We’ve just completed our second installment of the TrendSpotters Thought Leadership Series. In this episode, I interviewed Dr. John Bates, Chief Technology Officer and Dan Hubscher, the Director of Industry Solutions for Capital Markets at Progress Software.
Podcast: Download (16.2MB)
We talked about the current state of foreign exchange electronic trading, how banks are building single-dealer platforms (also known as FX ecommerce systems), and the challenges presented by this highly fragmented and opaque asset class.
The FX market is huge. According to the Aite Group, in early 2010, the market reached $4.5 trillion dollars a day. Trading is decentralized and is supported by commercial banks that serve as principals or intermediaries between buyers and sellers of currency pairs. FX trading includes spot, forwards, swaps and futures. Because FX trading is conducted primarily over the counter (OTC) between banks, pricing is extremely complex. To support electronic trading in FX, banks must develop sophisticated dealing platforms.
First of all, a dealing system needs to aggregate data from many different sources including data feeds such as Reuters, multiple ECNS, interdealer brokers, and dealing banks. So automated pricing engines require a view of liquidity from multiple sources. This requires extensive API connectivity, specialized feed handlers, and physical connectivity to pricing feeds from dozens of disparate sources around the globe.
But the complexity doesn’t end with aggregation. Once banks have a view of liquidity, they also must establish pricing algorithms that account for shifts in that liquidity, choose spreads to offer, hedge risk, manage positions, and incorporate commissions – all in a real-time, highly volatile environment.
Then, banks must publish prices out to clients. But this too adds complexity. Banks need to provide aggressive pricing to attract customer order flow, but not all business entails the same level of risk. In addition, different classes of customers have different needs. For example – traditional FX customers such as multi-national corporations value large size and ability to complete transactions quickly, while hedge funds running statistical arbitrage strategies generally deal with smaller and more frequent transactions and value lower execution costs. This creates a demand for tiered pricing and service packages based on client segment.
Single dealer platforms also need credit/margining systems, gateways and trading GUIs for clients, and connectivity to the back office and to bank and customer portfolio systems.
To further complicate matters, risk management and hedging needs to be handled in an environment of fast moving prices where substantial activity occurs outside of regular data distribution intervals and where the market can move against a trade in an instant. As high frequency trading ramps up in the FX world, new complexities are introduced. Most FX market data is delivered in pulse intervals instead of continuously, and most ECNs impose throttling to limit the number of orders that can be submitted within a rolling time window. Some also impose fill ratio requirements.
In spite of these hurdles, the number of single dealer platforms is growing, and the amount of FX trading done on these platforms now exceeds 35% of the overall FX daily volume, according to Aite Group. As the platforms grow more sophisticated, we expect to see even more adoption of electronic trading.
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