09.18.2014
By Terry Flanagan

FX Trades: More but Smaller

The foreign exchange markets, once dominated by big banks, are now starting to resemble other asset classes that use order books and electronic matching engines. The amount of spot FX trading being executed electronically continues to increase, especially among institutions.

“As assets get commoditized and commercialized, they eventually end in a fully electronic world. FX is electronic but it’s become more and more electronic,” Jake Loveless, CEO of Lucera Financial Infrastructures, told Markets Media. “You’re seeing more and more trades, with smaller and smaller trade sizes, you’re seeing the beginnings of execution services, and you’re seeing an increased fragmentation. You’re seeing a lot of players, a lot of new liquidity providers.”

Lucera currently has four FX matching engines running on its New York platform, and plans to launch two more in London.

Where once banks dominated FX market making, today non-bank liquidity providers are making really providing much of the liquidity, taking on liquidity risk, and offsetting it in other assets, not just hedging within the FX asset class itself. Equity market making firms, high-frequency trading shops, and statistical arbitrage players are all making the move into FX, providing competition to the traditional, bank-only liquidity model.

Jake Loveless, Lucera

Jake Loveless, Lucera

Although Lucera provide infrastructure for all asset class, the only one that is experiencing growth right now is FX. “It used to be that the equity trading groups were the ones that would get the lion’s share of the budget, but we’re now seeing the lion’s share go to foreign exchange,” Loveless said. “I expect to continue to see that grow.”

FX activity is also picking up among buy-side firms, most frequently on the liquidity taking side. “You have a lot of people coming into this marketplace who have always traded FX but haven’t given it all that much thought,” said Loveless. “They might have some FX exposure and they would hedge it out at the end of the day. Now, because volumes are low and volatility’s low, and everybody’s focusing on execution quality, all of a sudden FX matters.”

Traders of American depositary receipts, who trade stocks between different countries and who used to just take the FX risk onboard and then offload it at the end of the day, are now trading FX directly because the extra tenth or two-tenths of a basis point makes a difference.

ITG, an execution and research broker, has launched the ITG FX Volatility Index (ITG FXVX), a daily benchmark for FX traders and portfolio managers. The ITG FX Volatility Index forecasts the volatility in the coming trading day based on historical trends and adjusts for implied volatility as well as recent volatility trends across dealers and ECNs on the previous trading day.

ITG also upgraded the ITG FX Trading Cost Index (ITG FXCX) to include cost estimates for 5 currency aggregates (Asia Pacific, Big 3, Commonwealth, Emerging Markets and Europe) as well as 20 currency pairs.

“The new ITG FX Volatility Cost Index, together with the enhanced ITG FX Trading Cost Index, enable foreign exchange traders to estimate trading costs and potential price slippage from volatility before placing trades,” said Ian Domowitz, ITG managing director and head of analytics, in a release. “Both tools are available via a free web-based mobile app, offering an easily accessible reference tool for anyone seeking insight into FX trading.”

In addition to hosting FX matching engines on LumeFX, Lucera provides a software-defined network called Lucera Connect that enables customers to connect to dozens of FX trading venues.

“It’s not like equities, where there are exchanges and a few dark pools. There are 30 or 40 (FX matching engines) just in New York alone that you probably need to connect to, and then when you add London, you could be taking about sixty or seventy connections,” said Loveless.

“We’ve got buy-side customers who are using that to get better price executions, and we’ve got sell-side customers who are using that to aggregate prices; and we’ve got customers running full-blown ECN-style matching engines using LumeFX, which is our aggregation and pricing summation system,” he said.

Featured image via Sergio Martínez/Dollar Photo Club

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