What Is the Relationship between Last Look Windows and the Frequency of Post-Quote Rejections? ▴ Question

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Concept

The relationship between last look windows and the frequency of post-quote rejections is a direct and often contentious one, rooted in the fundamental structure of the foreign exchange (FX) market. Last look is a mechanism that grants a liquidity provider (LP) a final opportunity to reject a trade request after a quote has been provided. The duration of this final review period is known as the last look window. A longer last look window inherently provides the LP with more time to assess the trade against changing market conditions, which can lead to a higher probability of rejection.

The core purpose of the last look window is to serve as a risk mitigation tool for LPs in a fragmented and high-speed market. Unlike a centralized stock exchange, the FX market is composed of numerous trading venues, creating opportunities for latency arbitrage where traders can exploit price discrepancies between different venues. The last look window allows LPs to protect themselves from being filled on stale quotes, which could result in immediate losses. This practice, however, introduces a significant element of execution uncertainty for the liquidity consumer (LC), who has already committed to the trade at the quoted price.

The length of the last look window directly correlates with the potential for trade rejections, as it provides liquidity providers with more time and information to assess the profitability of a trade.

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What Is the Core Conflict in the Last Look Mechanism?

The central conflict arises from the asymmetry of information and optionality that the last look window creates. While the LC has made a firm commitment to trade at the quoted price, the LP retains the option to renege. This has led to concerns about the potential for misuse of the last look window beyond its intended purpose as a defensive risk management tool. Some market participants argue that certain LPs use extended last look windows to engage in “pre-hedging” or to reject trades that have moved in the client’s favor, even infinitesimally.

The FX Global Code, a set of principles for the wholesale foreign exchange market, has attempted to address these concerns by providing guidance on the appropriate use of last look. The code stipulates that last look should be a risk control for verifying price and validity, and that LPs should be transparent about their last look practices. Despite these efforts, the debate over what constitutes a “fair” last look window and the acceptable reasons for rejection continues to be a prominent topic in the FX industry.

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The Impact of Market Structure on Last Look

The prevalence of last look is a direct consequence of the decentralized nature of the FX market. In the absence of a single, unified order book, LPs provide quotes to multiple clients and venues simultaneously. This distribution of liquidity necessitates a mechanism to manage the risk of being filled on the same quote multiple times or at a price that is no longer reflective of the current market. The last look window serves as this control, but its implementation varies significantly across LPs, leading to a wide range of rejection frequencies and execution experiences for LCs.

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Strategy

For both liquidity providers and consumers, navigating the complexities of last look windows and post-quote rejections requires a well-defined strategy. LPs must balance the need for risk mitigation with the imperative to provide reliable liquidity, while LCs must develop methods to identify and reward LPs that offer fair and consistent execution. The interplay between these competing objectives shapes the dynamics of the FX market and ultimately determines the cost and quality of execution.

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Liquidity Provider Strategies

LPs employ a variety of strategies when implementing last look, with the length of the window and the criteria for rejection being the primary variables. Some LPs adopt a “no last look” or “firm pricing” model, where all quotes are binding and trades are executed without a final review. This approach can attract clients seeking execution certainty, but it also exposes the LP to higher levels of risk.

More commonly, LPs utilize a last look window as a key component of their risk management framework. The length of this window can be tailored to different clients or market conditions, with longer windows often applied to clients with “toxic” order flow, characterized by high-frequency trading strategies that seek to exploit small, fleeting price discrepancies.

A controversial strategy employed by some LPs is the use of the last look window for activities beyond simple price verification. This can include “pre-hedging,” where the LP attempts to hedge the client’s trade during the last look window. If the hedge is executed at a favorable price, the client’s trade is accepted.

If not, the trade may be rejected. This practice is contentious because it can be seen as the LP using the client’s own trade information to profit, while leaving the client with the risk of a rejected trade and potential market impact.

Liquidity consumers can strategically reduce rejection rates by analyzing liquidity provider data and favoring those with faster, more symmetric response times.

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Liquidity Consumer Strategies

For LCs, the primary strategy for managing last look and post-quote rejections is through rigorous data analysis and informed LP selection. By tracking metrics such as rejection rates, response times for both accepted and rejected trades, and the symmetry of these response times, LCs can identify LPs that offer the most reliable execution. Transaction Cost Analysis (TCA) is a critical tool in this process, allowing LCs to quantify the implicit costs of rejected trades, such as slippage and opportunity cost.

An effective LC strategy involves the following components:

Data Collection and Analysis ▴ LCs should capture detailed data on every trade request, including the time of the request, the time of the response, the outcome (accepted or rejected), and the reason for rejection, if provided.
LP Segmentation ▴ Based on the collected data, LCs can segment LPs into tiers based on their execution quality. LPs with low rejection rates, fast response times, and symmetric accept/reject times should be prioritized.
Execution Policy Optimization ▴ LCs can use their analysis to create dynamic routing rules that direct order flow to the most appropriate LPs based on the characteristics of the trade (e.g. size, currency pair, market volatility) and the historical performance of the LPs.

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How Does Transparency Influence Strategy?

Increased transparency around last look practices is a key factor influencing both LP and LC strategies. As regulators and industry bodies push for greater disclosure, LPs are under pressure to be more explicit about their last look methodologies. This allows LCs to make more informed decisions about which LPs to trade with.

Some LCs may choose to only trade with LPs that provide detailed disclosures and adhere to the principles of the FX Global Code. This, in turn, incentivizes LPs to adopt more transparent and client-friendly last look practices.

The following table outlines the strategic considerations for LPs and LCs in the context of last look:

Stakeholder	Strategic Objective	Key Actions	Metrics for Success
Liquidity Provider	Mitigate risk while providing competitive liquidity	– Define clear and consistent rejection criteria – Calibrate last look window duration – Provide transparent disclosures	– Low levels of toxic order flow – High client retention – Stable profitability
Liquidity Consumer	Achieve best execution and minimize implicit costs	– Conduct thorough TCA – Segment LPs based on performance – Optimize order routing	– Low rejection rates – Minimal slippage – Reduced overall trading costs

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Execution

The execution of trades in the FX market is where the theoretical concepts of last look and post-quote rejections become tangible realities for market participants. The precise mechanics of how last look is implemented, the factors that trigger rejections, and the tools used to measure and manage execution quality are all critical components of a successful trading operation. A deep understanding of these executional details is essential for both LPs seeking to optimize their liquidity provision and LCs striving to achieve the best possible outcomes for their trades.

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The Mechanics of Last Look and Rejection

When an LC submits a trade request to an LP, a series of events is set in motion. The LP’s system receives the request and, if a last look window is in place, holds the trade for a predetermined period. During this window, the LP’s system performs a series of checks. These checks can include:

Price Check ▴ The system compares the quoted price with the current market price. If the market has moved beyond a certain tolerance level against the LP, the trade may be rejected.
Validity Check ▴ The system verifies that the trade request is valid in terms of size, currency pair, and other parameters.
Credit Check ▴ The system ensures that the LC has sufficient credit to execute the trade.

The duration of the last look window is a critical factor in this process. A longer window allows for more market data updates to be received, increasing the likelihood that the price check will result in a rejection. The following table illustrates the significant variation in response times that can be observed in the market:

Liquidity Provider Profile	Average Acceptance Time (ms)	Average Rejection Time (ms)	Symmetry (Reject/Accept Ratio)
Aggressive (Long Hold)	21.5	2400	111.6
Moderate (Asymmetric)	49	169	3.4
Conservative (Symmetric)	3.7	1.8	0.5

This data, adapted from market observations, highlights the stark differences in execution practices. An LC trading with an “Aggressive” LP would experience significantly longer hold times on rejected trades, creating substantial execution uncertainty.

Executing a robust Transaction Cost Analysis program is the most effective way for liquidity consumers to identify and mitigate the hidden costs of high rejection frequencies.

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What Factors Influence Rejection Frequency?

The frequency of post-quote rejections is not solely determined by the LP’s last look practices. The LC’s own trading behavior and the prevailing market conditions also play a significant role. Key factors that can influence rejection rates include:

Market Volatility ▴ During periods of high market volatility, prices can move rapidly, increasing the likelihood that a trade will be rejected due to a failed price check.
Trade Size ▴ Larger trades may be subject to longer last look windows and a higher probability of rejection, as they represent a greater risk to the LP.
LC Trading Style ▴ LCs with aggressive, high-frequency trading strategies may experience higher rejection rates as LPs seek to protect themselves from being “picked off” by these strategies.
LP Risk Appetite ▴ Each LP has a different tolerance for risk, which will be reflected in the calibration of their last look windows and rejection criteria.

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The Role of Transaction Cost Analysis in Execution

TCA is the primary tool that LCs can use to measure and manage the impact of last look and post-quote rejections. A comprehensive TCA program goes beyond simply tracking rejection rates. It quantifies the financial impact of these rejections by measuring metrics such as:

Slippage ▴ The difference between the price at which a trade was requested and the price at which it was eventually executed after one or more rejections.
Opportunity Cost ▴ The potential profit or loss that was foregone due to a rejected trade.
Rejection Cost ▴ The market impact caused by the initial trade request, which can lead to a less favorable price when the trade is eventually executed.

By analyzing these metrics, LCs can gain a clear understanding of their true cost of execution and make data-driven decisions to improve their trading outcomes. This may involve adjusting their trading strategies, optimizing their order routing logic, or engaging in direct discussions with their LPs to address concerns about high rejection rates.

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References

Lambert, Colin. “A Glimpse Inside the Strange World of Last Look.” The Full FX, 18 Aug. 2021.
Norges Bank Investment Management. “The Role of Last Look in Foreign Exchange Markets.” Asset Manager Perspective, no. 3, 2015, 17 Dec. 2015.
Global Foreign Exchange Committee. “Execution Principles Working Group Report on Last Look.” GFXC, Aug. 2021.
Schmerken, Ivy. “A Hard Look at Last Look in Foreign Exchange.” FlexTrade, 17 Feb. 2016.
“Last look (foreign exchange).” Wikipedia, Wikimedia Foundation, 15 Apr. 2023.

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Reflection

The intricate dance between last look windows and post-quote rejections is a microcosm of the broader challenges and opportunities within the institutional trading landscape. The insights gained from analyzing this relationship extend far beyond the confines of the FX market. They prompt a deeper consideration of how your own operational framework addresses the fundamental tensions between risk, transparency, and execution quality. As you move forward, consider how the principles of data-driven analysis and strategic partnership can be applied to all aspects of your trading operations, transforming every interaction into an opportunity to refine your edge and enhance your capital efficiency.