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FOREIGN EXCHANGE

Consolidation, fragmentation and segmentation

The advent and growing sophistication of algorithms means that the pooling of liquidity can be done virtually, so why bother concentrating it on a venue that is widely loathed and could develop into a monopoly?

A few years ago I wrote what I thought was a clever article about the fragmentation of a consolidating market. In it, I tried to explain the contradiction of how more trading venues were springing up in the FX market at the same time as widespread consolidation was reducing the number of banks active in it. I argued that fragmentation was a major reason why the FX market revived and started to grow after a period of what appeared to many as almost terminal decline around the turn of the millennium.

Looking back, it now seems clear that the predictions of many – that the market would move towards an exchange model – were and remain wrong. The FX market has refused to centralise and it has continued to thrive in an extremely fragmented structure. Now, there seems to be a growing consensus that the market will never move on to a single exchange; but rather than talk of fragmentation, participants are starting to describe the market as being segmented. In other words, the numerous venues that already exist and which have yet to see much of the light of day may well continue to thrive because they all provide slightly distinct services tailored to meet the needs of a particular market segment.

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