Exchanges have been busy bolting on new acquisitions during the past 18 months.
Shareholders of the London Stock Exchange (LSE) have approved its deal to purchase Refinitiv, a financial data business that was carved out of Thomson Reuters and bought by Blackstone in 2018.
Deutsche Börse, meanwhile, has acquired GTX, an FX electronic communications network (ECN), while CME Group has bought NEX, which included the EBS trading platform.
The moves appear sensible. Each of the exchange operators has opportunities to provide trading, clearing, processing, data and analytics tools to both pure FX traders and traders who are hedging against securities or derivatives.
“The merger between LSE and Refinitiv should be a powerful package as it brings together the data expertise of Refinitiv with the trading experience of the LSE to create a services provider to banks and brokers offering a platform for trading shares, currencies, bonds and derivatives,” says Henry Wilkes, head of foreign exchange at Point Group, a consultancy firm.
Exchanges are now highly electronic marketplaces, so investment in electronic FX trading platforms is a logical move.
This is particularly important because of increased regulatory oversight, such as the European Securities and Markets Authority (ESMA) guidelines in Europe, which have increased compliance costs and squeezed exchange operating margins, according to Jason Hughes, global head of sales at ADSS, a multi-asset trading company.
However, data from the 2019 survey by the Bank for International Settlements (BIS) indicate that average daily volumes for the primary FX venues have fallen during the past three years – during which time spot FX volume rose by more than 20%.
Some of the factors behind this decline include the main liquidity providers losing control over liquidity as their pricing is recycled to secondary and tertiary venues.
Alongside that is lower volatility and an increase in internalization by liquidity providers, as well as the rise of the non-bank market-maker with connectivity across the market.
According to LMAX Exchange Group CEO David Mercer, this lack of growth highlights the difficulties of running an efficient and profitable business with a purely transactional model that serves the institutional market – which already benefits from some of the lowest transaction fees in capital markets.
“It is natural for transaction fee or commission-only models to be challenged in low-volatility environments, which we have seen for much of 2019,” he says. “The exchange groups that have purchased FX trading venues need to expand the footprint of their new acquisitions to add significant corporate value.”
This has encouraged exchanges to consider the peripheral services offered by over-the-counter (OTC) venues and to look at whether to impose minimum brokerage fees.
However, Mercer suggests the low value of market data based on last-look prices explains why some recent FX platform acquisitions have failed to generate revenues from their market data offerings.
“If you operate only in the bank space or the high-frequency trading space, it is hard to have a viable business model – particularly in low-volatility environments,” he says. “So, first of all you have to be able to access all segments of the market and then have some part of your business that is recurring.
“In the large exchange world, this is market data.”
Options for generating additional revenue include increasing market data charges. However, accurate and timely FX market data is tightly held by banks and non-banks that pay handsomely for the privilege, and it remains to be seen whether they have the appetite for even higher fees.
Euromoney has previously reported how FX investors do not want liquidity to become fragmented as has happened in other markets, but they also want more choice in how they trade and with whom.
Noel Singh, head of eFX business development at derivatives broker Sucden Financial, says exchanges are addressing these apparently conflicting demands in some cases by trying to create ‘FX supermarkets’, where clients can choose to trade a variety of products in different ways.
“For instance, clients may trade exchange-traded FX contracts or use an OTC spot FX central limit order book, or when trading longer-dated OTC FX contracts they may choose to use a disclosed multi-provider venue,” he says. “Exchanges seem to be trying to be all things to all users.”
On the basis that there are only a few genuine liquidity providers in the market, the buy side will find it more difficult to justify the cost of connecting to venues that simply provide recycled liquidity.
“If the exchanges can tap into this trend and bolster the importance and role of their primary venues, it will undermine the relevance of public ECNs, where more than half of the traded volume is likely to be based on recycled liquidity,” says Point Group's Wilkes.