A Hard Look at Last Look in Foreign Exchange

The debate over ‘last look’ in foreign exchange trading has resurfaced in 2016 as regulators continue to eye the practice and investors worry about slippage and potential market abuse.

Regulators are said to be scrutinizing FX dealing platforms that contain last look, a controversial practice that enables market makers to delay or reject trades from customers after they’ve agreed to a quoted price.

In January, the Foreign Exchange Professionals Association (FXPA), held a webinar on examining the implications of last look for the FX markets.

Attorneys with Steptoe & Johnson on the ‘last look’ webinar, advised market makers to be more transparent about how their last look systems operate.

“Regulators take a very dim view of institutional practices that emphasize a lack of transparency and that encourage employees to give either misdirection or less than complete information to counterparties when direct questions are asked,” said Mike Miller, litigation partner at Steptoe & Johnson, who spoke during the webinar.

In one high-profile case, a global bank used its spot FX trading platform to reject unprofitable trades. When customers asked why the trades were rejected, the bank reportedly gave “vague or misleading answers,” said attorney Jason Weinstein who analyzed the case during the webinar.

After a regulatory settlement, the bank posted detailed disclosures on its web site and also paid a steep fine, setting a precedent that could impact other banks, brokers and market-making firms.

Because the practice is not disclosed by FX trading platforms, the issue of last look has generated headline attention and worries on the buy-side over rejected trades and information leakage.

However, investors may not be able to avoid last look.

“Last look is still prevalent in the industry. In fact, it’s accurate to say that almost all single dealer platforms employ last look,” said Chip Lowry, who chairs the FXPA Professional Committee.

Vestige of an Earlier Era

However, last look is not new, noted Lowry. It originated in the early years of electronic trading in the FX market, and was originally intended to ensure the market maker’s price wasn’t based on stale market data information for the purposes of price formation and also that they had the credit available to trade with the client. As it evolved, last look has been programmed into automated FX dealing systems.

Some critics argue that banks are utilizing last look less as a risk management tool and more to generate profits as they compete against high-frequency traders and other non-bank liquidity providers.

The practice has led to uncertainty on the part of buy-side customers as to why they are receiving high rejection rates on their FX trades.

“The fact that liquidity providers can give traders orders a last look before accepting the order is something that frustrates many traders, as it can often result in a certain amount of slippage,” according to website TheFXView.com.  As such, they wait for the next best price. But if a customer’s order is rejected by a number of different liquidity providers, it can experience a significant amount of slippage, noted TheFXView.

Another issue is the lack of standardization and transparency into FX trading on various platforms, noted the Financial Times. In addition to single-dealer platforms, some multi-dealer platforms also allow last look including Bats Global Markets’ Hotspot and Thomson Reuters FXAll.  However, some platforms view last look as outdated.

ParFX, an FX venue owned by Tradition, does not utilize last look, the firm’s CEO told the Financial Times, citing advances in trading technology and the need for firm prices.

The UK-based FCA regulated LMAX Exchange offers traders ‘no last look’ execution on ‘streaming limit orders” which are provided by those who are members of the multilateral trading facility.

Pros and Cons of Last Look

FX experts contend that market makers need access to last look to protect against trading on stale prices due to latency and from high frequency trading clients that have asynchronous information advantages. Over time, last look was also a factor that allowed for non-bank liquidity providers to enter the market, noted Lowry.  Some supporters contend it allowed for more liquidity and more competitive pricing.

“Last look came about as a protection for the banks against latency arbitrage because they didn’t have the speed of technology. The rules were you could have last look. It’s kind of morphed into some places where it’s actually a free option,” said David Ogg, CEO of Ogg Trading at Market’s Media’s Global Market Summit in December.

Yet, others question whether last look is necessary since market makers now have faster technology and sophisticated risk management systems that can automatically hedge their spot FX exposures.

Others suggest that last look is a way for the market makers to reject unprofitable trades. “All in all, the purpose of the last look equation is to eliminate unprofitable trades for the liquidity provider, to maximize profit opportunities and provide a mirage of liquidity,” said David Ullrich, Senior Vice President of FlexTrade. The footprint for last look occurs through above average reject rates and excessive holding times, he explained.

“Last look also opens up the potential for front running currency orders in the sense that the customer is sharing its intentions with the liquidity provider,” says FlexTrade’s Ullrich.  A more meaningful electronic trading process would probably widen spreads a touch, ironically improving overall liquidity due to reduced drop rates, and lessening a negative outcome for the liquidity providers,” said Ullrich.

Bank of England Questions Fairness

The debate over last look falls into a broader industry conversation about the fairness of wholesale markets and the regulatory push for more transparency in FICC markets.

 After a series of scandals over manipulation of Libor and FX benchmarks, the Bank of England (BoE) published the final “Fair and Effective Markets Review” on June 10, 2015 with 21 recommendations to restore trust in the wholesale FICC markets and to develop a global code of conduct for FX trading. In the final report, published last March, the BoE said the global code should address the practice of last look and whether it should remain an acceptable market practice. At a minimum, the UK central banks called for clearer standards regarding the practice.

The BoE’s review also cited the lack of timestamps in FX trading. “The absence of time stamps on some client orders can make it difficult for investors to assess the efficiency of their FX executions, creating potential opportunities for abusive practices,”

The Buy-Side Speaks Up

Buy-side firms are also raising concerns about last look.  In January 2015, during the consultation period for the BoE’s fairness review, BlackRock, one of the world’s leading asset managers, called the practice “problematic.” In written comments, BlackRock drew comparison with indications-of-interest in equities, adding that in FX markets it created “phantom liquidity,” and that it would prefer “liquidity on which we can deal, even if this comes at a higher cost.” “Moving away from indications of interest to streaming prices would be fully consistent, we believe, with outcomes that are both fairer and more effective,” wrote the asset manager.

In December, Steven List, head of trading for AlphaSimplex, speaking on an FX panel at a Markets Media conference, said, “It’s an anathema to a fair market where the banks want the last look or the automated traders want the last look. I don’t see how that’s going to pass the smell test,” said List,

Unintended Consequences

Banning last look could backfire too. “Eliminating last look will effect liquidity,” warned a former e-trading professional at the Markets Media conference in December. The reason is that some bank liquidity providers are quoting prices on 20 or 30 platforms. It’s possible that one customer will try to hit their price on 10 platforms at the same price.  The bank could let the customer have one or two of those trades, but “reserve the right to protect symmetrically,” said the former electronic trading executive.

TCA Can Protect the Buy-Side

While the webinar focused on the sell-side’s concerns, institutions are controlling their FX trades now, and have tools at their disposal to investigate if there are delays or high rejection rates with their trades.

To identify last look, “you really need to be trading off of an EMS and managing your execution quality via an effective TCA product,” said FlexTrade’s Ullrich.

With advances in transaction cost analysis, buy-side firms can access their execution data and check the timestamps related to when they sent an order as compared to the price and time it was executed. Excessive holding times, high reject rates and partial fills all point to potential issues with last look, said Ullrich.

“Last Look is an issue that currency traders should be able to identify. Accuracy in timestamping provides traders the tools to see what’s going on,” said Ullrich.  Not only is the EMS collecting a wealth of information about the trade, but also putting that information to use in a pre-trade/post-trade process,” says Ullrich.

“In FX, evaluation of the quality of the execution is the first step. Millisecond time-stamping, enriched data on market impacts and reject rates coupled with a real-time TCA product will protect all interests alike,” said Ullrich.

The Way Forward

While the debate over last look continues into 2016, legal experts expect that regulators will continue to monitor FX dealing systems for signs of abuse or unfair market practices.

However, it’s uncertain that regulators would eliminate last look.

The decision is reportedly up to a group of central banks, including the BoE, to determine whether brokers can continue to use last look systems, according to a Bloomberg article. “The banks are working on a single rulebook to govern foreign-exchange trading in every country where it takes place. They will finish their work in May 2017, “reports Bloomberg.

In the meantime, banks are advised to be transparent about how their last look systems work. Disclosure and transparency can solve many problems with regulators and civil class action lawsuits, said the attorneys. For example, bank market makers could disclose their fill ratios and rejection rates — the basic raw data, which conveys to counterparties what percentage of their trades are filled or rejected, noted the FXPA whitepaper. This way, the buy-side can analyze the fill rates and rejection ratios in their EMSs to figure out how last look is impacting their trading performance, and compare

Going forward, regulators will not look favorably on last look systems that favor the house over the customer, said Jason Weinstein, partner in Steptoe & Johnson's Washington, D.C. office.

For instance, regulators will distinguish between FX venues that apply last look on an asymmetric basis versus a symmetric basis. “The issue is whether the rejection of trades occurs only when the trades are unfavorable to the market maker. A symmetrical system is one that triggers a rejection of trades when the market moves in both directions,” explains Steptoe's Miller. A bank could explain it has a rule that, when the latency appears on the system that is more than 250 milliseconds, it rejects the trade symmetrically whether or not it was in the bank’s favor. “Keeping the good ones, that’s got to go,” said the former FX trading executive.

Market forces are likely to push market makers in the direction of additional changes to their last look practices to create more fairness, predicted Miller.  By providing more disclosure, it becomes harder for market participants to take issue with the practice. So despite investor concerns, last look systems may be here to stay, but the buy-side will be armed with more data and analysis tools.