13 Oct

FCA and BoE encourage liquidity providers to move towards SONIA

October 13, 2020

By ForexNewsNow

The Financial Conduct Authority and the Bank of England which are leading financial institutions in Britain decided to support liquidity providers to make some changes and start quoting SONIA instead of LIBOR. They encourage adopting these new quoting conventions in the sterling swaps for the liquidity providers from the end of October. The financial institutions openly support SONIA-based inter-dealer trading which means focusing on traders where there is no official exchange or market maker system.

As experts at Bloomberg suppose, the reasons for the plan of both financial institutions can be connected to Brexit. It is said that these new conventions that FCA and BoE are pushing for are in preparation for Brexit sell-offs which they would like to make as available as possible so that the curve corrects as fast as possible. But it’s not only about Brexit. According to this report, this will also weed out some financial service providers who are not necessarily following the rules too well. Should the plan from the Financial Conduct Authority fail, it’s likely that the leverage offers with most brokers are going to decrease because they can’t provide that much liquidity anymore. But if it succeeds, then it should remain the same. However, it’s for this time it’s highly unlikely that these new conventions will succeed considering the rates of market liquidity of some of the British financial service providers.

The above-mentioned initiative of British financial institutions is not only the case. Besides, adopting this new quoting convention, British financial institutions also plan to promote further movement in market liquidity. For the end of 2021, they plan to completely shift toward SONIA swaps and stop using LIBOR. The key point for refusing LIBOR and making this move is to prevent linear derivatives connected to the new GBP LIBOR from starting. However, this change doesn’t apply to the risk management of already existing positions.

This type of development is sure to add a bit more complication to the creation of an online trading account as almost every broker will have to now re-adjust their services to suit this decision from the BoG and FCA. This may also limit the trading capabilities of large retail traders, but not by much. As long as the SONIA requirements are met, only market makers will see a huge shift in their volumes for the GBP in particular.

General influence on trading

The biggest issue for traders is going to be the massive shift in lucidity capacity for many non-market-maker service providers. These companies usually employ liquidity providers in order to process their client orders as fast as possible and make leverage more readily available for the population. Due to such major shifts to SONIA, it’s likely that most retail brokers will have to lower their leverage cap due to impossible liquidity caps. This then directly translates into much fewer profits for FX traders considering the massive curve movements that we can anticipate during the Brexit transitions. People will still have the ability to take advantage of such a volatile situation, but not nearly as much as before the SONIA shift. On the other hand, though, it may also be a good idea as the unpredictability of the Brexit transition could cause mass zero-outs for retail FX traders as they place the wrong trade at the wrong time with too much leverage. It’s a very iffy situation thus forcing the FCA to go with the safer route as it always does.

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Possible threat to the BoG and FCA initiative

What can be an interfering factor in any new initiative today if not the Coronavirus pandemic? Not surprisingly,  in this case, COVID-19 is a major threat as well. Spreading the virus delayed the previous plan of the Financial Conduct Authority from happening. FCA had been planning to speed up the change in quoting convention for March 2020 but the pandemic started and it made the plan impossible to be realized. The same thing can happen now as the coronavirus outbreak hasn’t gone anywhere and still bothers anyone in the world. However, now some things have changed and more liquidity providers agree to implement this new convention in comparison with the previous attempt. In fact, in the survey done by the Finance Magnates, 95% of the respondents expressed agreement for the SONIA-first convention switch which is much more than before.

According to Edwin Schooling Latter, head of Markets Policy at the FCA the chances to succeed are higher this time than back to spring. “I encourage as many liquidity providers as possible to join the initiative as we’ve seen a great improvement in the use of SONIA in recent years”. AS he believes, we will be able to see a shift from using LIBOR at the end of 2021.

By ForexNewsNow


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