As the multi-trillion-dollar, decentralized foreign exchange (FX) market has come under increasing scrutiny from regulators and as electronic trading technology develops, there are signs that exchanges are encroaching upon a market that has traditionally been the reserve of big banks.
A Centralizing Counter
Traditionally, trading on the over-the-counter (OTC) FX market, which accounts for a notional $5.3 trillion a day in cash, or spot, and derivatives trades, has taken place via a decentralized network of interbank trading platforms.
However, a combination of regulation and new technology has forced the currency markets to re-structure.
Firstly, after a series of scandals, including FX fixing and LIBOR rigging, the largely unregulated FX market has been catching the attention of regulators.
End users are getting used to technology where they have a full view of the market.
As such, in addition to heavy fines levied on banks and tough criminal sentences handed out to rogue traders, regulators have been reviewing and legislating in order to get a better oversight of the market. This is most notably evidenced in the UK’s Fair and Effective Markets Review and the United States’ Dodd-Frank legislation.
Moreover, new electronic trading technology has emerged, allowing more and more traders direct access to the market via electronic communication networks (ECNs). This has led to greater transparency in terms of market activity and pricing.
According to Chris Concannon, Chief Executive of Bats Global Markets: “End users are getting used to technology where they have a full view of the market. They are accessing more markets than they could ever do 10 years ago.”
As FX trading becomes more regulated and centralized globally, established equities and commodities venues are positioning themselves to be a central part of this transition.
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In recent weeks and months, we have seen both the Deutsche Börse Group and BATS Global Markets, the US’s second largest equities and options exchange, make acquisitions to position themselves as players in the FX market.
Established equities and commodities venues are positioning themselves to be a central part of FX markets.
In March, BATS successfully completed the acquisition of Hotspot FX from KCG Holdings for about $365 million. For BATS, the acquisition was a strategic priority in a world in which investors are increasingly interested in accessing and trading several asset classes, in which FX represents the largest asset class by volume.
While late last month the Frankfurt-based exchange, Deutsche Börse, announced that it would buy German-based institutional ECN platform, 360T, for €725 million. 360T operates an interbank currency trading platform, including spot, forwards, options and swap products.
Deutsche Börse sees 360T as a key part of its growth strategy, using it as a way to sell market data and develop futures, FX forwards and swaps trading to boost its Eurex derivatives business, according to one FT analyst.
However, exchanges still face tough competition from well-established platforms and global banks.
Indeed, BATS’ candle is wavering. Its acquisition of Hotspot FX came shortly after the Swiss National Bank’s decision to unpeg the franc from the euro, which sent the markets into turmoil. Consequently, the cost of credit and risk management have been on top of the agenda.
Volumes on the Hotspot FX platform are at multi-year lows.
Hotspot appears to have been affected by these changes taking place in the FX market. In recent months, volumes on the Hotspot FX platform are at multi-year lows, with an 8.6% MoM decline in July – though the exchange maintains that it is due to volatility and that Hotspot remains a long-term business acquisition, of which the month-to-month performance is less important than their overall longer term strategy.
Thus, there is some way to go before exchanges get any real share of the FX pie. Indeed, while OTC markets maybe becoming more concentrated and transparent, exchanges have historically been side-lined by the banks and established ECNs.