Buy-Side FX Shifts in Evolving Market Structure

September 8, 2015 | By: Ivy Schmerken

By Ivy Schmerken, Editorial Director

As electronic trading grows on the buy-side and top dealers retreat from sharing market color, exchanges are snapping up FX trading venues. In July, Deutsche Borse said it will buy foreign exchange trading platform 360T for $796 million to diversify and capture volume in the $5.3 trillion-a-day currency markets. This follows BATS Global Markets’ purchase of Hotspot FX from KCG Holdings for $365million earlier this year. Meanwhile, in late August, Nasdaq OMX said it’s preparing to launch its own FX trading platform, most likely in 2016, reported Reuters.

It’s not surprising that exchanges are making this bet.

Buy-Side Movement

In the aftermath of the FX-rate rigging scandals, buy-side firms are increasingly turning to multi-dealer platforms to trade foreign currencies electronically. Investors are seeking more transparency through multi-dealer platforms where they can obtain different price quotes from multiple dealers.  However, the picture is more complex than this suggests.  Similar to equities markets, FX markets are being transformed by streaming liquidity, algorithms and non-bank liquidity providers, such as high frequency trading firms. Some buy- sides are accessing liquidity from single dealer platforms pulling in streams from interdealer brokers. Like an artist creating a tapestry, the buy-side now has the opportunity to weave together different strands of liquidity. Meanwhile, the proliferation of multi-dealer trading platforms is also putting pressure on bank-led single-dealer platforms.

As the market structure evolves, some experts predict this could lead to the rise of all-to-markets where the buy-side can trade with each other.

According to a Greenwich Associates 2014 FX study, institutional investors and large corporates executed nearly half (49 percent) of their 2014 foreign exchange trading volumes via multi-dealer platforms, up from 45 percent in 2013 and 38 percent in 2009. The study was based on interviews with more than 1,600 individuals involved in forex markets globally from September through November 2014. Two-thirds of the FX users participating in the study plan to move volume to multi-dealer platforms.

Balance sheet pressure and regulatory scrutiny have forced some dealers to alter their approach. One result is that regulatory scrutiny has made some dealers more reluctant to provide “market color,” which is diminishing the value that clients derive from interacting with major dealers on the phone, states the report.

As banks focus more of their attention and capital on clients with the biggest profit potential, they are devoting fewer resources to the marketplace, notes Greenwich’s report. “These changes in turn are pushing some customers toward lower-cost electronic execution and contributing to the movement of trading volume away from the world’s top dealers,” writes Greenwich analysts.

Corporate Flows Shift with White Label FX Technology

Corporate FX users are also shifting their volumes from single-dealer to multi-dealer platforms. “In October 2013, the amount of non-financial FX flow transacted electronically on multi-dealer platforms began to consistently outpace volumes transacted on single-dealer platforms,” according to GreySpark Partners Senior Consultant Russell Dinnage in London.

An earlier Bank of England FX survey found that an estimated 40 to 45 percent of non-financial corporate FX volumes were still executed with a broker dealer via a voice channel. The tide began to turn in October 2009 when the amount of non-financial corporate FX daily flows transacted on single dealer platforms began to fall from about 25 percent to 10 percent by April 2010. This brought these flows roughly in line with the percentage of daily FX flow transacted by non-financial corporate users on multi-bank platforms like Thomson Reuters FXall facility, according to Dinnage. “By April 2015, multi-dealer platforms encompassed around 28 percent of non-financial corporate daily FX flows compared to approximately 10 percent of non-financial corporate FX flows traded via single-dealer platforms,” wrote Dinnage in an email. Dinnage suggests this change in behavior is indicative of their ability to access FX trading on white-label trading technology at a cost

Non-financial corporate FX users, like an IBM, Apple or DuPont Chemical, also have access to white -label FX trading technology at a cost-effective margin.

If a company can trade FX itself using white-label technology, then it can access D2C venues on its own without the need to do so through a relationship with a bank and the bank’s single-dealer platform. Hence this is lowering or eliminating completely the fees that a company would pay to a bank to trade FX, suggests Dinnage.

More Control

The question is how far will the buy-side go in taking over their own trading and in using the sophisticated trading platforms and algorithms that are available to them?  Many expect that algorithmic trading will gain more traction on the buy- side. Yet according to the Greenwich study, growth in algorithmic trading has been sluggish. Only 13 percent of the study’s participants used algorithms as part of their trading process, though 8 percent of non-users indicated they plan to use them.

As has been the case with equities, the trend is toward buy-side firms taking more control of their FX business.

Here are several prime market structure trends driving the evolution in FX trading:

  • Multi-Dealer Platforms

Many banks offer single-dealer platforms (SDPs) to their institutional clients. With regulatory and market transparency tailwinds, electronic trading among buy-side firms continues to evolve in terms of product development and market access. “No sooner had most banks offered single-dealer platforms to their clients, the demand for execution management systems, liquidity super aggregators, dealing strategies and real-time analytic venues came along to further change the game,” comments David Ullrich, SVP –Execution Strategies at FlexTrade.

  • Multi-Dealing Strategies

As a sign of this transformation, asset managers are adopting multiple dealing strategies, including RFQ, streaming price aggregation, voice trading and increased algorithmic trading, notes Ullrich.  FX execution management systems enable the buy-side to connect with scores of banks and e-trading venues. Through an EMS, asset managers, insurance companies and corporations can customize their access to liquidity providers based on their relationships with banks and other firms.  This can include direct connections to single bank platforms in addition to aggregating prices from traditional ECNs and brokers, such as Hotspot, Tullets or EBS. “As a broker-neutral financial intermediary, we have no stake in who they trade with and how they trade. We give them the tools to make better trading decisions at a lower cost, all the while preserving best execution practices in the pre-trade, trade, and post-trade life cycle,” says Ullrich.

  • Allocations

Although e-trading continues to grow on multi-dealer platforms, buy-side operational limitations remain a hurdle to truly efficient execution. Specifically, if a manager has 100m Euros to allocate across 20 sub accounts, the buy-side capability is not there for them to split these trades across multiple sell-side counterparties, notes Ullrich. “Unless the asset manager operates under a prime brokerage mechanism, or has the capability to split allocations proportionally, this can impair trading activity to a degree.  Lastly, client broker restrictions may also limit market access, and while not an issue in the equity world because of central clearing, this is far from a reality in FX, even in the current regulatory environment,” says Ullrich.\

  • Inter-Dealer Brokers (IDB)

The attraction of multi-dealer FX platforms is that they offer access to more dealers and the buy-side can get multiple quotes for the orders they want to execute. However, this can be a double-edged sword. While multi-dealer platforms show strong volumes, the liquidity is still being generated within the inter-dealer broker (IDB) environment.

  • Blurred Lines

While banks dominate certain dealer-to-dealer venues, the lines are blurring between wholesale dealer-to-dealer markets (D2D) and the dealer-to-customer (D2C) venues. Over the last several years, buy-side firms have been given access to IDB networks by certain banks.

As an example of the structural change underway, several big banks have given their asset management and large hedge-fund clients access to interdealer (IDB) platforms like EBS, owned by ICAP plc.

In 2014 GreySpark Partners research showed that the sell-side provision of direct market-acess for buy-side spot FX clients into either dealer-to-client-or-dealer-to-dealer liquidity pools was not a new service offering, according Russell Dinnage, Senior Consultant, GreySpark Partners.  “Typically, technically proficient hedge funds were able to gain access to D2C and D2D FX flow  via an application programming interface (API)connectiion or via FIX,” said Dinnage. However, analysis of the pre-trade, agency trading, principal trading, straight through processing and post-trade capabilities of Tier 1 broker dealers has shown that competitive differentiators are now emerging in the ability of banks to provision DMA or sponsored access via a proprieatry aggregator contained within the single-dealer platform. This allows the buy-side to tap into liquidity from dealer-to-dealer spot FX venues like EBS Market, a leading global dealer-to-dealer spot FX liquidity pool.

For example, EBS Market facilitates this service for banks and their clients through its EBS Prime platform. “As a result, it can be argued that an all-to-all market for spot FX exists in everything but name within EBS Market because it’s possible for buy-side firms to indirectly trade spot FX flows with other buy-side firms on the platform,” says Dinnage.  This is possible for the buy side, “albeit while trading under the name of the broker–dealer granting them access to the liquidity pool,” adds Dinnage.

  • Losing Clout?

But are banks losing clout within their own single-dealer platforms?

Banks have lost clout as IDBs have allowed hedge funds and HFT firms to serve as liquidity providers in these D2D venues, once exclusive to banks. By 2016, GreySpark predicts that the lines will become blurred between D2D and D2C spot FX venues, with an all-to-all FX market arising.

  • Central Clearing

Looking ahead, the global push toward central clearing could push more FX volume on to exchanges. Though the clearing mandate is uncertain, there is a view that non-deliverable forwards (NDFs) could be required to trade on SEFs. Some multi-dealer platforms will register as SEFs, which resemble exchanges For example, Thomson Reuters SEF is an approved SEF to trade FX NDFs and FX options electronically through multibank request-for-quote stream liquidity and an anonymous order book. The latest consolidation wave to hit FX trading venues suggests that spot trading is moving onto exchanges. “Algorithmic trading and streaming prices give a measure of agency-style trading, but central clearing in foreign exchange for spots and forwards would level the playing field immeasurably, and allow by sides to access each other’s liquidity pool,” says Ullrich.

  • Competition

Exchanges are girding for competition with the incumbent FX platforms. On Aug. 4, Hotspot, operated by BATs, announced a plan to offer free trades on its new London-based matching engine to target specific currency pairs that are active in Europe and to attract participation from Asia. The price cut will be in effect until year end.

Competition will heat up when Nasdaq OMX launches its own FX platform to diversify into another asset class. No doubt they are betting that the buy side would like to trade on a venue owned by an exchange.

How FlexTrade Can Help

To help buy-side firms navigate all the current and upcoming changes impacting the FX markets, FlexTrade offers award-winning FX execution management via our FlexFX solution, which combines full depth of book for spot, futures, NDFs and swaps with streaming and RFQ prices from more than 50 liquidity providers.

For a complete review of your firm’s FX trading requirements and a demonstration of FlexFX, please contact us at