EBS solves internalization and last look issues in FX: We speak to senior management on what single-ticket execution means

“If you’re a liquidity provider streaming into an aggregator, then it is possible that you don’t know what you’re pricing. It is also potentially the case that you would not be clear on whether you would be pricing $1 million in total, or just $1 million out of a trade that is in total $50 million. Under the current industry-wide method, you cannot be sure that someone else is involved and may move the market” – Tim Cartledge, Global Head of FX & Head of Product, NEX Markets

Aggregation of trades via single-ticket execution is not new to non-bank commercial electronic communication networks, often referred to as ECNs.

Indeed, the procedure was adopted by agency research broker and financial technology firm ITG in April 2011 on a pan-European basis, making it the first institutional broker and technology provider to provide the ability for buy side traders to manage liquidity aggregation across anonymous venues for certain markets.

That particular solution facilitated the consolidation of allocations and settlements across multiple brokers and executing venues within the ECN into a single aggregated delivery to a custodial account whilst allowing brokers to have full information and control of their commission credit.

Now, over six years later, EBS is adopting single-ticket execution methodology when trading orders of more than $5 million in base currency on its EBS Direct platform, an evolution that will be implemented during the first week of September.

Aligning itself somewhat with the product range provided by non-bank peer Currenex, in which a specific service is offered for commercial clients that process large orders. Under the moniker of ‘Currenex Big’, the execution methodology allows firms handling large trade sizes to execute on a single-ticket basis and also perform anonymous trading (often referred to as dark liquidity).

EBS is going down a slightly different route, solving two age-old issues in doing so

For manual orders of more than $5 million in base currency, EBS has for a few weeks maintained that it will execute automatically on a full amount single-ticket basis, to a disclosed marketplace, and to gain further clarity on how this will differ from current execution methodology for existing and new clients, FinanceFeeds spoke to senior executives at the business today in London.

This will be carried out by the firm’s EBS Direct platform, which offers relationship-based disclosed liquidity, allowing liquidity providers to stream tailored prices direct to liquidity consumers, however the company’s Global Head of FX & Head of Product Tim Cartledge stated just after the firm made the decision that as it’s not possible to tell if the order is for the full amount or not, it does not want to call it full-amount trading.

Mr Cartledge, who joined EBS BrokerTec (now NEX Markets) in November 2015 from Barclays Bank, where he was Head of Global Fixed Income Currencies and Commodities Electronic Trading, his position having been Managing Director level at Barclays during his tenure from 2004 to 2014, has extensive experience with regard to Tier 1 institutional FX execution.

As a member of the NEX Group Executive Management Group, Mr Cartledge’s ownership of changes to methodology comes with a high level of corporate pedigree in this particular sector.

Mr Cartledge explained today to FinanceFeeds in London the full rationale behind this move, and how it will rectify the problematic aspects of internalization of trades at Tier 1 level.

“In terms of background” explained Mr Cartledge, “when looking at EBS Direct’s method, it is a relationship model with liquidity providers making quotes, and consumers trading on them. Bearing this in mind, it is important to consider that The FX market over the last 13 years has been all about internalization from a liquidity provision point of view.”

“The key to internalization is that the market doesn’t move very much after you have traded. If the market doesn’t move, what you have sold to one client, you can buy from another one some time later. Perhaps it can be possible at that point to skew the price, hedge the risk and make a bit of spread in between, as long as the market doesn’t move” – Tim Cartledge, Global Head of FX and Head of Product at NEX Markets

Last look is the bete noire of all sides – clients, the regulators and the liquidity providers

Once looking at how the traditional internalization model has operated over the years, Mr Cartledge then explained “Bearing this in mind, one can see where last look comes in, because liquidity providers want to see if the market has moved or is moving or when they are assuming risk, which is all about making internalization work properly.”

“If the market tends to move when one client trades but not when another does then the former will tend to get a wider price than the latter. Also as an LP if you believe there are other LPs involved in the trade that will hedge quickly, then you too are forced to hedge quickly and will actually contribute to the move. These are the mechanics that we are dealing with and have been part of the landscape for 13 years. Effectively, this is how internalization works” he said.

“This is currently what we have with EBS Direct, and as is the case for many platforms that aggregate prices, it is not optimal for the relationship between liquidity providers and liquidity consumers” he continued.

“If you’re a liquidity provider streaming into an aggregator, then generally you don’t know what you’re pricing. You could be pricing $1 million in total, or just $1 million out of a trade that is in total $50 million. Under the current industry-wide method, you cannot be sure how many other liquidity providers are involved or whether they will move the market” – Tim Cartledge, Global Head of FX and Head of Product at NEX Markets

Internalization currently cannot be conducted well and the status quo must change

“This is why currently many firms cannot really internalize these flows well, as there is bound to be someone else that is involved in the trade that moves the market, so therefore whole thing doesn’t work optimally, a lot more rejections take place, or wider prices are provided because of having to defend against the market being moved” explained Mr Cartledge.

“On the face of it, it may appear that aggregating lots of prices is good, but we think not because by blindly aggregating everything you end up with more market impact, so therefore this is what we are trying to solve as it works better for both sides.”

Splitting trades and sending to various liquidity providers without market impact

Mr Cartledge then explained how the single-ticket system on EBS works, and what methodology it employs to avoid market disruption when parts of large trades are sent to different venues.

“So, how it works is that with trades of up to and including $5 million, the execution will be done by a blend of multiple providers, but each provider knows there will be a maximum of $5 million for each ticket and then there will be a blackout period before another ticket comes through” he said.

“If it is for a larger size than $5 million, what happens with that ticket is that the single best provider is fed the entire amount, for example, $10 million and the trade is not split at all.

Once that has been done, that particular liquidity provider will have a short time delay to be able to deal with that liquidity before another trade is put through” said Mr Cartledge.

“Because we are now giving confidence on what is being priced, then spreads should come down, rejections should come down, and market impact should come down” enthused Mr Cartledge.

On reflection, examining the traditional structure of the FX market has led to this decision. “Much of innovation in our market has echoes in the past” said Mr Cartledge.

“If you spoke to a voice trader 10 years ago and asked for a price in $5 million, the voice trader would want to know if they were pricing just $5 million, or part of a trade which is $50 million in total. People who lay prices want to know what they are pricing, if they don’t know they’ll be defensive, because they won’t know how the market will be reacting when they need to do the hedging afterwards” explained Mr Cartledge.

“I must make it very clear that this new methodology on the EBS platform is a single ticket methodology, and cannot be considered full amount because if someone wants to trade $20 million, for example, and then processes it as two sets of $10 million with a gap in between, then they can do that on EBS. It is important to remember that this is still a relationship based platform, we don’t want to be overly restrictive in how people trade with their LPs only that the LPs know what they are actually pricing within that relationship” Mr Cartledge clarified.

Last look may become less prevalent, even with no action from banks or regulators.

Mr Cartledge explained that this new single ticket method should also mean there is a lot less need for last look, which is a moot point among both sides of institutional trading transactions, and a matter that FinanceFeeds has dissected in great detail lately and that retail FX brokerages have started taking banks to task over.

“Clients want less rejections but liquidity providers are also under pressure from regulators and the non-banking world to reduce the amount of last look procedure that takes place” agreed Mr Cartledge.

“To help with reducing the need for last look I would like to iterate that certain aspects of poor behavior will be excluded from the platform. An example worthy of note is that there is a proprietary trading strategy in which firms are sometimes drawn toward showing wide spreads on small amounts. In reality, if you show a spread of 2 or 3 pips wide on EURUSD, when most liquidity providers in the live market are showing half a pip wide, then you’ll only be traded on when it is part of a big sweep and you would know other liquidity providers would need to hedge” said Mr Cartledge.

“This type of trading highlights that for the price of $1 million of risk, you would know that there is a larger trade that has to be covered so you would run a proprietary strategy, which is akin to front-running other liquidity providers.

“Our system puts a stop to this damaging behavior. If you were part of a trade where someone was using that strategy internalization would not work. You would be forced to reject the trade or hedge very quickly causing market impact” he said.

Concluding, Mr Cartledge believes that whilst these problems aren’t new, EBS is, for the first time, developing methods of solving the fundamental issues that affects relationship trading between liquidity providers and liquidity consumers.

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