FX ‘Electronification’ Flourishes

Terry Flanagan

Foreign exchange markets have readily adapted to screen-based trading; it’s not quite equity-like but it’s considerably further along than fixed income.

“There is increased electronification and adoption of electronic trading across different markets and products,” said Sang Lee, managing partner at consultancy Aite Group. “This has made the FX market more dynamic, fragmented and competitive.”

The state of the FX trading business will be discussed in detail at the inaugural FX Trading Network, presented by Markets Media and Aite. The half-day event will be held in New York in early October.

“The FX market is unique in that it is OTC, but it is highly electronic,” Lee said. “This is because it has certain elements and infrastructure in place that enables support for folks who trade FX quite actively. These elements mimic what you in exchange trading.”

Sang Lee, Aite

Sang Lee, Aite

Lee cited prime brokerage and continuous linked settlement as factors that set the stage for a thriving electronic FX market. Prime brokerage provides the credit that has allowed non-banks to participate in FX trading and electronic communication networks to emerge; CLS, introduced about a decade ago, addressed concerns about settlement risk.

“Having these two infrastructures in place makes it a lot easier for firms to actively participate in the FX market,” Lee said. “Because of that, you see surprisingly high levels of electronic trading within FX, especially spot FX.”

One trend in the FX market is for more regulation and transparency. Multiple highly publicized instances of FX price manipulation have drawn regulatory scrutiny, and underscored market participants’ need for a reliable check that an FX trade was a fair deal.

“It gets tied back to best execution and transparency,” “TCA (Transaction Cost Analysis) tools are being adopted within the FX market to provide a certain level of confidence in trade execution.”

Last year, five global banks agreed to pay $3.4 billion in fines for their roles in the so-called WMR/Reuters fix, in which traders were alleged to have taken positions before they knew clients were going to buy.

“There have always been question marks around best execution, lack of transparency, and other stuff you typically hear about when you’re looking at any OTC market,” Lee said. “FX happens to be the largest OTC asset class out there, so it’s notable that it has never really had any heavy-handed regulatory oversight. But there is an increasing likelihood of that coming.”

Other topics germane to the FX market are the agency execution model versus the traditional principal approach; the rate of algorithm adoption in FX trading; and advances in FX trading technology.

Feature image via OkFoto.it/Dollar Photo Club

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