FX trading venues using central limit order book (CLOB) systems to match buyers and sellers saw double-digit percentage increases in activity in 2022.
The CLOB approach, which is used by most exchanges and offers an alternative to asking for quotes, is what allows all kinds of participants to trade anonymously with each other and in real time. Trades are executed more quickly the closer they are to the best bid and ask at any one moment.
The importance of firm pricing in volatile markets was one of the factors driving the increases, say some market participants.
“Pricing or best execution will consider many factors, with spreads clearly being one of the most significant,” says Jeff Ward, global head of EBS at derivatives marketplace CME Group. “In addition, some customers value execution in primary markets, given the transparent nature of a central limit order book. We saw the return of clients last year who told us they lost out when volatility drove spreads wider on bilateral venues.”
While the speed of market data and execution has increased on the primary CLOBs, ECNs still surpass them when it comes to competitive pricing, flexibility, speed and execution options
Clinton Norton, Euronext
Some traders may think that CLOBs are more expensive than simply executing a risk-transfer trade with their chosen bank counterparty, but that would be painting too simple a picture, suggests Jamie Singleton, chairman and chief executive of Cürex Group, an FX-focused execution services and data analytics provider.
“The FX marketplace has many participants with different objectives and missions,” he says. “We focus strictly on the buyside – our platform does not include high-frequency traders and we do not allow our liquidity providers to trade with each other.
“Our trading clients care a lot about market impact since their trades are directional, and as a result they view their cost of trading differently.”
Cürex’s platform analyses the appropriate trading strategy before each customer trades and then assesses that decision using multiple criteria after the trade occurs. Sometimes the answer is to execute the trade directly via risk transfer, while in other cases the answer is to use an algo and an optimal speed.
“The objective is the same – to lower their overall cost of execution and minimize their market impact,” adds Singleton. “So simply assuming that central limit order book platforms are more expensive and less flexible would be wrong-headed without examining pre- and post-trade data.”
Yet many traders continue to view higher pricing and lack of flexibility as too much of a downside, despite the faster data and increased trading options available from CLOBs. The priority for the buyside is to find the lowest cost execution, while the sellside (liquidity providers) seeks non-correlated flow that allows it to capture a high proportion of the bid/ask spread.
Edward Bolton, institutional business development manager at StoneX Group – an execution and clearing services provider – explains that CLOBs generally have wider pricing and higher fees than direct bilateral trading “so there is very little there to attract the buyside. This results in central limit order books having a very high percentage of sharp flows, which ensures that pricing remains wide.”
Fair-price mechanism
The benefit of CLOBs is that they provide the street with a mechanism to discover the fair price of any instrument. The downside of a venue that can be used for price discovery is that there is a ‘signalling risk’ involved in placing orders into the market.
“On the basis that brokerage costs are relatively well-aligned across venues, it is intuitive that a trader would choose to place interest where they are able to maximize the chance of being filled subject to minimizing the chance of signalling their intention to the market,” says Geoff Jones, director FX spot venues at financial markets infrastructure and data provider LSEG.
However, Clinton Norton, head of FX global sales at Euronext, says that CLOBs are still outperformed in a number of ways by trading via electronic communication networks (ECNs).
“While the speed of market data and execution has increased on the primary CLOBs, ECNs still surpass them when it comes to competitive pricing, flexibility, speed and execution options,” he says.
Norton suggests clients trading over ECNs do not need to compromise on any of these factors. “We construct our liquidity pools based on specific client needs, rather than enacting the all-to-all format of a central limit order book,” he adds. “The number of counterparts a client faces are less important than the quality of pricing/execution.”
