Venue fragmentation set to continue, says FX veteran

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By:
Joel Clark
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MarketFactory chairman James Sinclair sets out the reasons why FX liquidity could fragment further, in a new white paper.

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Fragmentation of foreign-exchange liquidity has increased during the past five years and is set to persist as platform innovation continues and the market structure favours a growing number of trading venues, according to a new industry white paper.

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James Sinclair,
MarketFactory
Author James Sinclair, executive chairman and co-founder of FX trading technology provider MarketFactory, believes the proliferation of venues has been inevitable since the launch of ParFX, a bank-backed currencies platform hosted by interdealer broker Tradition that began trading in 2013.

The launch of ParFX coincided with a number of other new initiatives, each with a unique strategy to attract and maintain liquidity.

Though some platforms have been more successful than others, FX trading is no longer restricted to a small selection of venues. MarketFactory itself now connects to more than 75 venues, whereas in 2012 it was less than 20, according to Sinclair.

“The FX market seems to have moved from what was once a utilitarian model – the greatest good to the greatest number – to a model where we have a duty to every individual client,” he says.

“That is a good thing, and it is reflected in the FX global code. The combination of light regulation allowing so many execution models to form and a duty to every single client does create a healthy market.”

The paper attributes the ongoing fragmentation of liquidity to a number of factors. Among them, improved measurement of market impact means market participants are now better equipped to identify the trading venue that will offer the best execution.

Liquidity provider XTX Markets last year launched XTX-ray, a liquidity analysis tool that reveals the hidden costs of rejected trades, while increasingly sophisticated transaction cost analysis is now available from independent providers such as BestX.

Meanwhile, the increasing popularity of aggregators rather than single-venue screens means there is now less pressure on desktop space as traders can view quotes and orders across multiple trading venues without having to align themselves to a particular broker or platform.

Innovation

However, innovation is also important, and any new platform needs a unique selling point if it is to survive in the long term.

ParFX was originally conceived out of widespread frustration among the top-tier banks with the negative impact high-frequency trading firms were having on leading trading platforms. ParFX introduced the concept of a randomized pause applied to orders to encourage a level playing field, which has since been adopted by incumbent venues, including EBS.

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Roger Rutherford,
ParFX

“To be successful, a new platform must have a clearly differentiated model that challenges the status quo, adds meaningful value to traders and allows them to execute in an efficient and orderly manner,” says Roger Rutherford, chief operating officer of ParFX. 

“When we launched five years ago, we pioneered the concept of randomized trading in the FX market. Today, it has become a widely accepted market standard and forced incumbents and the wider market to rethink their business models by introducing greater levels of transparency and moving the focus away from speed to trading strategy.”

Other emerging platforms also have multiple unique attributes. FastMatch, which has attracted trading volumes of more than $30 billion on busy days and was acquired by Euronext last year, introduced its leak/sweep protection, whereby market makers can protect themselves when an aggressive liquidity consumer sweeps the market.

FastMatch would hold an order for a specified period when the protection is enabled, rejecting it if the market moves beyond a specified threshold.

FXSpotStream, another platform that has achieved growing traction since launching in 2012 – its average daily volume was $26.3 billion in January – brings together buyers and sellers in a bilateral, fully disclosed environment without charging transaction fees.

State Street recently became the 13th liquidity-providing bank to go live on the platform.

No limit

MarketFactory’s Sinclair believes there is no limit to the number of platforms that could ultimately serve the FX market.

“There may be no limit to new ideas and therefore new venues or possible models within venues,” he says.

“MarketFactory and many other firms have original ideas reflected in patents. Perhaps there will be new and precise ways of determining customers’ unspoken needs. Perhaps someone can solve the holy grail of telling electronically in advance whether a customer is really going to give you his or her promised amount.”

However, Rutherford at ParFX does not see further fragmentation as being inevitable.

“While it is entirely possible that the market will continue to fragment further, we are confident in our model, which provides an alternative that was desperately lacking prior to our inception,” he says.

“Any new trading venue must have a similar impact in order to succeed.”