Electronic FX trading gathers steam in 2014
While other leading markets are yet to follow Switzerland’s lead and mandate automated trading of currency, the industry moves inexorably towards automation. But the push creates new market risks for both the buy side and sell side.
Earlier this year, Tharman Shanmugaratnam, chairman of the Monetary Authority of Singapore, told an Institute of Banking and Finance event that three-quarters of global FX trading volume is now executed electronically.
Recent fines for market manipulation levied by US, Swiss and UK authorities will add momentum to the shift towards automated processes, says Howard Tai, senior analyst Aite Group.
“Spot FX is an example of a product that is well-suited to being traded electronically," he says. "Voice trading will never disappear entirely. It will be used for more complicated instruments with specific maturity dates and product features.”
Aite Group research indicates that in 2013 electronic trading accounted for two-thirds (66%) of the spot FX market activity and by 2019 that figure is expected to increase to 72%. In contrast, electronic FX options trading was at 38% last year and, even allowing for centralized clearing, the firm doesn’t expect that figure to be higher than 49% by 2019.
Kieran Fitzpatrick, CEO at Barracuda FX, is convinced that recent fixing scandals will encourage further use of automated processes.
“We are already seeing banks turn to automation to remove some of the human element from the fixing process, driven by the regulatory requirement to adhere to the recent Financial Stability Board guidelines as well as a desire to manage their market reputation,” he says.
Ticket sizes continue to increase as clients become more used to automated trading and tight bid/offer spreads encourage banks to push their electronic offerings.
While many processes outside the core trading activity remain manual, for example the on-boarding of a client into an electronic multi-dealer platform, these administrative processes are now also being addressed through initiatives such as TESI (trading enablement standardization initiative).
The general trend towards additional electronic trading is continuing, says Sassan Danesh, managing partner at Etrading Software.
“As well as the obvious reason of demand for greater transparency from regulators, electronic trading also provides greater control for banks to set and enforce trading and pricing policies through their systems,” he says.
Danesh warns that while algorithmic trading allows the buy side to achieve better pricing, it also increases market risk.
He adds: “By working a large order themselves, rather than delegating the function to banks, the buy side will need to be capable of managing greater risk even during periods of market stress. This is a challenge for some, as their risk-management systems are typically less mature compared to banks.”
If you were being cynical you would say this is
part of the motivation – further consolidation and monopolization within the global banking industry
CMC Markets analyst Jasper Lawler says banks have encouraged the trend towards further use of automated processes by owning their own proprietary trading companies that develop algorithms.
“Equally, high-frequency trading clients place a lot of their trades by their very nature so can be very lucrative for a bank that is making the market, although additional algorithms are needed to manage order flow,” he says.
Lawler suggests the cost of automation infrastructure limits the number of institutions that can participate in the market, thus reducing competition.
“If you were being cynical you would say this is part of the motivation – further consolidation and monopolization within the global banking industry," he says. "Automation brings with it high initial costs, which will only be recovered with increased efficiencies over time.
"The largest banks have the capital to invest and now is arguably one of the best opportunities for them to do so when expectations are so low for profitability in the industry because of increased regulation.”
Etrading's Danesh accepts that the latency race has eased somewhat as most participants have moved to a collocated infrastructure and as FX venues adopt measures such as randomized pauses. However, he says there are still substantial benefits to having scale in this market – especially when it requires handling market risk.
One of the hypotheses that has been doing the rounds during the past 12 months is that clients will gravitate away from the large banks, but this has not happened, according to George Kuznetsov, head of research and analytics at Coalition.
“However, I would expect banks that are reliant on institutional client activity to be in a challenging position, which may lead to consolidation,” he says.
Aite Group's Tai says this greater use of technology offers some advantages to larger institutions that can implement solutions more quickly, while smaller rivals might find it hard to generate the volumes necessary to offset additional infrastructure costs.
“However, white-labelling of third-party technology or even single-bank dealer platforms is becoming common practice, which means that smaller players with limited budgets can have an electronic platform,” he concludes.