WSJ:
By: Katie Martin

In early European trading hours Wednesday, the Reuters currency-trading systems fell over. Horribly. And globally. In all, the outage lasted for some four hours–believed to be a record for a major system.

This is one of the two key bank-to-bank currencies trading platforms. Along with arch rival EBS, owned by brokerage ICAP, it forms the backbone of the market.

For those four hours, it was significantly tougher than usual to trade the currencies where Reuters dominates, chiefly sterling, the Australian and New Zealand dollars, and the Nordic currencies.

Cue sense-of-humor failures on some trading floors. Some banks clearly struggled to figure out how to price these currencies for that time and the gap between where some currencies were bought and sold edged wider as traders sought to protect themselves while they weren’t sure what was going on.

But here’s the thing: If this had happened five or even three years ago, the impact would have been calamitous. Take away one of the two core price sources in the market and banks simply would have been unable to trade these currencies at all.

Instead, trades just flowed to EBS, to other trading systems, or indeed to the bigger foreign-exchange banks that command enough liquidity by themselves to act as trading hubs.

All-in-all, the incident is a neat illustration of how the foreign exchange market has evolved over recent years. Big trading systems, like EBS and Reuters, matter. But they no longer have the strategic importance they once enjoyed. If one goes down, the market shifts to the other, or to somewhere else entirely. There are enough big trading systems out there now that the market can cope with rare glitches.

The anxiety for the interbank heavy-hitters is that, at some point, the banks that control this $4 trillion-a-day business will decide they don’t really need them at all. This would have been considered ridiculous a few short years ago.

Already, the biggest banks in town have hatched a plan to circumvent these systems, in a mini-rebellion against EBS opening its doors to nimble high-speed funds. Those plans have since been shelved while the banks squabble over the details and wait to figure out how the regulatory landscape will pan out.

But they could easily come back to life.

There’s another big point here too: systems fail. Sure, older systems might suffer more strain than others, and EBS and Reuters have been around for an awfully long time, albeit with upgrades along the way.

Regulators are keen to push trading in a lot of currency products onto centralized exchange-type systems, or to force trades through clearing systems.

But what happens if one of those exchanges or systems falls over and there’s no other way to get trades done? The market ceases to function, that’s what. Global trade stops. Cross-border investments stop. Is that a good idea, even for a short period?

Foreign exchange functions perfectly well, in part because it is so fragmented. It’s probably best to leave it alone and avoid the law of unintended consequences