I don’t think there is anyone out there who
doesn’t think the FX market performed well under the stress of the surprise
outcome from the UK referendum last week, but I suspect the real test is only
Do risk managers need
to fundamentally re-think their approach to markets? Specifically, are they
paying enough attention to liquidity risk, assuming, of course, that there is
even a way to accurately and dynamically determine this risk in markets?
I ask ...
The subject of liquidity is very much to the fore in foreign exchange markets again following what has been termed a “flash crash’ in Cable in early Asian trading.
The pair broke through 1.2600 and fell very quickly to below 1.14 before going on a mini rollercoaster ride before finally recovering to 1.24.
Although the move is very much being seen as a flash crash, sources say there was good trading volume most of the way down with markets only getting very thin on a break below 1.1800. The low according to Thomson Reuters Matching, which is the benchmark for Cable high/lows, was 1.1378.
Market sources say the low in Cable is being disputed, in spite of what traders say was a clear print at 1.1378 on Thomson Reuters Matching.
A source familiar with the matter says the low trade was a mishit and that the deal is currently being repapered to a new rate.
While several platforms are printing a low between 1.1850 and 1.1950 – something that in itself highlights the level of confusion in the industry, Profit & Loss understands that “at least” 10 trades were executed at 1.1500 on three venues.
This morning’s flash crash in Cable in which it dropped 9.5% in seconds and the low of which is still disputed raise some interesting questions for the creators of the FX Code of Conduct.
Several sources say that the mayhem was triggered by one account executing a large trade into the market, possibly for GBP 200 million. This was enough to send the market into freefall as liquidity during the already thin early Asian session, thinned out further.
If the order was executed by one account, or even by several accounts on behalf of one customer, questions have to be asked about why they did it then, and how they executed.
After Cable’s apparent flash crash Friday, analysts are trying to determine what caused the move and the broader impact that it could have.
In a special note put out Friday Australian-based hedge fund Hunter Burton Capital says the sterling moves are being attributed to comments made by French president, Francois Hollande, about Brexit.
“There must be a threat, there must be a risk, there must be a price, otherwise we will be in negotiations that will not end well and, inevitably, will have economic and human consequences,” commented Hollande.
Where to start? Well I will get to those industry “experts” who have been arguing with me for the past two weeks (actually months) that liquidity is great in FX later, for now let’s kick off by getting to the crux of the issue. This is not necessarily about whether algos ran wild, or someone ran an option barrier, this is about a(nother) fundamental breakdown of the FX market structure.
The time has come to accept that what happened Friday morning in Asia is a mess of our own making; to take our heads out of the sand and at least acknowledge there is a problem with liquidity in FX markets.
A senior member of the Commodity Futures Trading Commission (CFTC) has called for a “thorough and unbiased analysis” by global financial regulators of the systemic risk of “unprecedented capital constraining regulations on global financial and risk-transfer markets”.
In a statement issued today, CFTC commissioner Christopher Giancarlo repeats his warning over liquidity risk in financial markets, noting, “The increased risk is in part due to untested bank capital constraints imposed by US and overseas bank regulators under the Dodd-Frank Act and similar laws.”
There seems to be general acceptance that last week’s flash crash in sterling merely highlighted what we have known for so long – there is a growing structural problem in FX markets.
Identifying a problem and solving it are, however, two entirely different things and in spite of the spirit of innovation reawakening in foreign exchange markets, my sense is that whilst the solution I propose here is unpalatable to some in authority it may help central banks better understand markets and curb flash events
Thomson Reuters says its sterling volumes trebled on October 7, the day of the Cable flash crash which saw the pair drop from above 1.25 to below 1.15 before recovering to 1.24.
The company does not break down its volume data by product or currency on a daily basis and provides no further details, however this would appear to be further evidence of the phenomenon in FX markets whereby dealers typically head to the major matching venues of EBS Market and Thomson Reuters Matching when markets get hectic.
On October 7, Cable flash crashed in early Asian trading, leading to chaos in the market and an official investigation into events surrounding the move. Colin Lambert takes a look at what happened.
A few minutes into October 7 UK time, at 12.07.03am to where there are grounds to believe that the transaction is be precise, Cable traded through 1.2600 having fallen 30 points in the previous minute. Just 23 seconds later it traded below 1.2200 and 45 seconds later it had traded at 1.1378 on one platform.
Just two minutes later the market was trading back above 1.2100 and just 10 minutes after the initial move, Cable was trading above 1.2400. The market had “flash crashed”.
I am probably not the only person nervously awaiting the outcome of next week’s US election, although I suspect many have much different – and to them much more important – reasons.
My concern is that in spite of it being a "known-unknown" the FX market is facing a major event - and this is on a global scale not the relatively local affair of Brexit - and its recent form when it comes to handling a massive surge of business is not great.
A US district court judge has entered a consent order brought by the US Commodity Futures Trading Commission (CFTC) against UK-based trader Navinder Singh Sarao.
Sarao was accused by US authorities of helping to trigger the infamous flash crash in US equity markets in May 2010 and was extradited to the US recently.
The order requires him to pay a $25,743.174.52 civil monetary penalty and $12,871,587.26 in disgorgement. It also permanently prohibits Sarao from further violations of the Commodity Exchange Act (CEA) and CFTC regulations, as charged, and imposes permanent trading and registration bans against him.
New regulations imposed on banks since the financial crisis could be contributing to “flash crashes”, according to Christopher Giancarlo, a Commissioner at the Commodity Futures Trading Commission (CFTC).
Speaking at ISDA’s Trade Execution Legal Forum, Giancarlo said that when the British pound suddenly dropped 6% against the US dollar in October, this flash crash was exacerbated by a lack of market liquidity.
He continued: “In fact, there have been at least 12 major flash crashes since the passage of the Dodd-Frank Act. The growing incidence of these events shakes confidence in world financial markets.