Articles
June 22, 2023
Electronification is a common theme for panels at industry conferences such as those moderated by Hilltop Walk’s Allan Guild at FX Markets Europe 2023 earlier this month. Participants have more choice than ever when selecting their execution protocol with RFQ, streaming, algos, and peer-to-peer trading to choose from. While the discussion increasingly includes other FX products such as forwards, swaps, NDFs, and options, the evolution of FX Spot electronification continues at pace.
According to the BIS Triennial survey, there has been growth in the percentage of Spot trading volume executed electronically (as opposed to voice), from 65% in 2016, to 69% in 2019, and most recently 72% in 2022.
Know-how and techniques have filtered down from the most advanced firms over the past decade, and participants are becoming more sophisticated in evaluating their performance with a combination of in-house expertise and external tools. This is driving changing expectations of liquidity providers with a growing emphasis on the ability to internalise flow and hold risk.
Internalisation refers to the practice of offsetting trades with an institution's existing positions or future flow, without resorting to using external market for risk management. That said, some LPs may choose to skew their prices to help offset risk, and the lines can start to become blurred. Additionally, if less flow reaches the lit venues, price discovery may become more challenging for many. Nonetheless, takers hope for improved execution overall through a reduction information leakage and market impact.
To do all of this profitably on the sell side, economy of scale is increasingly important. Those with less scale may choose to focus on their own edge in the market and outsource where the internal investment to become competitive is not economical. It is no longer simply a matter of buy versus build to achieve this – vendors recognise that firms want to leverage best in class technology that can lower their costs, but with the flexibility to maintain control and build custom where it makes business sense. The relationship between technology and business teams needs to be tighter than ever to facilitate this; it is not as simple as outsource and forget.
On the buy side, participants are increasingly using passive algos to execute, rather than transferring risk to the sell side. Whether managing access for algo execution or for taking liquidity, navigating the intricate web of liquidity sources and trading venues is a complex task, and this is not just from a technology perspective.
Off the shelf analytics solutions are gaining traction to help with the analysis. Anonymised shared pre and post trade analytics provide analysis based on external data sets, aiming to help solve challenges of small sample sizes and costly trade experiments. But having vast volumes of data to hand is not a silver bullet. Participants must understand how to interpret these metrics as there are nuances that can be hidden beneath the headlines; AI solutions will continue to come to market but the foundations must be in place first.
Regulatory changes post the global financial crisis continue to be another significant driver behind change. Regulations such as Dodd-Frank and MiFID II and their aftereffects are fostering greater market transparency and promoting digital solutions for compliance, risk management, and operational efficiency.
The electronification of FX involves more than just embracing the latest technology. It necessitates understanding the changing market dynamics, advanced data analysis, and adapting to regulatory transformations. As the landscape continues to evolve, market participants must stay nimble and informed.
