British Research Consultancy Predicts Way Ahead For FX Market Structure As Fragmentation of Liquidity Increases

Consultancy firm GreySpark Consulting has released a predictive report on the ways in which the structure of the FX markets

Speculation and actual occurrences rarely go hand in hand, especially in a business which is easily affected by world events, and has no physical product, therefore is subject to very quick changes.

Changes to the structure of the FX market are difficult to document, and therefore professional services consultancies often shy away from producing data which affects the dynamic of the industry.

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London-based capital markets consultancy GreySpark Partners has today completed such an endeavor by publishing a new report which examines changes to the market itself.

Trends in FX Trading 2013 examines how e-commerce trends, macroeconomic forces and new capital markets regulations in the EU and US are challenging the investment bank-dominated FX market. These forces are giving buy-side customers more choice and control than they have ever had before in their FX trading activities.

It dissects these aspects into five specific areas which are centered on the economic background, FX volume recovery, financial markets regulation within FX, the pricing war and how no bank will voluntarily exit the FX business, reallocation of roles between market participants and the similarity of roles between D2D and D2C venues over a four year period, and lastly how to adapt to a new competitive landscape.

Buy-side Venue Accessibility

According to the report, Since 2010, the proliferation of so-called dealer-to-client (D2C) multi-dealer platforms (MDPs) has meant that the buy-side has enjoyed more choice in where they trade FX than ever before. As the number of these platforms – many of which will be registered in the US as swap execution facilities – grows, GreySpark Parnters anticipates that FX liquidity will naturally fragment away from the concentrated, bank-to-bank dealer-to-dealer (D2D) platforms onto the new D2C platforms.

Predicting Liquidity Patterns

GreySpark’s research anticipates that over the next three years the lines will become blurred between the characteristics of D2D and D2C venues, and an all-to-all (A2A) market for FX liquidity will arise. An A2A FX trading venue is an equities-like market in which all counterparties share unrestricted access to currencies liquidity. The emergence of A2A venues will continue from 2017 onward as the blurring of the divide between the characteristics of D2D and D2C FX trading venues continues.

This is a considerably tall claim, as the factors affecting liquidity currently are several-fold. Aside from the ever-evolving Dodd-Frank discussions surrounding trade reporting and other potential factors which could affect delivery of liquidity for OTC products, along with the constant drive by technology providers to up the game in terms of network performance and connectivity, there is also a discussion within the institutional sector which is making itself heard.

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In addition, industry regulators and market participants still have a series of unanswered questions regarding how the Dodd-Frank Act’s stipulations should be adhered to.

At the iFXEXPO in Cyprus in May, Norbert Lukasiewicz, Global Segment Head of Retail Brokers at Integral Development Corporation explained during a discussion panel on liquidity: We have experienced recent cases of approximately 1,000 orders per second back to back.

This is relatively unknown in the institutional sector. In the retail sector, the value is recognized but institutional participants need to make sure that they can be a part of the retail sector. They understand all can go smoothly on the tech side, but they must be sure the liquidity providers are up to it”.

Integral Development Corporation also recognize the impact that fragmentation of liquidity has had so far, and last October supplied Wells Fargo with a technology solution with this in mind.

“A broker should be able to run its own liquidity curve and find out whether clients are profitable after 30 minutes or one hour for example” explained Mr Lukasiewicz at the iFXEXPO.

Jeff Ward, Global Head of FX Sales & EBS Direct at ICAP demonstrated his view on this matter, in that companies can improve efficiency and drive cost down whilst still providing seamless execution by operating a central order book and investing in their respective platform technology, therefore being able to leverage distribution internationally.

GreySpark’s view is that banks must be prepared to adapt to this shift in the FX market’s structure in an effort to retain client business that could be lost as the A2A market encourages buy-side FX investors to trade directly with one another, breaking the mold of their traditional relationships with inter-dealer brokers.

The GreySpark report, titled Trends in FX Trading 2013, examines this theme and also looks in detail at the existing currencies dealing models at banks, analyzing how each type of model can be adapted to become client-centric to offset the emergence of the A2A market.

Frederic Ponzo, GreySpark Managing Partner and Lead Author of the report, stated on behalf of Greyspark: “In the FX market of the future, there is no one-size-fits-all solution for banks as they look to adapt their currencies dealing models to make them more suitable for an equities-like, electronically-traded FX environment. Banks must focus on putting their clients at the centre of their plans to utilise single-dealer platforms for FX liquidity while also ensuring they have the technological sophistication necessary to maintain strong profits from proprietary currencies trading.”

Frederic Ponzo, Managing Partner
GreySpark Consulting, London

Contributing Author Russell Dinnage, an Analyst Consultant at GreySpark stated: “New regulations will incentivise the utilisation of innovative new technology in the design of multi-dealer platforms, bringing to an end to the banking industry’s attempts to maintain good-governance principles for the FX market.”

The Trends in FX Trading 2013 report is one of four reports GreySpark are set to publish in 2013 that build on the success of the Trends in E-Commerce and Electronic Trading annual reports. The next report in GreySpark’s series of reports will be Trends in e-Commerce 2013, which will explore wider issues dominating the cross-asset e-commerce field. The final report in the series will examine the current state of play in equities e-trading.

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