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

e-FX Industry Report - E-Forex Comes of Age

Using Greenwich Associates research data, Peter D'Amario illustrates how eforex could be entering a phase of more mature development.

Growth in electronic foreign exchange trading volumes failed to keep pace with the surge in global FX markets last year — a sign that e-forex could be entering a phase of more mature development.

E-forex trading volumes increased some 20% from 2006 to 2007. But because overall FX trading volumes jumped 36% year-over-year, the total share of foreign exchange trading executed electronically actually shrunk to 43% last year from 50% in 2006. (Note: Greenwich Associates tracks foreign exchange trading volume among end-use customers; volume figures reported in this report exclude inter-bank transactions and volume generated by other sources.)

Research from our firm, Greenwich Associates, shows that — prior to last year — electronic trading systems were gaining new users and new business from FX market participants around the world at a relatively consistent pace. E-trading systems captured 20% of global volume in 2003 and 30% in 2005 before hitting the 50% mark last year.

However, the results of our most recent e-forex study suggest that trading practices have begun to diverge among different types of FX users in different regions. This finding supports the notion that eFX is leaving behind its initial stage of dramatic across-the-board growth and entering a more mature period in which market participants begin to self-sort into active or infrequent users of electronic trading systems based upon their unique needs and strategies.

Growth and Segmentation

Worldwide eFX volumes increased to $43.0 trillion in 2006-2007 from $35.5 trillion the prior year. One reason for which this growth lagged that of total global foreign exchange trading volume — which soared to nearly $100 trillion last year — was that much of the growth in the overall FX trading business was driven by increases in the trading of options and emerging market currencies — two products not particularly conducive to electronic trading.



But the story of why e-trading declined as a share of the FX whole last year is much more complicated than that. For starters, the share of FX market participants using electronic trading systems for at least a portion of their business actually increased to 55% in 2007 from 53% in 2006 — a statistically significant increase in the context of the more than 1,700 companies and institutions participating in our research last year.

So even as the share of total FX trading volume executed through electronic channels declines, e-trading providers continue to attract new users. The customer bases of the leading e-trading systems have been growing steadily for the past several years: As recently as 2004, only 44% of FX market participants traded electronically. Just as importantly, the percentage of FX users telling Greenwich Associates that they have no plans to start trading electronically — a group we’ve dubbed the “hardcore eFX holdouts” — continues to shrink. In 2006, 36% of FX users said they have no use for electronic trading; that share fell to just a third in 2007.


But the research results reveal an increasing divergence in usage patterns between large, active traders — generally financial institutions — and accounts that generate relatively small amounts of annual FX trading volume. More than 80% of the world’s most active FX traders (those that trade more than $50 billion in foreign exchange every year) use e-forex systems, up from 77% last year. Usage rates decline with overall trading activity: About two-thirds of traders generating between $10 billion and $50 billion in annual volume trade electronically, as do 46% of those with annual trading volumes of $1-10 billion and about a third of users with smaller annual totals. (A growing group of computer-driven FX traders executes 100% of foreign exchange trading volume electronically—typically via the futures market—but these market participants fall outside the parameters of Greenwich Associates’ customer focused research.)

For the time being at least, the e-forex client base appears increasingly divided between actively trading financials that have taken up e-forex in large numbers, and corporates that often prefer to stick with traditional execution methods. Although the share of global corporates saying they use electronic trading systems increased to 43% in 2007 from 40% in 2006, usage remains far lower than that among banks (90%), hedge funds (65%) and fund managers/pension funds. This final group could represent an important source of e-forex growth in coming months. The share of fund managers and pension funds trading FX electronically increased to 55% in 2007 from 48% in 2006 — an impressive adoption rate that could be maintained as these institutions seek out effective methods for meeting regulators’ requirements for documenting best execution.

On a regional basis, eFX usage patterns seem less influenced by differences in trading strategies and more driven by cultural preferences and the state of development of e-trading systems in terms of technology and liquidity. E-trading providers have achieved the highest level of market penetration in the United States, where more than two-thirds of FX market participants trade electronically — up meaningfully from 61% in 2006. Europe is not far behind at 63% after an increase from 60% in 2006. In sharp contrast, e-forex use fell to 46% of Asian FX market participants in 2007 from 52% the prior year. Although the share of FX users trading electronically in Japan did increase year-over-year, the country continues to lag the rest of the world when it comes to e-trading, with only 36% of foreign exchange market participants trading electronically.


E-Forex Market Share

The relatively high levels of market penetration already achieved by e-forex providers within the most active part of the FX customer base — financials and the world’s most prolific traders — suggest that the industry’s ability to sustain growth rates will depend on its success in winning more business from existing clients.

From 2006 to 2007 the share of total foreign exchange volume directed to e-forex systems by existing eFX users was essentially flat at 63-64%. It must be noted, however, that simply maintaining this share amidst the rapid expansion of the global foreign exchange market required a significant increase in absolute dollar terms. The biggest bump came from existing hedge fund users, which essentially doubled the total amount of FX volume they directed to e-trading systems from 2006 to 2007. Thanks to this sharp increase, the share of total FX trading volume executed electronically by existing hedge fund users jumped to 62% from just 47%.


Also helping e-trading systems maintain their share of the business within their existing client base was a significant increase in electronic trading volume among e-forex users in the United Kingdom. In absolute terms, U.K. customers increased total e-trading volume by more than a third from 2006 to 2007 — a jump that increased the share of their overall foreign exchange volume executed electronically to 66% from 55%.

These relatively big gains helped offset declines in Continental Europe and non-Japan Asia, where modest increases in total electronic trading volume resulted in a decline in e-trading systems’ share of the overall FX trading business. E-trading also lost share among existing corporate eFX users around the world. Although corporate e-forex trading volume was up some 23% in absolute terms, the share of users’ overall trading volumes captured by electronic systems dropped to 51% in 2007 from 59% in 2006.

The Decline of the Single-Bank System

While the e-forex market as a whole continues to attract new clients at a relatively consistent rate, single-bank systems are failing to keep pace with the growth of multi-dealer platforms. The share of FX market participants reporting to Greenwich Associates that they trade foreign exchange on single-bank or proprietary electronic systems declined to 47% in 2007 from 55% in 2006. Use of third-party or multi-dealer platforms was effectively flat during the period. Meanwhile, the share of FX users saying they trade on both single-bank and multi-bank systems fell to 20% from 28%.

A defection by banks drove the decline in use of dealer-sponsored systems: In 2006, 83% of banks throughout the world said they used single-bank platforms; in 2007 that share fell to just 70%. Our research results also reveal a significant move by fund managers and pension funds away from single-bank systems. Usage by these clients fell to 27% from 38% year-over-year — a shift at least partially attributable to fund managers’ ability to use multiple prices posted on third-party platforms to document best execution.

Bank-sponsored trading platforms lost considerable ground in Continental Europe, where the share of FX market participants using these systems dropped to 46% in 2007 from 59% in 2006, and in the United States, where usage fell to 35% from 40%. Only in Asia (ex-Japan) did FX traders move in the opposite direction, with usage of multi-dealer platforms declining to 59% in 2007 from 67% in 2006 and use of single-bank systems increasing to 73% from 70%. One factor that could be contributing to the strength of dealer-sponsored platforms in Asia is the significant share of FX trading volume in the region involving emerging market currencies, which to date have not been the forté of the major multi-dealer systems.

For Small FX Users, a Push to Electronic Execution

The results of this year’s Greenwich Associates study reveal one additional finding that could be of critical importance to companies and financial institutions that use global FX markets on a less-than-frequent basis. Among foreign exchange market participants generating less than $1 billion in annual trading volume, the use of dealer-sponsored trading systems increased to 64% in 2007 from 52% in 2006 and the share saying they use both multi-dealer and single-bank systems rose to 15% from 9%.


This increase in the use of single-bank systems comes amid a broader pick-up in eFX activity among these small accounts. The share of market participants trading less than $1 billion per year that describe themselves as current users of e-forex systems increased to 34% in 2007 from 28% in 2006. Over the same period, existing eFX customers within this segment dramatically increased the share of their total foreign exchange business directed to electronic systems — to 56% from 52%.

Some portion of this growth can be attributed to natural progression: Infrequent FX traders continue to adopt electronic trading at a relatively slow rate, and as they do, they gradually increase the amount of business directed to the electronic systems. However, the sharp spike in e-forex usage among FX market participants with relatively small annual trading volumes — combined with an otherwise puzzling shift to single-bank systems — suggests that another factor is coming into play.

For the past several years, our firm has been advising smaller and relatively infrequent users of foreign exchange markets to be cognizant that “human” sales coverage is an expensive resource for their FX dealers to provide, and as a result, less-profitable accounts are likely to see a reduction in the amount of “face time” they receive from their dealers’ sales reps.   The significant increase in the number of these small accounts trading FX electronically on dealer-sponsored systems suggests that, in at least some cases, the move away from traditional “high-touch” trading may be less than voluntary.


This group of relatively small foreign exchange users that are adopting electronic trading simply as a means of accessing market liquidity is emblematic of the splintering e-forex customer base. To this point, the strong growth of the eFX industry has been an almost natural function of a new and effective technology permeating a dynamic market. Because the product offers such obvious benefits, it was almost inevitable that large numbers of market participants would give it a try and, finding it advantageous, begin directing growing amounts of their business to electronic platforms. At some point in the not-so-distant future, however, e-forex will leave the easy growth of its infancy behind.


Although e-forex might well maintain its double-digit growth rates for some years to come, the segmentation of the eFX client base is a clear sign that this maturation process is already underway. Today, we are seeing infrequent FX traders executing relatively tiny volumes through electronic systems because they might not be able to get coverage from dealers otherwise and we are seeing banks and hedge funds that are nearly constantly in the market using e-forex systems for two-thirds or more of their total trading volume. Meanwhile, a growing number of fund managers and pension funds are using electronic trading systems as a simple and cheap way to document best execution. This is the future of the e-forex business, and with each passing year, growth will become more dependent on providers’ ability to satisfy the diverging needs of these unique customer segments.