home of the Bank of International Settlements, the central bankers’ bank and meeting place for their governors.  Since 1989, many of us have analyzed the BIS triennial FX volume surveys; we remember the Allsop Report in 1996 that led to the formation of CLS.   The three Basel Accords recommended frameworks and measures for settlement risk, operational risk and capital adequacy and have had impact on how we do business. Yet, most of us rarely go to Basel.

Image via

Image via

One mild Sunday afternoon in January, several of us with different vantage points of the FX market did go to Basel to give short presentations to the BIS Markets Committee.  It was my first visit, and at the risk of turning an FX blog into a travel site, I would highly recommend a visit to the Kuntsmuseum, which includes a large collection works by Picasso; alas, it was the only museum for which I had time.  I should have allowed an extra day for my trip.

The rules of the BIS meeting mean I cannot quote the other participants, but excerpts of my own presentation are at this link.

Image via Kunstmuseum Basel

Image via Kunstmuseum Basel

The subject I was asked to discuss was “What are the platforms doing?”.  One aspect that I covered is the apparent mean reversion of platform volumes.  In other words, the largest platforms are losing market share while secondary platforms are gaining.   I show below volumes, indexed to December ‘09 of the three largest platforms, EBS, Thomson Reuters Matching, CME FX futures and Hotspot.  The trend is clear to see.  While most of the other platforms do not publish volumes, the trend holds well.

One reason for this trend is that the largest platforms are the most watched. They are the defacto reference prices.  EBS, Thomson Reuters Matching and increasingly CME FX market data is a large component of many banks’ e-FX price formation.  That means that information about orders placed on major platforms may transmit through the FX market faster than those on secondary platforms.   In turn, that means a price-maker’s market impact may be greater on a larger platform than a secondary platform.

Slide via Basel Presentation Excerpts

Slide via Basel Presentation Excerpts

Over the past two or three years, many participants have become more adroit at measuring market impact.  It is not as easy as it might seem: a participant has to factor out exogenous market moves; unless a model trades randomly, its choice of platform will indirectly reflect those market moves.

The net result is that traders, or more specifically their execution models, increasingly accept slightly higher execution risk on secondary platforms for the reward of lower market impact on the larger platforms.   This is a change from years gone by.  It used to be that traders favored greatly the platform that was the market leader because it resulted in the higher fill ratios and less waiting time for execution of passive orders.   This is no longer the case.

It no longer pays for a platform to be the reference rate.

‘Thoughts on Basel’ Series – Part 1 of 3
Catch up on the whole Series:
Part 3 – Into Darkness – Expressing our darker purpose – visit here
Part 2 – Traders in ever greater numbers – FX and the second law of thermodynamics – visit here

Written By: James Sinclair



Get updates from Market Factory!