How to navigate fragmented NDF liquidity

Liquidity consumers need to embrace dialogue with their LPs as an integral part of the liquidity curation process, argue HSBC execs


The fragmentation of non-deliverable forward (NDF) liquidity has created an opportunity for trading desks to optimise the liquidity pools they face. The rise of last look liquidity across a number of electronic communication networks (ECNs) has created the illusion of deep liquidity, but the reality is the liquidity provision incorporates trade validation through last look, which in return creates a liquidity mirage. Enhanced fragmentation has driven down the minimum spread increment in NDFs from 1 basis point to 0.1bp, which has put downward pressure on the cost of execution.

While the provision of deep pools of liquidity in the spot market was built over many years, with ECNs in a constant high-pressure race to create the lowest latent matching engine, the same revolution has happened at a much faster pace in the NDF space. Here, the market has seen all key players pushing out competing offerings in the space of a few months. As a result, liquidity consumers have been inundated with over-the-counter liquidity offerings at a pace never seen before.

While the concept of building a deeply aggregated NDF liquidity pool in the hope of compressing spreads is enticing, liquidity consumers need to embrace a two-way dialogue with their liquidity providers (LPs) as an integral part of the liquidity curation process. Those quick to aggregate liquidity across ECNs and bilateral LPs will rapidly see their pools evaporate as LPs regress market impact across their distribution channels and adjust spreads accordingly.


Ideally, each liquidity consumer should build their own profile of the underlying liquidity providers by deploying quantitative techniques. This can be done by recording key metrics such as round-trip times – which is the time between a request to trade and confirmation of its completion – and post-trade market impact (see figures 1 and 2). By adopting statistical clustering techniques, they can then optimise a cost function in order to estimate the number of LPs they face over ECNs (see figure 3).  


Clustering allows liquidity consumers to visualise LP performance and profile the underlying LPs which form the liquidity pool (see figures 4 and 5). Where resources are strained, pressure should be placed on ECNs and bilateral LPs to disclose round-trip times, historical market impact and fill rates so consumers can build a pool of unique principal LPs tailored to their needs. 



With liquidity scattered over multiple channels, sophisticated techniques are now required to efficiently price the underlying NDF instruments and take advantage of the newly fragmented landscape. LPs that have invested in the creation of orthogonal liquidity will be regressing future prices against proprietary engineered features to devise alpha for the construction of liquidity. Conversely, a similar statistical technique can be used by liquidity consumers to help them quantify the value of each LP they face.

Blurred lines

Fragmentation in the NDF market has blurred the once firm boundary between liquidity provided on and off swap execution facilities (Sefs). A competitive on-Sef market – once reserved for New York trading hours – is now also available during the Asia trading session (see figure 6).

Historically, a single exchange had a monopoly over liquidity for NDFs with clear and well-defined regimes between on- and off-Sef liquidity. The transition between the two liquidity regimes has always been a source of instability, but ECNs have improved market stability by allowing market-makers to reliably stream prices around the clock.  


With increased pricing venues for NDFs, intraday spread volatility will compress as the additional venues rise to the challenge of building a stable, reliable marketplace for all participants. It is up to liquidity consumers to ensure the benefits of the blurred lines between on and off Sef are now passed on to them, so they can avoid paying a premium for liquidity as the market switches between the two types of facility in the middle of the London trading session.

Liquidity consumers need to constructively engage ECNs and bilateral LPs to drive an open and transparent dialogue. Market-makers able to navigate the fragmented landscape will be best positioned to provide the deepest, lowest impact liquidity and embrace transparency, while those unable to efficiently navigate the evolving landscape will shun transparency. Ultimately, it is the responsibility of liquidity consumers to ensure they are facing unique pools of liquidity in order to maintain the integrity of the liquidity sources they face and benefit from fragmentation in the NDF market.

William Greene is head of quantitative FX trading and Hanna Assayag is head of e-risk quant for STIRs and EM forwards, both at HSBC

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