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Absorbing currency market liquidity shocks

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How ICAP’s EBS BrokerTec’s central limit order book for spot FX managed the SNB’s CHF de-peg…

The decision by the Swiss National Bank (SNB) on 15 January 2015 to de-peg the Swiss franc from the euro sent the markets into turmoil and left a trail of casualties. Within a twenty-minute period, between 9.30am and 9.50am UK time, the CHF went into hyper drive, appreciating almost 30 per cent as it pulled away from its three-year peg at 1.20 francs per euro to reach 0.85 before falling back close to parity. 

There are many reasons why the SNB decided to take this decision, chief among them an anticipated move by the ECB to embark on quantitative easing, which would in turn weaken the euro. The de-peg was effectively an acknowledgement that the central bank could no longer maintain an artificially low currency. However, many market participants were blindsided with SNB president Thomas Jordan only a week prior commenting that the bank saw no reason to de-peg. 

“It gave everyone a level of comfort that the status quo would continue. The reaction was quite violent in the market. As the primary venue for price discovery and best execution, it was vitally important that EBS Market, as a central limit order book (CLOB), was in existence on that day,” says Darryl Hooker (pictured), Head of EBS Market at ICAP’s EBS BrokerTec business. 

The market return to CLOBs

Being a market of natural interest without last look features, EBS Market always shows genuine liquidity. This is of no greater value than during a stress event where buyers and sellers are absolutely dependent on the availability of liquidity, especially if they are caught on the wrong side of the trade and need to quickly clear risk. 

On the day, EBS Market saw two-way pricing for 56 per cent of the first 15 minutes after the announcement, and for the other 44 per cent, had a side in the market so there was never a blank screen. That meant the platform always had an indication or point of reference for bids and offers.

“The second 15 minutes after the announcement we had two-way pricing for 96 per cent of the time. Thereafter, we had two-way pricing 100 per cent of the time. We were able to comfortably accommodate the unprecedented activity,” confirms Hooker. 

Unsurprisingly, on 15 January EUR/CHF and USD/CHF activity was close to record highs for the currency. In fact, EBS Market was reported to have had trade volumes more than triple the current average daily volume (ADV) on the day.

As the market reference for EUR/CHF and USD/CHF, for the first time in the history of EBS Market, on the day, the company sent a formal communication to customers to confirm the market low of 0.8500 to ensure clarity among market participants. Market highs and lows are calculated as “five base units of currency trading within a two-minute window by two different counterparts. If it trades within two minutes for the amount of EUR 5 million, then this is determined as a market high or a market low,” Hooker points out.

Since 15 January, many customers have taken a step back to review their infrastructure and prices in the market. This has led to an increase in appetite towards CLOB, non-last look, execution venues. “The advantage of a CLOB is that traders are able to place passive bids and offers into the market, which becomes sticky liquidity.  In market events, such passive quotes do help to absorb erratic price movements.  At 0.85 the market was both paid and given, showing a genuine interest to trade either way at this price and a subsequent degree of market stabilisation,” says Hooker. 

That is what the central banks want to hear. They want to know that the market can meet at a central point, find itself and recover. 

With CLOBs there are many different ways of engagement (passive, aggressive) that help to create a level playing field. This could prove invaluable if the currency markets experience more frequent volatility shocks going forward, given that interventions by the Bank of Japan, the ECB and the SNB have all led to significant moves in the last 12 months.

Protecting against future moves

With a trail of casualties following the event, there has been much discussion in the market about how to protect against big currency movements, with features such as speed bumps and circuit breakers being touted as a solution. Hooker points out that, while EBS Market has a number of inbuilt systematic restrictions and warnings, such features aren’t necessary. “In a bifurcated market, different platforms have different rules. When one stops trading, another continues. From our perspective, we were happy with the processes and the system in place.”

The firm carries out regular stress testing on the platform to ensure that EBS Market can handle a liquidity event multiple times the magnitude of that seen on 15 January. 

This is precisely the kind of resilience and reliability that central banks and global regulators want to see. Systemic risk has become a top line issue on the back of the sell-side implosion in ‘08. Everyone in the marketplace today needs reassurance that if major outlier events occur liquidity platforms like EBS Market are up to the task.

As such market participants take stock and improve systems for the future, EBS BrokerTec has seen an increased demand for its historical market data during the 20-minute window of heightened activity on 15 January. EBS BrokerTec has made this available for current trading customers and prospects. However, some customers have since gone a step further and signed up for EBS Live, the real-time market data product that provides updates every 100 milliseconds compared with every 250ms through EBS Ai and every 500ms for the manual community. 

Moving beyond 15 January 2015

Subsequent to 15 January, the market has seen further significant events, including the Federal Open Market Committee’s statement regarding US interest rates. This announcement at 18:00 GMT, which is considered a less liquid time of the trading day, caused a period of significant volatility. Between 17:50 and 18:30 GMT there was a 185.5 pip range in EUR/USD. This resulted in EBS Market trading at 93.8% of all price points, which is defined as a half-pip increment, whereas several other venues struggled to offer stable and consistent pricing during these times. 

Although black swan events such as that on 15 January are few and far between, they do represent a return of volatility to the market. As interest rates globally increase from historical lows, Hooker believes there will undoubtedly be an increase in the number of market events.

“The fact that we got through these events reminds everybody that it has always been, and always will be, business as usual at EBS BrokerTec. We are there every day and always when it matters. Whenever there’s a major market event customers will see bids and offers move but they’ll have information at their disposal all the time, whether it be to take on risk or clear risk. Everyone knows that with EBS Market they have a safe haven in which to trade spot FX.” 

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