Non-bank market-makers appear to pass Brexit test

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These firms proved their commitment to foreign exchange trading and may have outpaced some bank rivals during the high volatility following the referendum on the UK’s membership of the European Union on June 23, according to market participants.

It’s an important test of a relatively new part of financial infrastructure. Foreign exchange markets used to be kept liquid by banks offering two-way prices. But banks have come under pressure from rising capital constraints and increased regulatory scrutiny, which has reduced risk appetite. A band of tech-savvy non-bank liquidity providers, often little-known outside of industry circles, have stepped in to keep markets moving under the sometimes skeptical eye of industry insiders and regulators who fear they might withdraw services at times of crisis and let markets freeze up.

Industry executives said that during the tough trading on June 24, after the UK voted for Brexit, caused some of the biggest currency swings in decades, they stayed in the market.

Bill Goodbody, senior vice president for foreign exchange at Bats, said: “We did see some banks pull back, but non-banks definitely did a very effective job in ensuring there was continuous liquidity. Spread widening is to be expected in a volatile market, but generally the market functioned well and everyone was still able to get business done.”

Kevin Kimmel, chief operating officer at Citadel Execution Services FX, one of the market-makers, said: “We prepared very carefully ahead of the referendum and made sure our risk management and position limits were sufficiently robust so that we could continue to price competitively through the potential volatility.”

Citadel traded 4.5x its normal daily volume on June 24, increasing its market share on a number of trading platforms, according to Kimmel. Other non-banks also claim to have seen a surge during the volatility, with Chicago-based Jump Trading making the biggest contribution to a record day on the FastMatch platform, according to Sam Tegel, the firm’s head of liquidity strategy.

Tegel said: “FastMatch’s technology and transparent market data supported orderly market behaviour on a day with tremendous activity. We are pleased that they were able to demonstrate the price discovery and risk transfer benefits of their platform on such an important day in the markets.”

Non-banks are likely to use the Brexit experience as proof of their increased influence in the forex market, claiming that liquidity could have been much less reliable without their contribution.

Citadel’s Kimmel said: “There was a misperception among some in the marketplace that non-bank liquidity providers would not support the market during times of stress, but the pricing on Brexit day made it clear that this was a myth. Citadel Securities remained in the markets throughout the volatility and performed very well, capturing substantial market share with many clients.”

FastMatch traded $ 39.8 billion on June 24; its busiest day since the platform launched in 2012 and more than triple its average daily volume for 2016. Meanwhile Thomson Reuters saw spot trading volume on its platforms rise to $ 258 billion, nearly triple its average daily volume in May 2016. While its systems performed as planned, the company reported some temporary widening of spreads, which is indicative of liquidity providers stepping back from the market by pricing less competitively.

The Hotspot platform, which was acquired by Bats Global Markets in 2015, traded $ 59.5 billion on June 23 – its second busiest day on record.

The FX industry may have navigated the Brexit volatility in better shape than it did the shock of January 2015 when the Swiss National Bank dropped its attempt to hold its currency against the euro, which left several banks and retail brokers nursing heavy losses. On June 24, trading platforms reported some spread widening, but the effects were temporary and concentrated mainly around the short periods of volatility as the results of the referendum were reported.

Goodbody said: “We had a lot of dialogue with bank and non-bank liquidity providers prior to the vote and some confirmed that they would be dialling back on platforms and pricing in general until they had a sense of what was going on.”

Three top liquidity providing banks in FX – Citi, JP Morgan and UBS – declined to comment for this story. Though JP Morgan said it traded more as much as four times normal volumes on its Asia FX platform and at no point stopped provisioning liquidity to clients, according to reports in The Wall Street Journal.

But Hotspot is not the only platform to have been told by banks ahead of the referendum that they might scale back liquidity provision, depending on the outcome and market conditions.

Darryl Hooker, co-head of EBS Brokertec Markets, said: “A number of banks had warned us that they might have to widen their quotes or temporarily stop pricing and we did see some of that liquidity thinning during the periods of peak volatility on Friday morning, but it was generally a much more controlled event than January 2015.”

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