Saturday, January 7, 2012

Forex ECNs cater to banks more than buy-side

Forex ECNs compete by attracting buy-side and sell-side, but they work harder to /please/ and satisfy the sell-side -- primarily banks.

In the FX business, i was told liquidity and credit ultimately depends on cash pile. All spot trades (trillions each day) must be settled in cash. Banks are the only big shots. Hedge funds can play liquidity providers but they don't have anything close to that amount of cash. (Hedge funds ultimately need banks to support their FX trades.) I'd guess even investment banks can't match. Of course, banks aggregate so much cash because of depositors.

Now, there are only a small number of mega-banks. The entire market is largely controlled by these banks (except central banks). Therefore ECNs loop them in first (as what I call "anchors"), and customers will soon follow.

Therefore, in all the bank-to-client ECNs [1], many rules are bent towards the banks -- privileges of liquidity providers.  One of the privileges is the Last Look. I was told this is a protection demanded by liquidity providers. I was told LPs always need and have something like a last look.

Another privilege is requote...

The playing field is tilted towards the liquidity providers. LPs provide an "essential service" to the (huge number of) clients, and LPs basically dictate the rules to protect themselves. However, these rules aren't arbitrary, unfair or unreasonable. There's no monopoly here.

In contrast, Credit bond dealers presumably have weaker stranglehold on clients. The need to convert between currencies is more basic and critical than the buy-side's need in a credit market
* issuers have other means of borrowing, though bond issue is the most important
* bond buyers have many many investment choices.

[1] Is there any bank-to-bank network? I was told EBS was (http://www.investopedia.com/articles/forex/06/interbank.asp#axzz1ie9e5WS0), but then customers are also allowed.

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