What the market’s response to Brexit tells us about trading speed

While more trading is being carried out electronically, humans still have a role to play
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On the night that the UK’s vote to leave the EU became clear, traders’ eyes were focused on sterling as a proxy for the UK’s future.

Each regional polling result triggered fresh bouts of buying and selling and, when the referendum outcome finally became clear, sterling plummeted to levels against the dollar last seen in the Thatcher-Reagan era — and then lower still.

Amid the falls, the exchange rate for swung up and down violently. For some, it was a fair reflection of the uncertainty that accompanied a significant world event. The day of the results, after all, resulted in record volumes on trading venues such as Thomson Reuters and ICAP’s EBS.

For others, the moves were another indication of the changing nature of the marketplace as technology and capital rules upend traditional ways of doing business.

The historic role of banks in providing liquidity in the market has been curbed by tougher capital rules that shrink the amount of leverage on their balance sheets. As the role of banks diminishes, a growing number of independent electronic market makers using the latest technology are taking their place.

“This was a test of fire for non-bank liquidity,” says Javier Paz, an analyst at Aite Group, a US financial markets consultancy, referring to trading after the referendum. “The major banks have reduced appetite for making markets during these times of crisis. It was interesting to see that the major venues had tremendous volumes and there were no instances of negative feedback.”

The night’s trading reflects other changes — not just the faster pace but also the high-speed flow of information.

“Events affect market sentiment faster because information is more available to mass participants,” says Ari Rubenstein, chief executive at Global Trading Systems, a high-frequency trading firm. Trading then can happen faster because of the electronification of markets, he adds.

According to consultants Greenwich Associates, about three-quarters of the foreign exchange market is electronic. Kevin McPartland, head of market structure and technology research at Greenwich, says forex is becoming increasingly automated as well.

“What has changed is that there has been a further adoption of [algorithms]. In the past the market was electronified, but not automated,” Mr McPartland says. This time, “the movements were completely economically driven, but the market was able to react much faster than in the past.”

Yet there is some uncertainty as to whether this structure is helpful to the market.

“Markets are reacting faster,” says Tyler Gellasch, co-founder of Myrtle Makena, a capital markets and tax consultancy. “What we don’t know is whether they will naturally find the equilibrium faster.”

Jamil Nazarali, head of execution services at Citadel Securities, says the Brexit vote was the first time that he can remember having an expected event of this magnitude.

“In the past, when we have seen big currency moves this large it happened as a result of unexpected events, such as central bank moves,” he says. “Preparing for this event was very different because we live in an electronic world. Everyone is streaming quotes knowing there could be big moves. If you are on the wrong side, you will own that position rather than having someone call and you decide not to do the trade.”

On the morning after the Brexit vote, the market turned to tried and trusted methods. On ICAP’s London trading floor, around a quarter of the brokers started work at 2am and most were at their desks from 6am. While some forms of automated trading continued, traders say algorithms were turned off because the market was too volatile to use that type of trading.

“Everything is being traded on sentiment,” says one ICAP broker. “You’ve got some youngsters in banks who’ve never seen an interest rate rise. At times like this they’re relying on us a lot more.”

Larry Tabb, co-founder of Tabb Group, a capital markets consultancy, notes that foreign exchange trades differently from other markets. Pricing is personalised and based on size, creditworthiness and sophistication. Forex has mainly been traded through banks, but is increasingly migrating to a group of independent venues, known as electronic communications networks.

“Algorithmic trading has increased as the market [has become] more electronic,” says Mr Tabb. “You have forex [ECNs] out there that people are increasingly interacting with. The FX market is still halfway between an over-the-counter market and an electronic market . . . the bigger size trades are done by phone.”

The frenetic trading that followed the Brexit vote showed that human traders still have an important part to play in an increasingly electronic marketplace.

“As a market professional, you need to make sure you are taking all of this into account because mistakes can be costly very fast,” says Mr Rubenstein.

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