Written by Jack Davis, Marketing Executive at Fixnetix.
On the 10th of June George Osbourne, the Chancellor of the Exchequer, proclaimed that in the past the banks had been “part of the problem” but that going forward they were now to be “part of the solution”. The speech, given by Osbourne at the Lord Mayor’s Banquet, was of course echoing the language and vision of the Fair and Effective Markets Review, a joint report issued by the Bank of England (BoE), HM Treasury and the Financial Conduct Authority (FCA), unveiled that same day by Mark Carney, Governor of the Bank of England.
The report, which focusses on the Fixed Income, Currency and Commodities (FICC) markets, was launched after a particularly turbulent couple of years which has seen a number of scandals rock the Square Mile and seen five of the largest players in foreign exchange (FX) recently pay out a total of £3.6bn in fines for attempted manipulation of the marketplace.
For the most part, the report calls on accountability through various levels of reform, on the basis that slapping firms with fines has done little to curtail bad behaviour in the FICC markets. The creation of a new FICC Market Standards Board, extended jail time for law breakers, an extension of the regulatory framework and an agreement on the need for a global FX code of conduct all form part of the review recommendations.
However, the Fair and Effective Markets Review also pays minor homage to the emerging role of technology in the FICC markets. When reading it, there is a sense that the report’s findings reflect a mentality (that at the moment is still fairly common within the FICC markets) of appreciation that technology can bring change, but as of yet, no great uptake has occurred. Most of the suggestions that the review comes up with to improve the fairness and effectiveness of the FICC markets still have a heavy focus on human elements; the setting up of committees, penalties for rogue individuals, better education for market participants etc. These are all very commendable measures, but could there not have been a stronger emphasis on the role that technology has to play in creating a fair and effective marketplace?
Undoubtedly this comes in part from the lack of ‘electronification’ that the FICC markets have so far undergone. Futures and commodities are the most advanced of the FICC markets in this respect, but even so they are flagging a few years behind other asset classes such as equities in terms of development, which are almost completely electronic in nature. But without a doubt, technology is beginning to play a much more prominent role in the FICC markets. The review does acknowledge this but it also highlights what it sees as the potential dangers that come with it. Algorithmic trading, trading strategies based solely on latency, the fragmentation of the marketplace and the proliferation of order types are each identified as problematic within the review, with the potential to hamper our ultimate quest for a fair and effective FICC marketplace.
The warnings that the review gives are retrospective following MiFid I – they are all adversities that the equity marketplace has had to overcome in recent years. If indeed the FICC markets are following that particular development curve then it is fair to assume that they will encounter the same bumps in the road along the way. Yet whilst it is right to be aware of the potential implications of a completely electronic trading environment, it is also worth pointing out that the equity marketplace has dealt with these issues and moved on, almost entirely due to the trading technology and market infrastructure that has developed alongside.
Meanwhile, much of the market manipulation that has occurred in the FICC space has been because of the sectors dominant reliance on human interaction, where the potential for miscommunication, mistake and possible corruption is much more widespread and much harder to identify and eradicate. In a sense, the fairest and most effective way for the marketplace to evolve is to continue to move into the electronic trading domain because it can reduce misconduct by taking out the human factor.
In cases where some argue that certain crises, for example the 2010 Flash Crash or the removal of the Swiss Franc peg in January of this year, were exacerbated by algorithmic and high frequency trading, then one must also argue the flip side. The marketplace would equally never have balanced itself out as quickly as it did without electronic trading. Besides which, the Swiss National Bank’s (SNB) decision was one calculated and ordered by humans and not little black trading boxes.
The BoE said in a working paper back in March 2015 that algorithmic and high frequency trading were actually beneficial to the financial markets. The speed and frequency with which trades are executed makes pricing more accurate and efficient, and the process gives the marketplace much sought after liquidity.
No matter what your opinion on the old adage ‘history repeats itself’, the signs are there, the FICC markets are on a steady march towards the electronic trading domain. For the time being the Fair and Effective Markets Review might maintain an outlook that predominantly keeps the human elements of trading front and centre but by the BoE’s own admittance electronic trading is beginning to creep into a more prominent role, to the benefit of the marketplace.
For the moments where there are worries over stability of the marketplace in an electronic world, we’ll have to point (modestly) towards the technological solutions that have already been developed by firms such as Fixnetix which enable a much safer trading environment even with its ultra-low latency nature and our infrastructure deployments which give clients the flexibility they need to be constantly adapting their trading strategy in a fragmented marketplace. Solutions such as these are available now and are not limited to any single asset class. FinTech firms already have the expertise and existing technology; they have seen this all before and are ready, willing and pushing to see this offered at large. The FICC markets are ripe for a technological explosion.