Concept
The assertion that the FX Global Code provides sufficient guidance on the fair use of last look is a matter of ongoing debate within the institutional foreign exchange landscape. The Code, a set of globally recognized principles for good practice in the FX market, has undergone revisions to address the more contentious aspects of last look. A core issue is the potential for information leakage and the asymmetric power dynamic it can create between liquidity providers and consumers. The Code’s Principle 17 directly addresses last look, defining it as a practice in electronic trading where a market participant receiving a trade request has a final opportunity to accept or reject it at the quoted price.
The principle was amended to state that market participants should not engage in trading activity that uses information from a client’s trade request during the last look window. This amendment was a direct response to feedback from market participants who were concerned about the potential for unfair practices.
The very architecture of the last look mechanism, while intended as a risk control for liquidity providers against latency arbitrage, introduces a window of optionality that can be exploited. This has led to a significant trust deficit, with many on the buy-side viewing last look as a tool for liquidity providers to avoid honoring quotes, particularly in fast-moving markets. The Global Foreign Exchange Committee (GFXC), the body responsible for the Code, has acknowledged these concerns and has sought to provide greater clarity through supplementary reports and guidance papers. These documents aim to illuminate the nuances of last look practices and promote a more standardized and transparent application of the mechanism.
The FX Global Code’s guidance on last look has evolved to prohibit trading on information from a client’s request during the last look window, yet the debate over its sufficiency persists.
The effectiveness of the Code’s guidance is ultimately tied to its voluntary nature. While many institutions have attested to their adherence to the Code, the lack of a formal enforcement mechanism means that the onus is on market participants to act in good faith. This has led to a situation where the interpretation and application of the Code’s principles can vary, leaving room for ambiguity and potential for misuse. The GFXC’s efforts to provide additional guidance are a recognition of this reality, but they also highlight the inherent limitations of a principles-based framework in policing a practice as complex and contentious as last look.
What Is the Core Function of Last Look?
From a systems architecture perspective, last look is a risk mitigation protocol. It provides a liquidity provider with a final, brief window to reject a trade request after it has been matched with a client’s order. This mechanism is designed to protect the liquidity provider from being picked off by high-frequency traders who can exploit latency in price feeds.
In essence, it is a check to ensure that the market price has not moved significantly between the time a quote is provided and the time a trade is executed. This function is particularly important in the decentralized and highly fragmented FX market, where price discrepancies can arise across different trading venues.
The intended use of last look is as a defensive measure. However, the controversy surrounding the practice stems from its potential for offensive use. A liquidity provider could, in theory, use the last look window to reject trades that would be unprofitable for them, even if the market movement is within normal parameters. This practice, known as “last look as a free option,” allows the liquidity provider to benefit from favorable market movements while avoiding unfavorable ones.
This is where the issue of fairness and transparency becomes paramount. The FX Global Code attempts to address this by emphasizing that last look should be used as a risk control mechanism and not as a tool for generating profits at the client’s expense.
The Evolution of Last Look Guidance
The guidance on last look within the FX Global Code has not been static. The initial version of the Code, published in 2017, provided a framework for the use of last look but was criticized by some market participants for being too lenient. The GFXC responded to this feedback by amending Principle 17 to explicitly prohibit trading activity based on information obtained during the last look window. This was a significant step towards addressing the concerns of the buy-side and creating a more level playing field.
In addition to the amendment of Principle 17, the GFXC has published several reports and guidance papers on last look. These documents provide more detailed explanations of the Code’s principles and offer best practice recommendations for both liquidity providers and consumers. They also highlight the importance of transparency and disclosure, encouraging liquidity providers to be clear with their clients about how they use last look. The ongoing nature of this dialogue and the continuous refinement of the guidance reflect the complexity of the issue and the commitment of the GFXC to fostering a fair and efficient FX market.
Strategy
The strategic implications of the FX Global Code’s guidance on last look are multifaceted, impacting both liquidity providers and consumers. For liquidity providers, the challenge lies in balancing the need for risk management with the commercial imperative to attract and retain clients. The Code’s emphasis on transparency and fairness means that liquidity providers can no longer rely on opaque last look practices to protect their interests.
They must now be prepared to justify their use of last look and to provide clients with detailed information about their execution policies. This has led to a bifurcation in the market, with some liquidity providers choosing to eliminate last look altogether, while others have invested in technology and processes to ensure that their use of last look is compliant with the Code’s principles.
For liquidity consumers, the Code provides a framework for evaluating the execution quality of their counterparties. By understanding the principles of the Code, buy-side firms can engage in more informed discussions with their liquidity providers about their last look practices. They can also use the Code as a benchmark to assess the fairness and transparency of the execution they are receiving.
This has empowered the buy-side to demand better execution and to hold their liquidity providers accountable for their actions. The result has been a gradual shift towards a more client-centric FX market, where the interests of liquidity consumers are given greater consideration.
The FX Global Code has catalyzed a strategic shift in the FX market, compelling liquidity providers to adopt more transparent last look practices and empowering liquidity consumers to demand better execution quality.
A Comparative Analysis of Last Look Practices
The FX Global Code does not prescribe a single, standardized approach to last look. Instead, it provides a set of principles that market participants are expected to follow. This has resulted in a variety of last look practices being employed in the market. The table below provides a comparative analysis of some of the most common last look models.
| Last Look Model | Description | Implications for Liquidity Consumers |
|---|---|---|
| No Last Look | The liquidity provider commits to the quoted price and does not have the option to reject the trade. | Provides certainty of execution, but may result in wider spreads as the liquidity provider has to price in the risk of adverse market movements. |
| Symmetric Last Look | The liquidity provider can reject the trade if the market moves against them, but must also pass on any price improvement to the client if the market moves in their favor. | Offers a degree of fairness, but the client still bears the risk of the trade being rejected. |
| Asymmetric Last Look | The liquidity provider can reject the trade if the market moves against them, but is not required to pass on any price improvement to the client. | This is the most controversial form of last look, as it creates a significant power imbalance in favor of the liquidity provider. The FX Global Code discourages this practice. |
The Role of Transaction Cost Analysis
Transaction Cost Analysis (TCA) has become an indispensable tool for buy-side firms seeking to navigate the complexities of the FX market. By analyzing their execution data, firms can gain insights into the performance of their liquidity providers and identify any patterns of unfair or inconsistent treatment. TCA can be used to measure a variety of metrics, including:
- Rejection rates The percentage of trades that are rejected by the liquidity provider.
- Hold times The length of time the liquidity provider holds a trade request before either accepting or rejecting it.
- Price slippage The difference between the quoted price and the executed price.
By monitoring these metrics, buy-side firms can build a detailed picture of their liquidity providers’ last look practices. This information can then be used to inform their trading decisions and to engage in more productive conversations with their counterparties about execution quality. The insights gleaned from TCA can also be used to demonstrate to regulators and clients that the firm is taking a proactive approach to managing its execution risk.
Execution
The execution of the FX Global Code’s principles on last look requires a concerted effort from all market participants. Liquidity providers must implement robust governance and control frameworks to ensure that their use of last look is fair, transparent, and consistent with the Code’s principles. This includes providing clients with clear and comprehensive disclosures about their last look practices, as well as establishing a process for monitoring and reviewing their execution performance. The Code also encourages liquidity providers to invest in technology that can help to reduce hold times and minimize the need for last look.
Liquidity consumers, for their part, have a responsibility to educate themselves about the Code’s principles and to use this knowledge to assess the execution quality of their counterparties. This involves conducting thorough due diligence on potential liquidity providers, as well as regularly monitoring their execution data for any signs of unfair or inconsistent treatment. The buy-side should also be prepared to engage in a dialogue with their liquidity providers about their last look practices and to push for greater transparency and fairness. The ultimate goal is to create a market where last look is used as it was intended as a risk control mechanism and not as a tool for generating profits at the expense of clients.
The effective execution of the FX Global Code’s last look principles hinges on a symbiotic relationship between liquidity providers’ commitment to transparent governance and liquidity consumers’ diligent oversight of execution quality.
A Procedural Guide to Analyzing Last Look Practices
For buy-side firms looking to gain a deeper understanding of their liquidity providers’ last look practices, a systematic approach to data analysis is essential. The following procedural guide outlines the key steps involved in this process:
- Data Collection The first step is to collect detailed execution data from all liquidity providers. This data should include, at a minimum, the time the trade was requested, the time it was executed or rejected, the quoted price, and the executed price.
- Data Cleansing and Normalization The collected data should then be cleansed and normalized to ensure that it is accurate and consistent across all liquidity providers. This may involve removing any outliers or errors, as well as converting all timestamps to a common format.
- Metric Calculation Once the data has been cleansed and normalized, a variety of metrics can be calculated to assess the performance of each liquidity provider. These metrics should include rejection rates, hold times, and price slippage.
- Peer Group Analysis The calculated metrics should then be compared across a peer group of liquidity providers. This will help to identify any providers that are outliers in terms of their last look practices.
- Root Cause Analysis For any liquidity providers that are identified as outliers, a root cause analysis should be conducted to determine the underlying reasons for their poor performance. This may involve engaging in a dialogue with the provider to discuss their last look practices in more detail.
Quantitative Analysis of Last Look Data
The table below provides a hypothetical example of how a buy-side firm might analyze its last look data. The table shows the rejection rates and average hold times for five different liquidity providers over a one-month period.
| Liquidity Provider | Rejection Rate (%) | Average Hold Time (ms) |
|---|---|---|
| Provider A | 2.5 | 50 |
| Provider B | 1.8 | 45 |
| Provider C | 5.2 | 150 |
| Provider D | 3.1 | 60 |
| Provider E | 2.1 | 55 |
In this example, Provider C stands out as an outlier with a significantly higher rejection rate and average hold time than its peers. This would warrant further investigation to determine the reasons for this poor performance. By conducting this type of quantitative analysis on a regular basis, buy-side firms can ensure that they are receiving fair and consistent execution from all of their liquidity providers.
References
- GFXC. “GFXC Changes Last Look Practices in Global FX Code.” 15 November 2017.
- ACI Financial Markets Association. “Report on Last Look for the FX Global Code.” 20 August 2021.
- The TRADE. “Global FX Code making an impact as ‘last look’ executions diminish.” 4 September 2018.
- FlexTrade. “Global FX Code Gains Adoption but Last Look is a Thorny Issue.” 13 June 2018.
- Global Foreign Exchange Committee. “Execution Principles Working Group Report on Last Look.” August 2021.
Reflection
The journey towards a fairer and more transparent FX market is ongoing. The FX Global Code has provided a valuable roadmap, but it is up to all market participants to follow it. The guidance on last look, while not perfect, has sparked a much-needed conversation about the nature of liquidity and the responsibilities of those who provide it.
As technology continues to evolve and the market becomes ever more complex, the principles of the Code will become even more important. The challenge for all of us is to ensure that these principles are not just words on a page, but are embedded in the very fabric of the FX market.
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