Forex ventures beyond the phone

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The development of online foreign exchange trading has lagged behind e-trading of other financial products but optimists predict it will account for 70% of the market by 2004 and 95% by 2012. The advantages are obvious, so why has take-up so far been so slow?

Henry Wilkes
The application of online technology to foreign exchange trading has taken a surprisingly long time to get going. One of the industry's leading players admits that the pace of innovation has been, until the last year, disappointingly slow. Only two online platforms are trading so far - the independent Currenex and State Street's Global Link FX Connect system. These will soon be joined by the new consortium sites FXall and Atriax.

Though no firm dates are yet forthcoming for when these will begin full trading, both are in final testing and are expected to go live this summer.

It may be that development of these online forex facilities has been held up by a lack of consensus among leading forex banks as to how to develop the sites and a reluctance to undertake investment. Some insiders even contend that certain of the bank members of the consortia sites have deliberately held back developments in order to buy time to perfect their own proprietary systems. Others simply have doubts about the benefits of the multi-dealer model for either dealers or end users.

The benefits of moving more business to online and other electronic systems would seem self-evident. By using electronic means to carry out the bulk of trading, operational efficiency should be greatly improved. Fully electronic systems offer a higher level of straight-through processing, ensuring that less time is spent on post-trade administration and vastly reducing the possibility of error, a major headache when manual input is used.

Although many forex dealers fear that online trading could hurt their profits, the benefits to customers in terms of easier access to research and analysis, quicker and more comprehensive price discovery, and more efficient processing and transparency, suggest that they will demand these services. That almost compels banks to undertake the necessary investment in time and money.

Henry Wilkes, senior vice-president and head of European foreign exchange at Brown Brothers Harriman, sums up the benefits for some players on the sell side. "The long-term advantages will come through straight-through processing and the associated benefits it brings for clients," he says. "Online initiatives also level the playing field as all dealers are able to get their prices out to clients equally, irrespective of size. We are more able to compete with the larger banks through these systems."

One of the chief unanswered questions for many on both the buy and the sell side is whether moving to electronic trading means a fundamental change in how forex business is conducted. Fear of the unknown has played its usual role, perhaps delaying innovation. But the extent to which patterns of behaviour will change is debatable. Some in the industry feel it is on the brink of a revolution but others believe that the change is more evolutionary than revolutionary.

Phil Weisberg, chief executive officer at FXall, thinks that the truth is somewhere in the middle. "At FXall we believe that online trading will revolutionize the way business is done, but this is really an evolutionary process," he says. "Over time, many things will change but this will not happen overnight." Lori Mirek, president and chief executive officer at Currenex, is also keen to allay fears. "There is certainly a significant change here," she says. "I think that many in the banks are worried about the prospect of disintermediation but this is not what we are about. What these systems do is offer a new way for all concerned parties to come together in a digitally efficient marketplace. The efficiencies gained will allow both banks and buyers more time to concentrate on their core competencies."

Although adapting to new technology is always challenging, it is important to remember that most developments are intended as a means to replicate existing processes much more efficiently, speeding the system up while reducing the possibility of costly mistakes.

Fabian Shey, managing director and head of global e-commerce for interest rates and foreign exchange at UBS Warburg in London, confirms this. "Electronic markets like FXall will play a significant role in the business from now on," he says. "But these systems are complementary to traditional channels, not an entirely new way of doing business."

Additional capabilities
Online protocols match the existing methods of price discovery and trading. Instead of ringing a bank for a quote, a buyer simply registers the inquiry via the screen. Where online systems score highly, though, is in the additional capabilities offered. Finding prices from a number of different banks in the past would have meant phone calls to numerous dealers. This can now be performed in a fraction of the time, as a quote can be requested from many banks simultaneously. As FXall's Weisberg points out: "You simply can't do this over the phone."

The flexibility of the various platforms is such that a number of pre-trade and post-trade procedures can be performed automatically, saving even more time. As well as improving price discovery and post-trade processing, the systems can be tailored to meet the specific rules of engagement required by each client.

Users are able to define the type of trades that each individual trader is able to make, set up warning systems and reminders if the value of a trade exceeds a certain level, and carry out much of the onerous but essential detail of trading. Electronic platforms also provide a full audit trail for all trades executed and quotes obtained. This latter is particularly useful for transparency, making report generation and justification of trades a much less tedious affair.

There's also reassurance for those worried that online platforms will take the human element out of the business. Although the telephone will play less of a role in the business, most of the platforms offer online chat facilities, meaning that interpersonal contact is still possible: only the medium has changed. UBS Warburg's Shey says: "Dealing online doesn't have to mean no human contact. Indeed, a well-designed discussion channel may actually enhance relationships."

Online trading may actually help to improve buy side/sell side relationships as less time spent on the actual mechanics of trading means more time available to focus on a client's needs. Stephen Smit, managing director of State Street's Global Link in Europe, points out that the system informs the dealer about who is making a request. Both sides know who they are dealing with at all times and are able to maintain their relationships. And online platforms do not, of course, prevent protagonists from picking up the phone and talking to each other whenever they want. The online system is not intended to replace the other methods but to augment them.

The developers of the electronic platforms are well aware that dealers at both buy-side and sell-side institutions will still want to use the telephone for certain problematic or large transactions, or whenever delicate negotiation is needed. FXall's Weisberg admits that the telephone will never become completely redundant. "Online trading will never amount to 100% of the business," he says. "There will always be some trades which need to be handled over the phone. This requirement is incorporated into our workflow model.

Customers can just pick up the phone if they feel the need."

While acknowledging this, Currenex's Mirek points out that users will become more comfortable using the platforms as they gain experience. She cites one corporate customer who was reluctant to conduct large-volume transactions over the internet alone. "After trying our system for three weeks, the customer steadily began transacting larger and larger deals and ended up wanting to do all his transactions online." Once the client had first-hand knowledge of the simplicity of the system and the operational benefits it conferred, the initial and very understandable technophobia that many of us feel simply disappeared. It's a tale that many of us will recognize from our own experiences with many of the other new technologies that seem to have swamped us all in the last few years.

As the forex business has begun looking to electronic platforms, two business models have emerged. Currenex and its counterparts FXall and Atriax constitute the multi-dealer side of business. These platforms embody the development of a neutral exchange model. On the other side of the coin are the banks' own proprietary single-dealer platforms, exemplified by Brown Brothers Harriman's FX Worldview product. The former, offering as they do a choice of dealer and competitive quotes, would seem to have the upper hand. But there is much to be said for the single-bank model and there are those who voice concerns over the multi-dealer platforms.

One of the major worries about the multi-bank platforms is the role played by the banks themselves in managing them. All of the major banks have some presence in at least one major site. Atriax, for example, estimates that its member banks account for around two-thirds of the existing trade in foreign exchange. It's an issue that is not faced by the independent Currenex but one that Atriax and FXall must address.

Claims to independence
Platforms whose strategy is guided by a team of board members from a core of banks have struggled to convince users that they are fully independent of these backers. But they keep trying. Atriax chief executive officer Dan Morehead says: "Atriax is structured to be completely independent. None of our bank shareholders holds any veto rights. The company is completely free to enter into any business it wants to." Morehead backs this up by pointing out that Atriax is actually in competition with one of its major partners, Reuters, through its news and information service. That's not the hallmark of a company in thrall to the whims of its shareholders.

Dan Morehead
Morehead seems to see no contradiction in also claiming that the fact that the banks have such a large stake in the success of the platforms should help to ensure that the business will develop in a manner that ultimately works to the benefit of the market as a whole. "Complete independence from the banks would not be ideal anyway," he says. "Our member banks are not only investing capital but also their reputations in this venture. They are making a big commitment so their main interest is in building a completely robust system that offers the best possible solutions." All are working together, claims Morehead, for the good of the industry, though not for completely altruistic reasons.

Not everyone is convinced. One banker points out that the motivation for joining a consortium platform is different for each of the banks. Some genuinely do want to make online trading in an open-market model successful. Others merely feel they must have at least a presence in the developing systems to have any influence over future business models. Yet others, it is claimed, may actually want the multi-bank sites to collapse, forcing all the online business onto single-dealer sites where the banks can concentrate all their efforts on attracting a much larger proportion of the business than they would receive through a multiple platform. It's a view that cannot be dismissed entirely.

In the long term, the issue will be decided by the governance structure of the platforms. Robust corporate governance guidelines, ensuring transparency and safeguarding the interests of all shareholders, will protect the interests of all and instil confidence in the independence of the various consortia.

However the market plays out in the near future, there are sure to be winners and losers. It will be interesting to see which players, and how many, can survive in the online forex marketplace. Some feel that there is room for several survivors serving different customer requirements but others believe that only the fittest will survive.

Larry Tabb, vice-president in securities and investment practice at TowerGroup, is convinced that mergers and acquisitions are inevitable. "We will certainly see consolidation in the long run," he says.

Smit at Global Link agrees: "Will four or five competing systems exist alongside each other in future? I think not, but it won't come down to just one. I think there is room for two or three systems and different sectors of the market will be served by different systems. But there will definitely be consolidation." In the end it will, of course, be the users of foreign exchange who dictate how many systems are sustainable. It may be that one or two global portals carry a large proportion of the business, with a handful of smaller platforms catering for the niche markets or conducting business on a regional basis.

Tabb, though, outlines a different vision, and one that will be of little comfort to those brave pioneers launching their platforms in the coming months. "I can foresee a time when all of these platforms have fallen by the wayside," he says. Perhaps in future it will come down to one industry standard electronic protocol that will enable buyers to deal directly with whichever dealers they wish, efficiently and securely, on an anonymous platform. "What Atriax and the others are offering," Tabb says, "is essentially an intermediary service. In the long run, the banks won't want an intermediary between them and their customers. A protocol will be developed to allow them to deal directly."

Richard Estes
Such an outcome would be of little consequence to the banks that have invested in the platforms but of profound significance to those working for the likes of FXall and Currenex.

If an industry standard protocol is what the market requires, would it be better for the industry players to join forces to develop an industry utility in the first instance, in the mode of the equity trade's FIX system and the Global Straight-Through Processing Association's plans for an STP protocol?

Predictably, those involved in the various commercial initiatives don't think so. The argument that open competition for customers will result in the forging of the best services is strong. Wilkes at Brown Brothers Harriman feels that the competitive model is the only option: "From the clients' point of view, it could be argued that the utility model would be better, as a monopoly model would most likely mean the development of an inferior service. I think that clients will get the best of both worlds as competition will result in similar platforms being developed and competing to offer the buy side the highest possible standard of services and the best price-discovery mechanisms."

There are also doubts about how quickly the buy side will take to using online systems. Exact figures are difficult to come by, but Morehead at Atriax reckons that only around 5% of forex trading is transacted online at the moment. Weisberg at FXall cites one report that forecasts an increase to around 70% by 2004. That's rapid considering that so far many corporate customers have seemed reluctant to migrate their business to online systems. "Why should we change our practices?" asks one corporate treasurer. The existing process is perfectly adequate, he argues, and changing to electronic trading would prove too costly, particularly as many feel that their internal systems would need upgrading in order to be compatible with online systems.

It seems that many in the corporate world don't know how simple the changeover could be and the extent of the potential benefits. Tom Buschman, treasury corporate development manager at oil major Shell in London, is convinced that the advantages fully justify the change. "The main benefit for us is the ability to integrate the foreign exchange trading process into our own systems," he says. "Our transactions and settlement can be executed straight-through via the Currenex platform." This means substantial improvements in operational efficiency and provides the corporate client with easy access to the liquidity pool that the company requires.

Shell International carried out an extensive research process before settling on Currenex as its preferred provider of online forex solutions. The firm was so impressed with Currenex that it recently invested $11.5 million in the platform. Buschman is thoroughly convinced that online trading is the way to go. "The combination of research and analysis tools that Currenex provides, coupled with an efficient transaction mechanism, opens up an array of possibilities for us."

Richard Estes, head of FX e-commerce at the Bank of New York, feels that online trading will soon take off. "Ten years from now, I think it's certainly possible that up to 95% of foreign exchange trading will be online," he states. "So far, just a small group of early adopters that are aware of the potential benefits have come on board. But a lot of end users seem to be holding back, maybe because they want multi-bank access and there's only one portal that provides this just now."

Estes believes that many are waiting to see how things develop before committing themselves to online trading, and draws comparisons with mobile phone use. At first, only a few people bought mobile phones but, as the market grew and their usefulness became apparent, sales boomed.

"Once people see that these platforms are successful," argues Estes, "more and more users will want to take the plunge."