Managing informational asymmetries in foreign exchange markets
In our new Asset Manager Perspective we suggest improvements to strengthen global foreign exchange markets.
10 November 2017
Foreign exchange markets are critical to the functioning of the global economy, and provide robust solutions to the liquidity needs of both corporate and financial market participants.
The bilateral nature of foreign exchange markets naturally leads to significant informational asymmetries between dealers and clients. These asymmetries serve to limit the adverse price risk for dealers and ensure deep liquidity availability. However, they can also lead to excess intermediation profits and inefficient price discovery.
The recent release of the FX Global Code of Conduct is an opportunity to revisit common market practices in global foreign exchange markets. Norges Bank Investment Management has signed a statement of commitment to the FX Global Code.
In our new Asset Manager Perspective, we identify three foreign exchange market practices where informational asymmetries are particularly relevant: Last Look, the implementation of electronic algorithms and the linkages between request-for-quote (RFQ) feeds and inter dealer market prices.
Given the current foreign exchange market structure, and in the spirit of the FX Global Code, we suggest concrete improvements to these market practices. We believe that transparency and verifiability are key to mitigating the impact of informational advantages, without negatively affecting the liquidity of this important market.