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Barclays Took a Last Look at Its FX Trades

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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This is bad customer service:

On June 6, 2011, in an email discussion about Last Look, a Barclays Managing Director and Head of Automated Electronic FX Trading wrote: “Do not involve Sales in anyway [sic] whatsoever. In fact avoid mentioning the existence of the whole BATS Last Look functionality. If you get enquiries just obfuscate and stonewall.”

It comes from this New York Department of Financial Services consent order with Barclays, which agreed to pay a $150 million fine over the "last look" function in its electronic foreign-exchange trading business.  In a minute we can have a nice nuanced discussion about the intricacies of last look, but let me start with a very simple point, which is that if you send an e-mail like that, you will pay a nine-digit fine. I fancy myself a bit of a connoisseur of  embarrassing investment bank e-mails, and that e-mail has all the hallmarks of a $150 million e-mail.  Don't write e-mails like that. But also, don't put yourself in situations where e-mails like that might be called for.

Anyway, last look. Last look is dirt simple. Here is how it works:

  1. Barclays posts bid and offer prices to buy or sell currencies on its electronic trading platform, called BARX.
  2. A customer sends it an order to, say, sell 10 million pounds at Barclays's bid price.
  3. Barclays waits a beat.
  4. If the price goes up, Barclays buys pounds from the customer at its (now ever so slightly too low) bid price.
  5. Barclays also buys if the price stays the same, or goes down just a little bit.
  6. But if the price goes down too much, Barclays doesn't buy pounds from the customer at its (now ever so slightly too high) bid price. Instead, it sends the customer back an onomatopoeic "NACK" message,  and the customer has to look elsewhere to trade.

Why would you do this? There is only one possible answer, and it is plain and simple and transparent. You want to buy low and sell high. If the pound is trading at $1.5212, you don't want to buy pounds now for $1.5214. That would be dumb, you'd be leaving money on the table. But just as importantly, if the pound is going to be trading at $1.5212, 1/10th of a second from now, you also don't want to buy now for $1.5214. That is equally dumb. Here is Larry Harris:

Dealers do not like to trade with traders who know more about future values than they do. When they do, more often than not dealers will be on the wrong side of the market. If prices change before they can restore their original positions, they will lose money. Economists call this risk adverse selection risk

Obviously one way to avoid trading with traders who know more about future values than you do is to wait until the future, see where the values are, and then decide whether or not you traded in the past.  So you bid $1.5212, find a customer, and wait the 1/10th of a second. If the pound is at $1.5212 or $1.5215 or, you're a generous computer, even $1.5211, you buy at the $1.5212 that you quoted. If the pound is at $1.5210 or $1.5205, you NACK the order right back up and lower your bid. It is the perfect Will Rogers trading strategy: "If it don't go up, don't buy it."

When you put it like that, though, last look itself sounds like terrible customer service. Because it is! It is as perfect an embodiment of "heads I win, tails you lose" as you could ask for: If the price moves against the customer, the bank wins; if the price moves against the bank, the bank decides not to play. 

But you could put it a different way. You could say stuff like this:

The ever-increasing power of sophisticated automated electronic trading systems and technologies creates opportunities for investment entities, which might be able to exploit latencies in the flow of information by requesting trades at prices informed by information that Barclays and other market makers might not yet have. Orders of this kind, which seek to outflank and exploit a market maker’s less nimble trading systems, are known as “toxic order flow” or “toxic flow.”

For example, a sophisticated electronic trading business might detect market movement some milliseconds (1/1,000ths of a second) before Barclays’s systems have, and therefore benefit by trading with Barclays before Barclays’s systems have properly adjusted their prices. Similarly, a sophisticated client could obtain a better price by breaking up and spreading fractions of its total order volume across a number of market makers. A market maker would then execute this apparently low volume trade at a lower price than it would have had it been aware of the total size of the customer’s order in the market place, because lower volume orders have a lesser impact upon the market and require market makers to assume less risk. This practice, known as “spraying the market” is another example of the kind of “toxic flow” that concerned Barclays.

Barclays didn't say that, by the way; that's from the consent order, which suggests that the Department of Financial Services kind of believes it. "In order to protect Barclays from toxic flow, Barclays designed Last Look," says DFS. And that would be fine? I guess? But then Barclays fell off the straight and narrow path. It "did not seek to distinguish toxic order flow from instances in which prices merely happened to move in favor of the customer and against Barclays after the customer’s order was entered on Barclays’s systems." It "did not perform an analysis to ensure Last Look was limiting its rejections to trades that in fact reflected 'latency arbitrage' or other truly 'toxic' flow." And so, "instead of employing Last Look as a purely defensive measure, Barclays instead used it as a general filter to reject customer orders that Barclays predicted, based on price movements during the hold period, would be unprofitable to the Bank."

This is all basically hokum. The way you know that a trade was toxic to you is if you lost money on it.  It doesn't glow green or smell bad. This kind of "toxicity" is just about losing money, so the way to tell if it exists is if you lose money. I mean, you can do fancy analyses to determine the likelihood that an order -- or, at least, a trader's pattern of orders -- reflects latency arbitrage or breaking up of big orders. But for a market maker, those questions are purely academic. The very best measure of toxicity, for a market maker, is profitability. So Barclays just measured that directly.

In any case, Barclays's sin doesn't seem to have been telling people that last look was a defense against toxicity when it was really just a profit center. Barclays's sin seems to have been not telling people about last look at all. "Do not discuss Last Look with Sales," wrote the head of automated electronic FX trading. Sometimes clients would ask about NACKs and "Barclays failed to disclose the reason that trades were rejected, instead citing technical issues or providing vague responses." Or just ignoring the customers until they went away. Again, the sins here seem to have been mainly failings of customer service, though with a distinct overtone of fraud.

A lot of the action in electronic trading consists of fearmongering about high-frequency traders and how toxic they are. (On the equities side, Barclays is in trouble over just that, as New York's attorney general has sued it for making bold but allegedly false claims about how well its dark pool protects investors from predatory high-frequency traders.) Last look doesn't seem to have been particularly well targeted against toxic order flow, but it was at least somewhat targeted against electronic traders: Barclays applied last look to all customers who traded through its application program interface (that is, who hooked up electronically), but only to a "handful" of those who traded through its graphical user interface (that is, by a person looking at a screen). "Barclays’s systems assumed the use of the API/FIX system was itself a clear indication of customers’ ability to engage in latency arbitrage and create toxic flow." I think Barclays is not alone in assuming that any electronic trader is engaging in latency arbitrage and creating toxic flow. That is rather the stereotype.

Weirdly, though DFS fined Barclays $150 million and required it to fire a person in charge of this, it did not say that last look is illegal or that Barclay should stop doing it. It has become more fair: Now Barclays's price filters "operate symmetrically," so that "rather than reject only those orders that became sufficiently unprofitable to the Bank, trade requests sufficiently unprofitable to customers (but profitable to the Bank) would also be rejected."  And, of course, it has become a lot better disclosed, what with DFS's announcement and the fine and all. The question is whether customers, now that they know all about it, will be willing to keep putting up with it.

(Corrects fifth item in description of how "last look" works to say Barclays would buy if the price stays the same or goes down just a little bit.)

  1. Not to be confused with the ... by my count about $2.4 billion of fines that Barclays paid in connection with its non-electronic FX trading business. Remember, no matter how bad computers are, humans are an order of magnitude worse!

    By the way, I assume BATS means something like "Barclays automated (alternative?) trading system"; it does not refer to the BATS exchange. 

  2. Except that it features only one "[sic]," and that for more of a spacing error than a spelling one.

    Oh also I am kidding about that being a $150 million e-mail; the fine is really distributed among a number of bad e-mails. Like:

    On September 4, 2014, when a Barclays Sales employee emailed a BARX Support employee, the employee responded by describing Last Look as a “pricing check setup against BARX clients” to “ensure profitability of a trade for Barclays,” but emphasized that “Our Team generally does not share this info with the client, and just say it was a business reject.”

    Or:

    On November 7, 2011, the Barclays Managing Director and Head of Automated Electronic FX Trading wrote: “Do not discuss Last Look with Sales. If there has been a spurt [in rejected trades] just blame it on the weekend IT release and say it’s being fixed.”

    As part of the consent order, Barclays agreed to "take all steps necessary to terminate" a "Managing Director and Global Head of Electronic Fixed Income, Currencies, and Commodities ('eFICC') Automated Flow Trading," which sounds like it's not this person?

  3. I am not sure how long Barclays's "hold period" was, but the order refers to "the tens and hundreds of milliseconds following the order." So I guess north of 1/10th of a second, but south of a second. One-tenth of a second is, of course, an eternity in the electronic-trading world; BARX could write symphonies during that hold period.

  4. "Whenever prices within this holding period moved against Barclays and in favor of the customer beyond a certain undisclosed loss threshold, Barclays treated the trade as toxic flow" and rejected it.

  5. "NACK" stands for "Not Acknowledged," though I prefer to think of it as the sound of Barclays's computers hacking up the customer's now-rancid order. This is especially pleasing if you think of those computers as being named BARX. "BARX NACKed my order," customers could complain.

  6. Or go back to Barclays a bit later.

  7. Here I am talking about the present, the future and the past as though they are distinguishable. But one fact of high-speed electronic trading is that someone else's present may be your future; that is, some other trader may be getting information about prices just the teensiest bit faster than you are, and so he may see now what you'll only see in the future. (This is what the consent order refers to as "latency arbitrage.") So last look is also a way of making sure that your present catches up to his present, as it were, and then leaves it in the past.

  8. I am sort of implicitly ignoring bid/ask here. If you like, replace "trading at" with "bid at."

  9. In the subsequent short amount of time, I mean. The time period of toxicity depends on the time period of trading; in corporate bonds, you can get run over by a big holder taking weeks to dump bonds, but in equities or FX, toxicity tends to be a matter of seconds or less.

  10. This is a good one:

    On December 15, 2010, a Barclays client wrote, “[w]e have noticed that there were over 300 rejected orders with you today and the reason is ‘NACK’, could you pls have a look at them and advise what’s causing it?” After failing to receive a substantive response, the client followed up two days later, writing, “[w]e have not heard anything back with regards to the rejections. And this has become quite a serious matter. . . . We kept receiving top of the book rates from you and hitting your rate, but we got rejected by you 9 times out of 10 where we could have been well filled by other liquidity providers who have been providing competitive rates. . . . Could someone from your side shed some lights on the rejections? Whether they are due to technical difficulties or business decisions?” There is no evidence that Barclays ever responded to these queries.

  11. Though technically the only violation in the consent order is that Barclays "has conducted banking business in an unsafe and unsound manner."

  12. On Twitter, Remco Lenterman said that this case "may spell the beginning of the end of last look," that "Last look functionality in the FX market enables dealers with second rate technology to continue to compete," and that "If last look in FX is abandoned it will create a big shift from traditional dealer banks to non bank electronic mkt makers." Obviously if you think that non-bank electronic market makers are themselves toxic, this will bother you.

  13. This happened "in September and October 2014," which was "after the commencement of the Department’s FX trading investigation." And the roll-out was buggy:

    In executing these revisions to make Last Look symmetrical, Barclays neglected to update one of its trading platforms, causing 7% of its trading volume to continue under the asymmetrical paradigm until August 2015. Barclays has since updated all trading platforms.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
Zara Kessler at zkessler@bloomberg.net