What are liquidity providers
Liquidity is an important concept in financial markets, which determines flow of funds there. This term means mobility of instruments (futures, options, shares and other securities). Liquidity ratio gives an opportunity to define how fast it is possible to sell an instrument and get an income. It is obvious, that the higher is this figure, the lower is spread, and the higher is a demand on tendered positions.
The importance of liquidity
Conditions of liquidity improvement play very important role in the foreign exchange market, because inside it flow of funds is calculated in trillion dollars per 24 hours. But not each participant has highly liquid actives. Otherwise, there would be neither competition, nor the basis of trading – the vertical ladder between all the members.
Liquidity providers are the companies, that are on the top of this ladder. The examples of them are:
- Deutsche Bank;
- Bank of America;
- STP-brokers, which trade faster than anyone.
How do liquidity providers work?
Thanks to their work, an overall picture of exchange rates and quotations is obtained. For example, liquidity providers for banks with the highest rates execute exchange transactions of the volume which can not be exceeded by any other counterparties. But the companies with average liquidity can be mediators between the top organizations and the other market participants. These companies are also liquidity providers, or, also known as aggregators. The examples of them are:
- KCG Hotspot;
- CFH Clearing;
- LMAX Exchange.
Depending on the strategy of work, aggregators are divided into ECN and MTF ones. ECN-providers work this way:
- All the quotations of liquidity providers are gathered.
- They are compared with existing at the moment pending orders.
- Conformity between clients’ requests is found. It is made for closing as many orders as possible between them.
- Remaining orders wait for confirmation of the deal.
- After getting the confirmation, order is executed. If the waiting time is exceeded, they proceed to other liquidity providers.
- If the requested price isn’t offered by anyone, a new quotation will be sent to a client.
Of course, this scheme has some flaws. One of them is that the work of liquidity providers lead to slippage, which causes delays in order execution. In contrast to ECN, MTF aggregators execute orders automatically. This excludes the possibility of slippage. But there is a payment for this. MTF spreads are wider, than ECN-providers offer.