The migration from voice trading to electronic execution in foreign exchange markets continues to build momentum, and the results of the EuromoneyFXNews e-trading survey show that buy-side clients expect this growth to continue.
Voice trading makes up, on average, 18% of all executions the survey shows. Respondents expect this to fall to less than 13% in the near future.
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The results also show that customers are moving more electronic volume flow towards single-dealer platforms (SDPs), with their share of turnover expected to grow from 29% to 33% in the next two years.
Meanwhile, the use of tailored connectivity to multiple counterparties via application programming interfaces (APIs) – a big growth area in electronic trading – seems to be slowing. Respondents, who execute, on average, 19% of their volume using APIs, expect this to remain unchanged during the same period.
“The days of having as many market connections as you wished are gone,” says Javier Paz, a senior analyst at technology consultancy group Aite. “Having so many bespoke connections is now perceived as increasing both counterparty and operational risk – spread improvement has taken a back seat.”
Much of the demand for APIs has been driven by smaller algorithmic traders, smaller hedge funds and commodity trading advisers wanting to connect their model trading black boxes to market makers.
More generally, according to several heads of e-trading at leading FX platforms, a substantial number of clients believe they could get better pricing by building their own aggregators, the principal use of API connections. APIs also help traders in streamlining their desktop real estate. That attitude might now be shifting for two reasons: pricing performance and cost.
In terms of pricing performance, APIs have shown signs of being self-defeating. According to e-trading specialists, the problem in using sweep execution methodology is that it can, in many cases, turn out to be a poor experience for liquidity providers on the whole, because of the way in which one liquidity provider reacts to price action, and how that affects all the other liquidity providers.
“Therefore, it becomes slightly self-defeating and in the long run getting worse spreads to the client,” says the head of e-trading at a leading SDP platform. An SDP might, therefore, represent a better option.
At the same time, as price-transmission speeds continue to improve, there is also a shift to more direct connections with lower latency. These can require a leased line between the bank and the client, rather than using the internet, and are becoming more popular. Connection speeds can be further enhanced by cross-connecting via a data centre.
“The prevalence of these leased lines and cross-connections is only going one way, and that’s up,” says Richard Anthony, head of e-risk at HSBC in London.
However, there is a cost to such a service, and in an environment where technology costs are being constrained this might be a less attractive option, Anthony argues.
“If you have a direct connection that does go across a leased line, or if you cross-connect via a data centre, then you have to pay for the privilege of that, which is expensive,” he says.
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| EuromoneyFXNews e-trading survey: Index |
While most technology budgets tighten, as anecdotal evidence seems to suggest, the SDP might be a preferred and cheaper option, as the survey results show. Respondents indicated a preference to move more of their execution on to SDPs.
That’s not to suggest that multi-dealer platforms (MDPs) are falling out of vogue – respondents still expect further growth, but at a slower rate; its portion of the e-trading market is expected to grow from 33.6% to 34.4% in the near future.
Indeed, it might also be a beneficiary of cost constraints, and some real-money managers argue that MDPs are in the long run cheaper for connecting and disconnecting counterparties when the client decides to switch.
Jack Crawford, head of currency trading at JPMorgan Asset Management in London, says buy-side clients need to consider the costs associated with adding connectivity to a favoured counterparty, a situation that is much more dynamic in a crisis – such as with the present European sovereign crisis – and where continual counterparty assessment is vital.
“Having to go through all of the connection and cost, it doesn’t seem like the best idea most of the time,” says Crawford. “Whereas with an MDP approach, as and when you favour one counterparty over another, one can choose to trade with them or not. So you can be more alive to change in an environment.”
Another supporting factor for MDPs is their ability to demonstrate best execution, a requirement that ranked equal-highest with narrow bid-offer spreads as the main reason why buy-side clients use such platforms.
“We’re seeking the voice-dealing experience electronically, that is clearly demonstrable, and which gives lower risk of execution, and increases efficiency and speed that mirrors the voice-trading experience,” says Alec Farley, principal dealer of global FX at Legal & General Investment Management in London.
To some extent, the introduction of algorithmic order trading tools has brought SDPs closer to some form of best execution.
At the launch of the latest version of Citi’s trading platform, Velocity 2, the bank said clients that trade algos on it can get reports that compare their execution versus what they could have achieved via limit orders.
A lot of clients that want best execution will go for a standard benchmark execution model that will take a snapshot and give them an audited report.
Nonetheless, it remains to be seen if it can deliver the same results as multi-dealer best-execution methods, which can become self-reinforcing.
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| James Wood-Collins, chief executive of Record Currency Management |
“Because we can show them the results – like the hit ratios, how often they come second or first, et cetera, and in different currency pairs – it’s very powerful because it’s a quantitative feedback that you can’t often give when you’re just trading on voice,” says James Wood-Collins, chief executive of Record Currency Management. “That then feeds through to best execution, which then feeds through to even better best execution.”
While electronic execution does enhance the measurement of performance, and voice trading as a percentage of overall turnover declines, buy-side traders say it will remain relevant because it’s still a market that requires human intervention in execution. Indeed, chief traders report that more larger clients are requesting a direct line into trading desks to gauge market sentiment from traders.
JPMorgan’s Crawford says 99% of his allocations are done via a platform, but he still uses the phone for a fair proportion of firm’s larger trades. He says it allows him to work orders in the market, gauge liquidity, take risk prices and choose who he wants to trade with.
While Crawford highlights that many SDPs are now offering trading algorithms for large-volume trades – a big growth area in recent years – he is yet to be convinced it’s the best mechanism for JPMorgan Asset Management.
“I’m not yet converted,” he says. “We’ve used it and it works, but one has to determine the parameters of the trade prior to entering the market. You can do this in your head, as an experienced trader, in half a second, then pick up the phone and begin to trade. Putting these parameters into an algo will take me a minute. I could have completed my deal by then and I might have missed a move in the market.”
The purpose of EuromoneyFXNews’ inaugural e-trading survey was to assess the behaviour of buy-side clients when trading on electronic platforms, but we also asked respondents to name their three most-preferred SDPs, as well as their least favourite.
The results show that electronic FX delivery is broadly in line with market share at the top end of the rankings, although not in the same order as referenced by the 2011 Euromoney FX survey results.
Barclays Capital’s Barx platform leads the list by a margin, followed by Deutsche Bank’s Autobahn, close behind is UBS, with a further gap to Citi in fourth.
The most notable feature of these results is that while Barx polled way ahead of Autobahn, the German bank still commands a large market share over Barclays Capital based on the 2011 survey. More interesting, perhaps, in the context of the market events in 2011, Barx was forced to shut down pricing on two sets of currency pairs, USD/JPY and EUR/CHF, on two occasions.
While Barx was not the only one to do this, the leading platforms have made much of their ability to provide liquidity to the market 24/7. The survey seems to suggest this hasn’t harmed Barx’s reputation among buy-side clients. Indeed, according to some of the clients who spoke to EuromoneyFXNews, the standard of the overall electronic offering and ease of functionality appears to trump 24/7 liquidity provision.
Competition is becoming more intense among the top four banks. Citi has launched its new and improved Velocity 2 less than two years after rolling out Velocity. Meanwhile, UBS started up its much-anticipated UBS FX Trader Plus in June, while Deutsche is expected to announce enhancements to Autobahn this year.
JPMorgan has also been busying itself with redeveloping its MorganDirect platform, and HSBC will launch its single-dealer offering this year.
JPMorgan has focused on improving its functionality for currency options and commodities, looking to add silver and gold derivatives pricing. It is also developing new functionality on algorithmic and general orders, which the bank sees as one of its key strengths. It has started linking algo orders together, a feature few of its competitors are yet offering.
The typical comment from respondents as to why they preferred using an SDP over a MDP is that they valued the relationship with the bank. That manifested itself in being able to deal with operational issues much more efficiently, having direct daily access to traders, and receiving a more bespoke service and product than was available in other formats. That’s particularly the case in the emerging markets, where, almost unanimously, respondents preferred to use SDPs.
“If you’re going to be trading in the emerging markets, you’re going to be looking at broken dates; you need to tailor the dates you’re going to be trading these non-deliverable forwards and you need the relationship with the bank,” concludes a user at a large European-based corporate, who says that you cannot get that level of service on a multi-dealer platform.
