Forex – The Info You Must Learn
What proportion of people at the end of the investment chain are institutional investors; market-makers; producers, wholesalers and processors of commodities; or retail investors?
If almost all of the end users are not retail investors or non-financial businesses, this indicates that, at least at the moment, this is a professional market, and participants are able to look after themselves. In a professional market traders are aware of most of the trading information because they are active participants in the market. In which case, the formal publication of this information does little to increase their knowledge, and the publication of trading information to increase transparency is seen as pointless as ‘everybody knows’. If the end users are non-professionals, then there is a stronger case for a high level of transparency as they are not party to the same information as market participants.
However, using the proportion of non-professional participation in a market to judge transparency standards may run into a chicken and egg problem. Without transparency there will be no non-professional participation; and without non-professional participation, there will be no transparency. In consequence, transparency may get stuck at a low level. This suggests that basing a long-term transparency regime on the current proportion of non-professional business may be ill-advised, unless there is no prospect of retail or producer – consumer interest in the market. If non-professional users are taken to include businesses which need to manage their forex and interest rate risk, then it is hard to think of markets which do not have a nascent non-professional interest.
Does the trading system use a dealer or an auction trading mechanism?
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The choice of trading mechanism determines the minimum amount of pre-trade transparency. In a dealer system investors know at least some dealer quotes, while in an auction market investors know at least the best current limit orders. In a dealer market, the absence of transparency may not be as damaging to efficiency as in an auction market because the quotes are set by market-makers who have some access to the available quote and trade information. Therefore, the prices at which customers are invited to trade with the dealers reflect this private information.
The level of private information available differs from market to market. In some markets (e.g. equities) there can be considerable information asymmetries, and so the quote and trade information is very informative. However, in other markets there is less private information (e.g. government bonds and forex) and the flow of orders and quotes is less informative. Transparency is more important in markets where there are considerable amounts of private information.
Although the importance of private information will probably be higher in manipulable markets, this does not imply that transparency should be increased only if the security, or underlying security, is easily manipulable. Even if there is little private information, a well-functioning market which meets the four statutory obligations of the FSA requires transparency to ensure confidence, best execution and non-manipulation (although manipulation is unlikely in the government bond and forex markets).
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