It’s clear to see that buy side institutions are increasingly turning to peer-to-peer as a source of liquidity, and in the discussions we’ve held with our FX community since the beginning of the year understanding the advancements in this space has remained a top priority. In preparation for our FX Leaders Residential Meeting, 16th – 17th June, we thought we’d revisit the topic, and share what we’ve learnt so far.
As with all things for the buy side, recent interest and uptake in peer-to-peer liquidity is driven by the quest to achieve best execution for investors. The challenge for buy side is being able to go beyond purely looking at price to determine best execution – firms also need to consider the overall risk exposure of trading. One way of doing this successfully is unbundling the costs of credit and balance sheet from liquidity and market access, a topic we have broached before with our recommended partner FX HedgePool.
On the back of this, peer-to-peer is gaining popularity as buy side become more and more aware that the sell side no longer hold risk in the way they used to, there is a drive to go to market at a faster pace which causes greater market impact. Often the strategy employed to overcome this focuses on breaking larger orders down, and spreading flow over a longer period of time – something that peer-to-peer can allow with a way to net away from the market.
For FX swaps, the challenges are even more pronounced. For passive hedges in particular, the requirement to routinely execute on a highly scheduled basis with a relatively small number of counterparty banks leaves the banks having to manage the large risk position of these hedges which can often result in market impact. We have seen however, that this can be avoided, and ultimately if peer-to-peer matching is utilised effectively it eliminates market trades, which in turn eliminates market impact.
FX HedgePool focus in on this area, and rather than cutting out the banks, allows them to continue to play an essential role as credit provider, where the buy side are able to source pure liquidity from peers whilst continuing to settle against the banks whom they currently trade with. This is a win-win situation as the sell side are able to avoid position risk altogether, and the buy side are able to better achieve best execution.
Recent volatility in FX markets, which seems set to remain for the foreseeable future has also acted to exacerbate some of the existing issues outlined above with market impact and risk. As markets continue to be unpredictable, if you’d like to learn more about the opportunities presented by peer-to-peer, make sure to join us at the FX Leaders Residential Meeting on 16th – 17th June where we’ll be hosting dedicated roundtables and working groups aimed at allowing the buy side to benchmark best practice for peer-to-peer, as well as other key topics for Heads of FX.