Always interesting to read the Bank of International Settlements (BIS) studies, this 61 page report on FX Liquidity in the Americas being no exception.
The report looks at the impact of technology, regulation and market structure on the availability and cost of FX liquidity and comes to the following conclusions:
1. No single FX liquidity metric gives complete picture, but in combination, several metrics can provide insight into the state of market liquidity (see tables below)
TradAir Comment: That’s an interesting observation, and something that at TradAir we understand, which is why our trading analytics service highlight multiple metrics that enable price takers to understand, analyse and optimize their available liquidity. Bid-Ask spread and spread ranking, are only part of the story, but understanding a liquidity providers (LPs) last look hold time, their rejection ratios (by currency pair and trade size) and cost of that rejection on covering residual balances and market impact when hitting a LP (are they able to internalise your flows), provides greater insight into the quality of available liquidity (see previous blog post “Understanding the quality of FX liquidity provision”).
2. FX markets has declined during periods of market stress, particularly post CHF float in Jan 15.
3. Technological innovation has lowered transaction costs, enabling wider set of players to participate, by increasing the channels for market access and contributing to:
- Increased market fragmentation by highly concentrated large bank dealers internalising client flows,
- Proliferation of new platforms
- Enabling more non-banks to participate in FX markets
All in all, technology has made possible the use of (algorithmic and high-frequency) trading strategies that are viewed by many market participants as having changed liquidity dynamics – enhancing liquidity in normal conditions and offsetting the impact of market fragmentation, but also adding to FX volatility in stressed market conditions. These elements are particularly evident in global FX markets, including the USD and CAD, but are also present in Latin American currency markets.
4. The impact regulatory change on FX market liquidity remains unclear and requires further study.
- Changes in bank behaviour to discourage risk-taking in the FX market is uncertain
- Fines and requirements for participants to closely monitor trader behaviour, have reduced incentives for dealers to engage in discretionary risk trading
- These developments may have prompted large bank dealers to shift their market-making activity from the open FX market into their own internal market
The table below show the various FX liquidity metrics used by participants in different countries/regions in the Americas in response to central bank questionnaire.
Full BIS report available here