The need for a strategic approach to liquidity management

5 February 2017  •  Author(s): Bryan Seegers, Director – Co-Head Global eFX Coverage at ADS Securities

The need for a strategic approach to liquidity managementBryan Seegers, Director – Co-Head Global eFX Coverage at ADS Securities, tells FX-MM why it has never been as important as it is now for currency investors to take a strategic approach to liquidity management.

What has been the most significant change in FX liquidity provision in recent times?

Prime brokers are less willing to extend the amount of credit across multiple venues as they once were. Because of that, many participants in the market have been squeezed out and have to be much more selective if using a prime broker to access liquidity.

This has caused a lot of market participants to try to trade bilaterally, and that has created more pockets of liquidity, which aren’t always the best thing for the market. By concentrating liquidity in different places, many people no longer have the reach they once had.

There is also a major shift going on at the tier-one liquidity providers. Due to regulatory and risk changes they are no longer able to take the risk and manage flow as they once did, which has caused a ‘glut’ in available liquidity to the overall marketplace. This again has pushed many market participants to the periphery.

So with the market going in the direction that it is, it is no longer sufficient for market participants to just have access to the top five banks in order to source liquidity. It is no longer enough for that to be their liquidity pool. Market participants need to reach the periphery – to the non-banks, to the ECNs – in order to complement their liquidity pool so that at times of stress in the market, they are able to optimise their client’s experience and their own trading experience.

How are currency investors going to do that?

The way some market participants are going to do that is by forming more bilateral relationships. There has been a trend recently of firms raising capital in order to facilitate that. Non-banks are looking at such avenues as prime of prime or other larger tier brokers to facilitate more bilateral relationships. It comes down to market participants knowing what they need from their liquidity providers in order to better allocate their funds.

What factors should currency investors take into account when connecting to a trading venue?

It is ultimately about the access and understanding what type of liquidity investors are facing behind each venue. That involves spending a lot of time with the liquidity management groups from each of the venues. Three years ago the liquidity management role was just coming into fruition – before then it was not considered important because liquidity was just so readily available. Now it is essential to engage with liquidity management teams to truly understand the nature of your FX trade and order flow.

Investors also need to consider how many other market participants are accessing that liquidity – that is another major concern since liquidity is not finite. There is only so much liquidity available and that is why it is important to understand where they are placing their funds. They must also consider whether it is a venue in which they can actually execute transactions and how much overlap there is with other trading venues.

Trying to diversify their liquidity pool is also crucial for currency investors. Reliance on only one venue is not a wise decision in current times because of those pockets of liquidity.

What are the advantages of discretionary versus anonymous FX trading venues?

A big question is what type of trader you are; what your profile is as an entity. If you are more of an aggressive type of client, at times it may pay to be able to go to the anonymous venues. Anonymous venues add uniqueness in that currency investors are able to execute orders that other participants can’t see.

Disclosed trading adds a significant amount of value, however, because the primary market – even in the non-bank space – is much more interested in disclosed relationships. They want to know who they are facing and what to expect from the flow.

If as a currency investor you properly manage the expectations of your liquidity providers, by engaging with liquidity management teams, you will be able to get yourself a better service in the end. Relationships have become crucial in the FX market and the days of liquidity providers paying for volume are long gone. They now look at the value of each client, and if there is no profitability there, in most cases they are not going to service the business just for volume.

This realisation is reflected in the fact that some of the venues that once just offered anonymous trading are now offering disclosed trading as well, and it is a growing business for them.

What role can machine learning and artificial intelligence (AI) play in improving currency investors’ performance?

Instead of performance I would say that investors can use machine learning and AI to improve the quality of their execution, which should in turn improve their trading performance. They can use machine learning and AI to better allocate liquidity based on their trading performance, or their trading technique, and then to better understand what their liquidity providers are doing with their business in the market. That means that when smart order routing occurs, they have the edge.

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