A 22% rise in euro FX futures and options volumes on derivatives exchange CME in September might offer encouragement for other exchanges seeking a larger slice of the FX market, but there is no definitive evidence of a dramatic shift in trading away from over the counter (OTC).
Euronext’s recent completion of the acquisition of FastMatch is the latest illustration of exchange operators’ desire to grab a larger chunk of the trillions of dollars traded in FX every day.
It followed the 2015 acquisitions of trading platforms Hotspot and 360T by Bats Global Markets and Deutsche Börse, respectively.
Kevin McPartland, Greenwich Associates’ head of market structure and technology research, has previously told Euromoney that the future lies in venues that support multiple trading models.
Investors do not want liquidity to become fragmented, as has happened in other markets, but they do want more choice in how they trade and with whom.
On this basis, providers that can offer investors choice in execution methods, counterparty interactions and product types should have an advantage over the coming years.
This view is shared by David Holcombe, product manager for listed FX and clearing at 360T, who says clients are becoming sophisticated in terms of how and where they want to interact with the market.
Meanwhile, FXSpotStream CEO Alan Schwarz notes that since cost of execution is of paramount importance for the sell side and the buy side, venues that address the costs of execution will naturally have a better chance of attracting a client’s business.
The 2016 Bank for International Settlements (BIS) triennial survey showed a modest shift in market share from spot to swaps and non-deliverable forward (NDF) trading, which requires venues to embrace additional models.
Furthermore, since most venues’ revenue depends on volume traded and overall spot volumes have decreased slightly, there is an incentive for venues to seek new trading models.
This echoes changes that took place when the BIS survey reported a spot volume decrease in 2001, explains James Sinclair, executive chairman of MarketFactory.
“That spurred radical innovation, including Reuters’ and EBS’s launch of both API trading and service to non-banks through prime brokers,” he recalls.
Demand for multiple trading models makes sense given the diversity of market participants, business models, products and liquidity profiles, but doesn’t necessarily mean every venue must support every model, says Joshua Walsky, CTO and co-founder of Broadway Technology.
“Instead, participants can use cross-model aggregation tools to gain access to the right models from the right venues for different business goals at different times,” he says.
Institutional FX Advisory Partners (IFXAP) founder Henry Wilkes also takes a circumspect view, suggesting that while there is a future for exchanges accommodating certain aspects of the FX market, not all trading will migrate to such venues.
“However, there could well be demonstrable advantages to trading NDF and some FX forward contracts on such venues, allowing market participants to create a centralized collateral management programme for all asset classes,” he adds.
“This would minimize the cost of collateral and the associated costs of resourcing the programme.”
Disclosed or undisclosed?
R5 CEO Jon Vollemaere notes that while his platform offered fully disclosed trading from the outset, undisclosed remains more popular.
Market participants have only recently begun to fully leverage electronic disclosed trading in an aggregated setting.
A key requirement for this to happen is software that allows traders to trade against liquidity from a multitude of sources while at the same time automatically respecting all counterparty relationships, notes Broadway’s Walsky.
“Increasingly we are seeing explicit discussion among parties about what type of direct channel they will share and how they will include it in aggregation,” he says.
“It is not uncommon for a single party to have two distinct pricing streams from the same counterparty – one that is aggregated and a second that is ‘full-size only’, to leverage the benefits of disclosed trading and relationship-based pricing.”
Algorithmic trading models support the move to disclosed trading and IFXAP’s Wilkes refers to increased appetite from buy-side institutions to understand such models.
“Algorithms will become a key element of any trading strategy in the Mifid II world and transaction cost analysis is also essential for monitoring the validity and accuracy of any agreed costs in a fully disclosed trading model,” he says.
“However, there is much work to be done by all market participants before the FX market becomes a fully disclosed trading model.”
Sinclair at MarketFactory reckons that the balance might even be shifting the other way, with the trend towards disclosed trading losing steam last year.
“A possible reason for this is that a good way to show that you achieved best execution is to trade on a recognised, liquid central limit order book, such as an ECN, and they are largely anonymous,” he says.
“Another potential explanation is that many non-bank market makers that have come into FX from other asset classes are very comfortable with the central limit order book model.”
Euromoney asks Pritesh Ruparel, head of FX options origination and structuring at Sucden Financial, how FX options clearing might affect the balance between OTC and exchanged-traded FX.
He suggests there are notable limitations on the current clearing offering that outweigh the efficiency benefits that a full-service prime, or prime of prime, can offer for clients who trade a full suite of FX products, including spot, forwards, NDFs and FX options.
“A prime brokerage or prime of prime relationship is more efficient for the majority of users as it provides a portfolio effect for multiple instruments, enabling cross-margining,” he concludes.
“Until the clearing product suite is broadened, netting benefits are realised and administrative costs of post-trade clearing are addressed, there is unlikely to be much impact on the overall market.”