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

Electronic trading systems capture one half of global FX volume

Peter D’Amario reports on the remarkable increase in electronic forex trading activity over the past 12 months.

More than half of 2006 global buy-side foreign exchange trading volume was executed through electronic systems — the first time that e-trading has cleared the 50% hurdle. The increase in electronic forex trading activity over the past 12 months has been nothing short of remarkable. Just one year ago, e-trading systems were capturing less than 30% of global FX trading volumes.

The dramatic growth is the result of two trends: a sharp pick-up in the number of foreign exchange users trading online, and a significant increase in the proportion of total FX trading volume sent to electronic trading systems by existing e-traders.

The increasing presence of electronic trading in foreign exchange is not only improving the fortunes of the many competing e-trading platforms, it is also contributing in a significant way to the overall growth of the global FX market. (Global FX trading volume increased by approximately 17% from 2005 to 2006, according to the latest research from my firm, Greenwich Associates.) Electronic trading systems encourage volume growth by making currency transactions easier and cheaper, by aggregating and increasing liquidity, and by extending market access to investors that otherwise would not be able to participate — especially retail investors.
Electronic trading systems capture one half of global FX volume
Last year, Greenwich Associates predicted that these benefits would soon entice e-trading hold-outs to experiment with electronic trading. The prediction held true. Every year, Greenwich Associates conducts approximately 2,800 interviews of which around 1,700 are the largest and most important users of foreign exchange. This global survey examines trading practices. From 2005 to 2006, the proportion of these companies and institutions identifying themselves as users of e-trading systems jumped from 44% to 53%. At the same time, the total e-trading volume generated by study participants more than doubled for the second consecutive year.

As a growing number of FX users moved to electronic trading, the proportion stating that they have no plans to ever trade FX electronically dropped to 36% in 2006 from 43% the prior year. These results suggest an important shift in attitudes toward e-trading. For several years, the FX market was essentially evenly split between e-traders and abstainers. This year it seems the tide has turned, and users that in the past have spurned e-trading systems are becoming converts.
Electronic trading systems capture one half of global FX volume
The only group of hard-core holdouts seems to be corporates, many of which might feel they do not trade frequently enough to warrant the investment of money or time required to get up and running on an e-trading platform. The proportion of global corporations trading FX electronically did increase from 37% in 2005 to 40% in 2006, but the proportion saying they have plans to start using e-trading systems dropped to 13% from 15%. Meanwhile, a full 47% still say they have no intention of trading currency electronically at all, as do more than 60% of all FX users with less than $1 billion in annual trading volume. At the other end of the adoption spectrum, the proportion of banks trading FX electronically jumped to 94% in 2006 from just 72% in 2005, and the share of banks saying they never intend to use e-trading systems withered to just 4%.
Electronic trading systems capture one half of global FX volume
Even as late-comers embrace electronic trading, earlier adopters are ramping up their activity significantly. In 2005, users of e-trading systems told Greenwich Associates they executed 53% of their total foreign exchange trading volume through e-trading systems. Although one might expect that overall average proportion to fall as new users dip their toes in electronic trading, that share actually jumped to 60% in 2006, and e-traders say they expect to be conducting 63% of their total FX trading business electronically in 12 months time. The data suggest that more experienced e-traders are executing considerably more than 60% of their total volume through electronic systems: Among bank users of these systems, e-trading accounts for 68% of total FX volume — up from just 46% in 2005. E-trading systems have achieved their highest levels of penetration in Europe, where 60% of FX users now trade electronically. Half of FX users in North America trade electronically, but that average number spans a deep divide between the practices of U.S. and Canadian users. Sixty-one percent of FX users in the United States trade currency electronically, as compared with only 22% of those in Canada. Trailing these regions in e-trading adoption is Asia, where only 41% of FX users trade electronically. Here too, however, the regional average encompasses wide variation. In Japan, for example, only about a third of FX users trade electronically. In the rest of Asia, that share is 50%, and the data suggest that this gap will only widen in coming years.

These results strongly suggest that the success of electronic trading platforms in winning customers and trading volume is an important driver of recent growth in the overall FX market.

The data show a strong correlation between use of e-trading systems and increases in overall forex trading volume. For example, FX trading volume among corporates, who experienced the slowest e-trading growth in 2006, was essentially flat over the past 12 months.

By contrast, e-trading use among financials increased to 67% in 2006 from 52% in 2005 and total FX trading volume in this group rose more than 20%.

Electronic trading also contributes to overall FX market growth in another important way — the technology facilitates retail participation in foreign exchange trading.

Trade flows generated by retail investors are making up a growing share of the global FX market. Greenwich Associates research suggests that the growth in retail volumes may well be eclipsing that of institutional volume. Retail trading flows to the global market through “retail aggregators” — companies that extend market access to retail traders — and bank retail networks. Both businesses reach their retail customers and transact their trades primarily through electronic systems.

This increased participation of retail investors is one of the reasons for which FX trading volumes have grown so rapidly and so consistently over the past several years. Just a few short years ago, there was no mechanism for retail investors to participate directly in FX trading. Electronic trading technology is changing that situation rapidly. Of course, only time will tell if retail participation in foreign exchange trading is a permanent development, or, for that matter, a wise one.