Peter D'Amario Consultant with Greenwich Associates
Peter D'Amario Consultant with Greenwich Associates

The new drivers of e-trading growth

Peter D'Amario assesses the importance of Hedge Funds, Real-Money managers and the Retail market in driving current e-trading growth.

First Published: e-Forex Magazine 23 / e-FX Industry Report / April, 2006

Since the inception of electronic foreign exchange trading, companies and large financial institutions have driven the rapid and consistent growth in e-trading volumes. In 2005, however, the pace of growth among corporations and large institutions slowed considerably relative to that seen in prior years. Despite this slowdown, e-trading continued to boom thanks in part to a somewhat unexpected source: retail customers.

EFX trading volumes among large companies and institutions had been doubling every 12 months for the past three or four years and this year’s growth among the institutional segment was more in the range of 10%. In many respects the real action in electronic foreign exchange last year took place among ‘non-traditional’ FX traders including hedge funds and so-called ‘retail aggregators’ operating around the world.

Total electronic foreign exchange volume among the forex customers interviewed by Greenwich Associates as part of its annual global FX Research Study increased from approximately $15.7 trillion in 2004 to almost $17 trillion in 2005. The majority of this growth was generated by financial institutions, which as a group increased their annual e-trading volume by about 8%.

Among the financials, fund managers and pension funds significantly increased their eFX trading activity, with average volume increasing some 68%. Only one other class of financial institution topped this rate of growth: organizations classified not as banks, funds, hedge funds, nor insurance companies. E-trading volumes among these ‘other’ financials increased 70% from 2004 to 2005 — a rate of growth that we would attribute to the large increases in the amount of business coming through ‘retail aggregators’, particularly those in the United States and Asia.

eFX 2005: Financials Lead the Way
The proportion of large corporate and financial users of foreign exchange services trading FX online remained stable at about 44% from 2004 to 2005. Over the past 12 months, however, the proportion of e-trading holdouts that say they plan to start trading electronically in the coming 12 months slipped slightly from 14% to 13% a sign that electronic trading systems might have reached at least a temporary plateau in terms of number of customers.

Across all geographic regions, more than half of financial institutions trade FX electronically as compared to only 37% of corporates. Among all types of FX user, those with the heaviest foreign exchange trading volumes are also the most likely to trade electronically. More than 55% of corporates or financial institutions with more than $10 billion in annual forex trading volume use electronic trading systems, as compared with 37% of users with total trading volumes between $1 billion and $10 billion, and just 27% of smaller traders.

E-trading systems last year did manage to attract a significant number of new customers from one important group: hedge funds. The proportion of hedge funds interviewed by Greenwich around the world trading FX electronically increased from 49% in 2004 to 53% in 2005. Over that same period, the total amount of electronic trading volume generated by hedge funds increased 46%.

The new drivers of e-trading growth
Total eFX volume also rose dramatically among fund managers and pension funds. Although the percentage of these FX users trading electronically was roughly stable from year to year at just over 40%, fund managers and pension funds that do trade online increased the portion of their total FX trading volume done electronically from 53% in 2004 to 61% in 2005. As a result, the total amount of electronic trading volume generated by this group increased nearly 70%. Real-money managers increased their presence in global FX markets last year due to a pick-up in cross-border investment activity, as well as the growing proclivity among fund managers and pension funds to trade foreign exchange as an independent asset-class. It appears that this pick up in activity has carried over into electronic trading, leading to an increase in e-trading volumes second only to the retail-driven growth among ‘other’ financials.

Seasoned E-Traders Get Busy
The increasing share of total FX trading volumes directed by fund managers and pension funds to eFX reflects a consistent pattern revealed by Greenwich Associates’ research over the past several years: Once an FX user decides to trade online, it usually begins a gradual increase in the share of its total forex trading business executed through e-trading systems.

Forex users that trade electronically execute an average of 53% of their total FX trading volume through eFX systems, up from 48% in 2004. Currently, the share of total forex trading volume captured by e-trading systems tops 50% among all e-traders regardless of size, with the largest FX users (those with more than $10 billion in annual trading volume) executing 51% of their overall business electronically, and FX users with smaller annual trading volumes directing between 52% and 55% of their business to e-trading systems. eFX users in the United Kingdom execute the highest proportion of their overall FX volume electronically, at 64%, followed by users in the United States who direct 60% of their total volume through electronic trading systems.

Users of e-trading systems around the world tell Greenwich Associates that they expect electronic trading to account for a full 57% of their FX volume in 12 months time. E-traders in the United States expect to be doing nearly two thirds of their total trade volume electronically by this time next year. These expectations suggest that e-trading volumes will continue to grow for the foreseeable future, but both the pace and duration of that growth could be tempered by the fact that eFX platforms will have a harder time attracting new institutional customers.

E-trading platforms have achieved the highest level of market penetration in the United States, where 54% of participants in the Greenwich Associates FX research say they trade electronically. European FX systems are not far behind, having attracted 48% of European FX users to online trading.

At the other side of the digital divide, FX usage rates are lowest in Canada, where 18% of FX users trade online, Latin America (21%) and Japan (31%). In terms of recent progress, electronic trading providers in Asia finally achieved some long-awaited gains in their customer base in 2005.

As providers addressed user concerns about technology and security, the proportion of Asian FX users (outside Japan) employing electronic trading systems increased from 30% in 2004 to 45% in 2005.

Looking ahead, however, Latin America might be the region with the greatest potential for near-term growth in its eFX customer base. Nearly two-in-10 of the large Latin American financial institutions and corporations participating the Greenwich Associates FX study in 2005 say they plan to start trading online in the coming year.