Volumes in electronic FX trading (eFX) have experienced huge growth over the last two years, moving at a much faster pace than global FX trading as a whole. According to a recent report by Greenwich Associates, eFX volume more than doubled from $7000bn in 2003 to almost $16,000bn in 2004.
The research, based on interviews with FX customers, shows that the use of eFX among banks increased the most, representing $6000bn of the total growth in the sector. More significantly, the growth in eFX has been consistent over the past few years and is expected to continue in the near future.
It is important to note that most of the growth has come from existing eFX users who increased the proportion of their total trade volume executed electronically from 43 per cent in 2003 to 48 per cent in 2004. Many investors who haven’t yet embraced eFX are still uncertain about how electronic trading can benefit their organisations.
“The ones that are more reluctant to make the move are typically corporates,” says Giovanni Carriere, consultant at Greenwich Associates. “You need a certain basic investment to set you up with electronic trading, and if you don’t trade enough it might not be worth it.”
On the other hand, banks and hedge funds are adopting eFX at a faster pace, both driven by similar factors. “Banks are mostly moving because it makes sense for them to put together an overall e-trading infrastructure. In addition, this helps banks with a trend that we have been seeing recently, which is the outsourcing of liquidity,” he adds. And, indeed, a lot of banks, specially mid-sized ones, have come to the conclusion that making markets in many different currencies was just too expensive. For them, e-trading means a quick access for buying currency when clients need it, without having to keep a wide range of currencies in their books at all times.
It seems that when it comes to eFX things are actually black or white. Those who use it, love it. Those who don’t, are happy to stay away claiming they simply don’t see any compelling reason to change the way they trade.
As things stand at the moment, some FX users see that the potential benefits of electronic trading are not worth the possibility of losing contact with the salespeople who provide them with information about the market. Also, they see the investment in technology needed to get them up and running in eFX as being too high. However, according to the Greenwich report, things could dramatically change if EBS Prime’s trading system manages to extend its services to the FX buy-side, giving users access to an electronic system that promises to provide more liquidity and tighter spreads.
Restructuring conditions
“What we see is that the market is at a critical junction and we don’t know for sure which way it will go. But providing that a couple of things happen there is a chance that the e-trading market will re-structured itself, becoming different from what it is today,” says Mr Carriere. “The first condition for this to happen involves the banks reaching an agreement, opening up their platforms offering liquidity to everybody in the market. Second, it will also be necessary to have a universal STP solution and to be able to access a simple processing solution, which is what is keeping a lot of people outside of this market.”
Mr Carriere compares the FX market with the fixed-income market saying that the latter is much more efficient because there are only one or two big platforms where all the liquidity converges. He believes that if the two aforementioned conditions become a reality, then those trading in the FX market could benefit from the same efficiencies as those trading in bonds.
“It’s difficult to forecast if this will happen because it depends on a human decision and the banks basically reaching an agreement,” he says. “For a lot of the banks it does not make sense because they already have good proprietary trading systems that have been reasonably profitable, and also they have built strategies around those systems.”
Whatever happens in terms of the extension of EBS Prime or indeed the establishment of another centralised platform, the market will continue to grow and those who haven’t already done so will have to examine whether their current infrastructures are well equipped for the future and can cope with growing volumes.
“The problem with this market is that margins are very tight and you need the right infrastructure to lower the costs,” says Gerard Rafie, vice president of marketing at trading and trade processing of software provider Calypso. “This is a replacement market where more and more banks are moving to change their systems. There are more electronic platforms specific to a certain segment and each platform is crying loud and clear that they are the leaders. But what all these platforms are doing is to contribute to boosting the market.”
Integration
The problem for those trading on these platforms, he explains, is to integrate the infrastructure of the trading system of the bank to those platforms and to the back office.
“Today the real problem is to create an STP environment and this is very difficult even with a new system because the real challenge in FX projects is integration and all the processing that comes from the trading, allocating payments, settlements, credit risk management and so on,” Mr Rafie says.
“You have new systems that are front office-driven integrated to those platforms, but you still need to integrate with the back office. So STP is not really here as yet.”
Because of this, banks are having more and more problems and are now interested in having systems where the back office part is also integrated with the front office and risk management part.
Calypso aims to position itself as a potential solution to replace existing systems in the market, offering clients its cross-asset front to back trading and trade software processing. Its clients already include HSBC and Rabobank among others.
“FX is a very simple market but the volume makes it very difficult to handle. If you look at the big banks we are talking about hundreds of thousands of deals per day and even millions to be handled from front office to back office,” he says.
Gaining ground
Traditional software houses are showing substantial interest in gaining ground in this replacement market, as banks find their existing systems will not be able to cope with growing volumes. “The problem for traditional software vendors is that they are trying to adapt the technology of the last 15 to 20 years to a new infrastructure that can handle high volumes. This can be done but not without consequences,” he says.
As the market develops the need for developing new systems and replacing others will carry on over the years to come. eFX platforms covering different segments will continue seeing new business coming in as more customers embrace electronic trading.
Mark Warms, chief marketing executive at FXall, thinks the increasing need for improved control and compliance in business is one of the drivers behind eFX growth. “In the US we are seeing a big move in terms of people looking at their control and compliance. Sarbanes-Oxley is pushing corporates to look at a more controlled way to business,” he says. “Globally investors are demanding more and more from their asset managers or the places where they are putting their money in to provide them with best execution-even in the foreign exchange world.”
He explains that even those clients who thought their old FX trading systems were good enough, once they make the move eFX they typically find the change was well worth it. “Most clients, corporate or asset managers, that we put in our system are doing more than 90 per cent of trading over our platform within 12 months.”
FXall, one of the leading online FX trading platforms, recently announced that daily trading volumes on their platform have broken through $43bn, due to increased activity across all its client segments - active traders, asset managers, corporations, banks and broker-dealers – with new clients signing up and existing ones increasing volumes.
Mr Warms describes FXall not as a trading platform but as a workflow trading solution that helps people streamlining and automating what they already have. “It is not just about getting a trade done. It is about control and compliance, best execution, automating the trading cycle, improving efficiencies and reducing errors.” He explains that since FXall went life five years ago numerous features have been added, meaning a higher percentage of customers can automate their entire workflow.
As e-trading platforms improve and add new features, and customers update their current infrastructures the future for eFX is a promising one.
