#### Need to know

• Cboe FX has cut the time in which liquidity providers can review their clients’ trade requests before deciding whether to accept or reject them. Electronic trading platforms across the foreign exchange sector are likely to follow suit.
• Some market participants argue that such a change would be detrimental to smaller firms, including regional banks, that currently lack the technological capabilities of their larger counterparts. Bringing them up to speed could cost each firm hundreds of thousands of dollars extra per month.
• However, others believe an across-the-board reduction in allowed response times could encourage LPs to ditch unjustifiable additional hold times, to the benefit of clients and the market as a whole.

A week might be a long time in politics, but 35 milliseconds is an eternity in the world of foreign exchange – which is why an increasing number of market participants believe that all electronic trading platforms will soon reduce the number of milliseconds in which liquidity providers (LPs) are allowed to review a client’s trade request before accepting or rejecting it.

In January, Cboe FX became the first electronic communication network (ECN) to announce it will reduce the maximum order review timeframe for LPs on its platform since the updated FX Global Code of Conduct was published last July. Since March 1, LPs have had 35 milliseconds to decide whether to accept or reject a client’s trade request, compared with 70 milliseconds previously.

Although the market believes it is only a matter of time before other ECNs follow suit, participants are divided as to whether such a wholesale policy change would be a good thing. Some are concerned that it would have a negative impact on regional banks and smaller firms that do not have the technology to respond to trade requests in the same timeframes as their larger counterparts. These participants believe that response time reductions from ECNs would further undermine competition in the market, resulting in additional consolidation and a negative outcome for clients.

However, others claim these arguments are an excuse for maintaining hold times that are unnecessary, unjustifiably long and which act to the detriment of clients and the market as a whole.

Stephane Malrait, chairman of the ACI Financial Markets Association, is among the opponents of any wholesale reduction. “If you’re a regional bank in Indonesia, you don’t have the same type of pricing and automation systems that a high-frequency trader based in London will have,” he says. “Your response time might be something like 300 milliseconds, while the high-frequency trader could respond within only a couple of milliseconds. Not every LP in the market has the same technology capabilities, meaning there are certain types of traders who simply can’t compete if allowed response times across ECNs are reduced.”

### Fresh look at last look

Others support a reduction in allowed response times across ECNs because they believe it might encourage LPs to ditch their additional hold times within the “last look” phase of a transaction.

“Other platforms definitely will – and should – follow Cboe’s lead in reducing their allowed response times,” says Kevin Kimmel, global head of electronic FX at Citadel Securities. “ECNs can’t solve the issue of additional hold times on their own but they do have a part to play in helping progress the market towards the standards of the FX Global Code, and Cboe reducing their total response time is a positive step in that direction.”

Any LP offering clients non-firm liquidity in the FX market will conduct last-look checks on that liquidity. These have traditionally comprised price validity and credit checks. However, in recent months, there has been increasing attention on whether LPs impose additional hold times to monitor clients’ behaviour. Critics claim this leads to a disproportionate number of trades being rejected when prices move in the client’s favour, resulting in greater profits for the LP and extra costs for the client when it resubmits its order at a worse price later on.

In September, Guy Debelle, as chair of the Global Foreign Exchange Committee, stated that such hold times were in breach of the FX Global Code of Conduct. Two months later, the UK’s Financial Conduct Authority formally recognised the updated version of the FX Global Code and stated that the code did not permit the use of additional hold times in last-look checks. Many LPs, including Citi and NatWest Markets, have since removed the additional hold times they previously imposed on client trades during last look as a result.

However, ECNs have generally remained silent on the matter. Most electronic FX trading venues tend not to police additional hold times and instead enforce only a maximum response time – that is, the time an LP can take between accepting the trade and executing it. These are typically in the range of 35–300 milliseconds, depending on the venue.

The new GFXC chair, Andréa Maechler, last month reiterated the importance of reducing last-look windows and additional hold times. “They [ECNs] define the rules of the game for liquidity providers and consumers and can help create the dialogue necessary between the two parties to provide for an environment that is in line with GFXC objectives,” she told FX Markets.

Whether venues will create a trading environment that satisfies the GFXC is an open question, but those calling for an end to additional hold times will no doubt have been encouraged by Cboe FX’s policy update.

“We reduced the response times on all of our spot FX platforms because we wanted to improve execution quality for liquidity consumers, at the same time as providing a level playing field for our market-makers,” says Jonathan Weinberg, head of Cboe FX. “As the FX market has continued to electronify, Cboe felt it was the appropriate time to again bring down our response time, this time to 35 milliseconds.”

As the last-look windows that LPs operate across Cboe’s platforms will be shorter, a client will have more time to successfully trade with a different LP should its trade request be rejected in the first instance.

Cboe’s update also means that LPs continuing to impose additional hold times on clients will have less time in which to do so. For example, under Cboe’s former rules, if it took an LP 10 milliseconds to conduct a price and credit check, that LP could then decide to impose an additional hold time of 60 milliseconds. Under the new rules, the additional hold time would be capped at 25 milliseconds.

“This move towards a 35 millisecond total response time, while not preventing hold times completely, does significantly reduce the hold time that an LP could apply to a [liquidity] taker request and is therefore still a very positive move from the perspective of addressing additional hold times in the market,” says Kimmel.

One ECN that may well be following in Cboe’s footsteps is 360T. Although it currently has a 100 millisecond technical time-out for LPs taking too long to respond to a trade request, the platform’s chief growth officer, Simon Jones, says the limit is under review.

“360TGTX has long had a technical time-out, not used as a quality filter for liquidity providers but to provide some certainty of outcome,” he says. “We have considered changing this but we see it as a separate topic to the industry changes recommended in the FX code of conduct revisions last year where our efforts have been directed.”

### Behind on a technicality

One FX trader at a European buy-side firm who spoke to FX Markets remains cautious about any reduction in allowed response times across ECNs. Much like ACI’s Malrait, the trader fears it could undermine the market-making capabilities of regional banks that have legacy technology and which therefore take longer to respond to trade requests than the biggest names in the market. Any ECN looking to follow Cboe should do so with caution, the trader believes, lest they undermine competition in the market and deny clients access to valuable liquidity.

“While we do have regional banks in our liquidity stack, it’s not these LPs that are able to respond to trade requests within a couple of milliseconds,” the trader says. “Because of that, I do question whether regional banks will be able to survive in the spot market if the maximum response time allowed across ECNs continues to go down.”

Concerns over regional banks’ ability to respond to trade requests in shorter timeframes are among the principal arguments given by the ECNs that remain cautious about following in Cboe’s footsteps.

Kevin Wolf, chief executive of Euronext FX, stresses that platforms such as his want to remain aware of certain LPs’ technological limitations. Reducing the maximum allowed response time would, he says, prevent regional banks from providing clients with valuable liquidity and expertise within local currencies.

“Even though we do have a maximum response time rule on our platform, we prefer to let clients make their own decisions on response times and give them access to trading data such that they can filter out which LPs they want to be connected to based on an LP’s response time – and other trading metrics like fill ratios and market impact,” he says.

Euronext has never publicly shared the maximum response time it affords to LPs and declined to provide it to FX Markets when asked.

Grigoriy Zeleniy, Euronext’s head of liquidity management, says that ECNs reducing their maximum response times would not necessarily prevent LPs from imposing additional hold times on clients. For example, if an ECN set its maximum response time to 50 milliseconds, an LP with sophisticated technology could perform its last-look checks in 10 milliseconds and use the remaining 40 milliseconds as an additional hold time.

“Shorter allowed maximum response times across ECNs in and of themselves do not necessarily prevent bad behaviour from happening – such as LPs imposing an additional hold time on clients – even though doing so clearly goes against the spirit of the FX Global Code,” says Zeleniy. He adds that Euronext encourages good behaviour among LPs by incorporating their response times into the platform’s smart order routing logic.

EBS is reviewing the 100 millisecond maximum response time allowed across EBS Direct as part of upgrades that are being made to the platform. However, Jeff Ward, global head of EBS, is equally conscious of alienating regional banks by imposing a rigid rule that would make them unable to provide liquidity to clients. Like Euronext’s Wolf, he prefers to let clients set their own rules and preferences on trading metrics.

“The FX market is incredibly diversified as there are numerous LPs on offer, each with their own currency pair specialty,” he says. “So any changes to specified response times would need to consider the impact on smaller and regional players who are integral to the overall health of the FX ecosystem.”

Yet the head of FX at a large dealer argues that the regional bank argument is just an excuse given by ECNs that do not want to update their policies and by LPs that want ECNs to keep response times long in order to mask the additional hold times they impose on clients.

The regional bank argument is real but I don’t think it should be an excuse given by ECNs and market-makers who want to keep high response times,” says the head of FX. “Nothing is stopping LPs who can’t respond within 35 milliseconds from updating their technology in order to reduce the time it takes them to respond in the near future. The market has evolved to a point where shorter response times are expected and so platform rules need to keep up with the evolution of the market.”

This argument is backed up by data from EBS’s Quant Analytics platform. The average response time for the top 10 liquidity providers across its EBS Direct disclosed venue was 34 milliseconds in 2018. Last year, it was closer to 20 milliseconds – a figure EBS expects to be reduced further.

### Risk of going underwater

However, the head of macro trading at another European dealer says the technological updates required would mean regional banks and smaller FX names having to spend significant amounts to gain access to the intricate system of undersea cables that allow messages to be sent across the world in a matter of milliseconds. One such cable – the Hibernia Express – has been in operation since 2015 and facilitates messages between London, New York, Chicago, Paris and Canada in transatlantic “round trips” of less than 59.5 milliseconds. Spanning 2,850 miles, it has a transmission capacity of 100 gigabits per second – nearly triple the amount of any other transatlantic cable in service today.

Regional banks would probably have to pass on the resulting costs to clients in the form of wider spreads – which would cancel out the benefits of investing in better technology in the first place. Sources we spoke to estimate that accessing the system can cost traders up to $20 million over five years, or$333,333 a month – a hefty amount not every LP is willing to shell out for. Slower cable options – which can take closer to 62 milliseconds to make a round-trip transmission – cost around \$35,000 a month.

“While a change from 70 milliseconds to 35 milliseconds wouldn’t necessarily require a tech upgrade, going from 35 milliseconds to a single-digit response time likely would,” says the head of macro trading at the European dealer. “And going from single-digit response times to a response time of nought point something definitely would. My concern is that the FX market will increasingly get caught up in response times becoming faster and faster, such that technology costs will start to become prohibitive.”

Jones of 360T says one way to prevent an expensive technological arms race among LPs would be for ECNs to increasingly offer “zero additional hold time” liquidity streams for any client that only wants to deal with LPs that adhere strictly to the FX Global Code. The platform already offers such a stream to clients, and Jones suspects its popularity will grow over the coming months – when more LPs are expected to have published updated trading disclosure sheets on the GFXC’s website.

“We have trialed, for some months, pools of liquidity with LPs who are zero additional hold time only and have found no degradation in liquidity for the end client,” he says. “This has given us confidence that there will be a wider roll-out of this approach on 360TGTX.”

Jones says he cannot tell definitively that no LP in the stream is imposing an additional hold time on clients. However, he stresses that historical trading data and the last-look disclosures of each LP give the ECN a good idea as to whether the LPs in the pool are telling the truth.

“If cheating occurs it will be very short-lived,” he says. “Platforms like ourselves have extensive data and the direction of disclosure for us, as well as all participants, has been very much for more. We have a strong vested interest to ensure our ecosystem isn’t polluted, so I believe attestations, transparent metrics and an ongoing dialogue with participants will address this concern at source.”

Editing by Daniel Blackburn

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