Last year’s Bank for International Settlements (BIS) triennial FX market survey, which was published in December, cited increased inter-dealer trading as a major factor in the growth in trading volumes, and also noted that more trades were being executed via bilateral methods than through multilateral platforms that make prices available to all participants.
Dealer trading with customers has stagnated in dollar terms since 2019, with the market share of dealer-customer turnover falling from 62% to 54%. Inter-dealer trading has not accounted for such a high percentage of trades since the mid-2000s, with 54% of all swap trades now executed this way.
The information available to customers to make informed decisions regarding FX service provision is greater than ever
Geoff Kot, Standard Chartered
According to Vladyslav Sushko, senior economist at the BIS, this shift towards bilateral forms of trading implies a continued reduction of ‘visible’ trading, suggesting that the transparency of the FX market may have decreased further. While accepting that this trend has so far not hampered market functioning, Sushko says it could harm price discovery for the market as a whole.
This view is shared by Maxime Mordelet, institutional digital asset and e-forex liquidity manager at Swissquote, who says the shift towards bilateral forms of trading reduces the information available on primary and secondary sources of liquidity on which smaller banks or non-banks rely to construct their own mid-price.
However, Geoff Kot, global head of financial markets electronic trading and platforms at Standard Chartered, reckons that advances in the availability and use of technology have mitigated many of those potential downsides.
“There are numerous solutions available for aggregate pricing and deploying more sophisticated algorithmic execution strategies to optimize execution across various dimensions, including price, speed and market impact,” he says.
These technologies are now cheaper and easier to access for a broader range of participants, adds Kot. “At the same time, the growth and availability of independent execution analytics services and mandatory transaction reporting for certain trade types means the information available to customers to make informed decisions regarding FX service provision is greater than ever.”
Not transparent anyway
Unlike many other asset classes, FX has never had a central exchange that represents a true picture of the market, so the concept of ‘reduced transparency’ is relative.
Inter-dealer trading and the lack of a central price discovery mechanism for FX can make it more difficult for market participants to get a clear picture of the supply and demand dynamics and this can limit their ability to determine fair value. However, inter-dealer trading also provides significant benefits, such as increased liquidity.
We believe that the shift towards bilateral forms of trading has no negative implications for price discovery
Gerard Melia, StoneX Pro
As a result, the impact of this type of trading on transparency may vary depending on the specific market and measures that are in place to promote transparency, explains Gerard Melia, head of sales at StoneX Pro.
“We believe that the shift towards bilateral forms of trading has no negative implications for price discovery,” he says. “Professional clients are highly informed and markets have become less opaque with the availability of market data and industry benchmarks.”
In his analysis of the market data, Sushko suggests stagnant customer trading may also partly reflect the risk-off environment.
“A significant part can be attributed to the risk-off environment, but there is also a decrease in risk appetite from larger banks and more interest in risk reduction, either internally across different desks or externally with other banks,” says Mordelet.
Most current forecasts for the global economy and markets are either negative or at best uncertain, and this environment tends to drive investors from risk-on assets such as emerging market currencies to safer assets like government bonds or gold.
There is a decrease in risk appetite from larger banks and more interest in risk reduction
Maxime Mordelet, Swissquote
This can have a short-term volume-increasing effect as investments move to safe haven assets, usually denominated in more stable currencies. Once this cycle of migration of capital has been completed, FX volumes naturally decrease.
However, Melia suggests that this is not the full story. “As the economic outlook worsens and uncertainty prevails, companies pull back on ordering raw materials and investment in projects to increase international market share,” he says. “This in turn can lead to changes in FX trading and hedging strategies as companies adjust their positions based on their outlook for different currencies and the perceived level of risk in those markets.”
The BIS survey also notes the decline in the market share of principal trading firms, which may be a function of firms migrating to other asset classes with greater opportunities. But Kot reckons it is also likely that the improvement in the use of technology among dealers has contributed to this reduction in principal trading firms’ market share.
“Pricing and execution algorithms have become more sophisticated, and the depth and persistence of liquidity from dealers is more highly valued during volatile market conditions,” he concludes.
