Last month, inter-dealer broker Tradition, supported by 11 founding banks, including three of the top four by market share in the 2013 Euromoney foreign exchange survey, launched ParFX, a new spot FX trading platform to rival EBS and Reuters. The new venture initially grew out of the big FX market-making banks’ alarm in 2011 at the strategies of high-frequency traders that had worked their way onto the EBS platform and then developed latency arbitrage, a way of timing order execution to pick off best pricing from genuine two-way market makers, while appearing to make prices themselves, but either withdrawing these, changing them or only standing firm for tiny amounts, quicker than the market-making banks could keep pace with.
After much wailing and gnashing of teeth, EBS revamped its rules last year to make it much harder for these liquidity takers to game the system. But by the time EBS publicized its change of heart, a group of leading banks, including Deutsche Bank, Barclays and UBS, had approached Tradition to design, build and deliver a spot FX trading venue as a means for the large banks to prevent the two leading liquidity venues from exercising undue pricing power.
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| Mike Bagguley, of Barclays |
Mike Bagguley, managing director and head of foreign exchange and commodities at Barclays, says: “ParFX is one of the biggest things to hit the FX market for some time. I believe it shows the markets getting back to the business of real, underlying trading rather than the sometimes excessive and spurious trading, with volume for volume’s sake, that certainly emerged in the run-up to the financial crisis. “We are going back to only essential business. It’s an unpopular view but financial markets are going to shrink. ParFX shows the foreign exchange marketplace evolving and adapting to survive at very thin margins by getting very rigorous on cost.”
There is a certain irony here. Although studies of FX market structure usually say EBS and Reuters have well over 40% share of inter-professional FX trading between them, the two leading FX banks now have 30% of customer business, and the top four over 50%: so, not quite a duopoly like EBS and Reuters but close to an oligopoly.
What share might ParFX take? Daniel Marcus, global head of business strategy and development at Tradition, says: “In a year’s time, I would hope we are doing significant volume across all the CLS currency pairs we are covering. That’s the target. I hope that by bringing efficiency, low cost and a level playing field to trading FX, ParFX could deliver new volume, not just take it from incumbent platforms. It could be that some of the big participants direct some of the flow that they currently internalize, if they see a very efficient, low-cost central liquidity pool.”
Marcus runs through the key points.
“ParFX runs the same rules and the same fees for all participants,” he says. “Our fees will be low at $2 per million and the model does not envisage making a profit from selling market data, although we may ultimately have to charge the basic cost of providing it. We use a randomizer on order entry, which from inception will create a non-deterministic pause between a period of multiple milliseconds before an order will hit the market. That removes the latency advantage, thereby reducing execution-price slippage.
“One delivery requirement of the platform was configurability; so all elements can be changed to ensure that the purity of the fairness model is maintained. Accordingly we can adjust the randomizer parameters, if participants come in and try to work around it.”
Participants will join over time, initially the founding banks, including three of the top-four leading FX liquidity providers, with many more in the pipeline to sign up. ParFX operates a central limit order book, which is anonymous pre-trade but counterpart transparent immediately post trade. Any high-frequency trader dealing through a prime bank will immediately be disclosed to the bank on the other side once the deal is struck. All counterparties will know who they are ultimately dealing with.
High-frequency traders themselves could join in time. Marcus says: “ParFX does not discriminate against trader type, and come phase two, later this year, all entities that settle directly or indirectly through CLS are welcome. I had a conversation recently with one who told me: ‘Look, we have five trading strategies, only three of which have low-latency dependencies and two of which are simply based on our superior relative-value analysis. We could execute those over ParFX.’ So we’ll see.”
The pitch runs beyond abolishing latency arbitrage. It is about low cost. Connection fees are low and simple through an industry-standard FIX protocol API. Banks only have to hook up in one centre, rather than in three as for EBS.
Level playing field
Kevin Rodgers, global head of foreign exchange at Deutsche Bank, says: “ParFX is mainly about ensuring a level playing field for true liquidity providers. It also shows that the liquidity providers would like competition in this field. No one wants there to be just one or two places where all providers have to go. Competition on price and service levels is healthy for the market.”
Indeed.
It’s just as well then that the top market share positions in foreign exchange, while they look close to a duopoly right now, are never truly locked down.
