Virtu Revenue In Peril: Reuters, BATS Launch Crackdown On Algo FX Manipulation

Now that the Department of Justice has cleared the financial world of all carbon-based  FX market rigging traders by sending precisely nobody to prison and forcing bank shareholders to foot the bill on a settlement that amounts to about 1% of the proceeds earned thanks to years of market manipulation, and has since moved on to such more relevant to US taxpayer fields as football, it is time to turn attention to the robots.

Recall that back in December it was first reported that both Deutsche and Barclays "algos" were busted for FX rigging: something we alleged was taking place about 3 years ago. And now, six months later, exchanges are finally admitting that this too conspiracy theory was in reality fact, and quietly have started to clean up their game before the DOJ comes knocking.

As the WSJ reports, Thomson Reuters Corp. and BATS Global Markets Inc. will limit the practice known as “last look", also known as quasi-FX spoofing, on their platforms in coming weeks "in a move aimed at increasing transparency in the foreign-exchange market.""

What is last look?

The last look practice is a legacy of over-the-phone currency trading, when traders would take a final check of the market before executing an order. It has survived even as foreign-exchange trading moved onto electronic platforms, leaving banks with the option to back out of an order after it was accepted by a client.


Phil Weisberg, global head of foreign exchange at Thomson Reuters, said last look requires “more clarity.” Some clients don’t understand “the rules of engagement with the bank” and “are confused about trading protocols,” he added, referring to the exact conditions banks have to respect on the execution of each specific trade.


William Goodbody, head of FX at Hotspot, said, “Last look is a widely used practice in the industry. To make it work, it needs a clear set of guidelines.”


Banks’ foreign-exchange trading clients are likely to welcome the move to curb last look, said Kevin McPartland, a principal at Greenwich Associates.


“Giving market participants more visibility into where, how and with whom their orders are executed is a good thing,” Mr. McPartland said.

In short: an unfair practice that gave collocated algos with nanosecond reaction times an unfair advantage. Perfectly normal defenders of HFT would say, just buy yourselves a collocated server and compete with us, right.

Well, no.

Javier Paz, a senior consultant at Aite Group, said last look echoes the equity-market practice of “spoofing,” an illegal strategy in which traders place orders they don’t intend to execute to move the market to their advantage.

There is a small difference:

But there are also some significant differences, he said. In spoofing, a trader places an offer to buy or sell, then cancels it quickly, whereas in last look, there’s always a client willing to execute one side of the trade, Mr. Paz said.

Yes, but with last look the "other" side of the trade can always back out. So call it half-spoofing. Does that make it half-illegal?

And here is the punchline: "Thomson Reuters and BATS plan to tighten the time frame for canceling quotes and introduce a minimum acceptance rate banks have to respect."

In other words, slowly but surely the exchanges are beginning to admit that algo rigging is real, clear and present, and the bulk of it comes thanks to the gargantuan order cancelation rates, which have become a norm in a market in which it isn't how one trades that matters, it is guessing how the other algo will trade "if" something happens. Hence the reason why spoofing has become such a huge component of market making, and market manipulation: because we live in a world in which actual executions are no longer relevant - after all actual trade volumes are abysmal. The only thing that matters is what one "intends" to do... or rather what one "intends" to do if others do X. And so on.

Which sadly is what "trading" has become: a world in which it is all about divining the intentions of others, especially if those others are cost-indescriminate central banks, whose presence in the market is ever greater with each passing day.

Which is bad news for one firm: Virtu. Recall that for the recently public HFT giant, FX is now the largest source of revenue.


Why did Virtu bet the farm on FX? Due to such "legal" practices such as last look. 

Curb those, and watch Virtu's trading revenues collapse. The question now becomes: can VIRT frontrun the shorters of its stock, as suddenly its business model begins to unravel?