Foreign exchange markets the world over have been lifted by historic levels of volatility and from the inflow of investors seeking liquid markets and “plain vanilla” assets. But new research from my firm, Greenwich Associates, shows that the growth of e-forex last year far outpaced the expansion of foreign exchange trading as a whole. In fact, the 37% growth rate in electronic trading was almost triple that of the 13% year-over-year increase in total FX trading volume. As a result, the proportion of global foreign exchange trading volume executed through electronic systems jumped to 53% in 2008 from 44% in 2007.
(Note: Greenwich Associates tracks foreign exchange volume among a universe of 1,440 end-use customers; volume figures reported in this report exclude inter-bank transactions and volume generated from other sources. Interviews were conducted in September, October and November 2008, and the research covers the prior 12-month period.)
The severity of the global banking crisis makes the continued strength of e-forex and foreign exchange markets all the more impressive. Despite a crisis of confidence that caused counterparties to stop trading with certain banks altogether and to reduce the trading lines they were willing to extend, the market managed to sustain its momentum and grow to new record levels.
E-trading growth was strongest in Europe, where electronic trading volume jumped some 78% in the United Kingdom and 36% in continental Europe from 2007 to 2008. The share of total FX volume routed through electronic trading systems climbed to 57% from 47% on the Continent and to 58% from 41% in the United Kingdom. Growth in U.S. e-trading volumes was only slightly more modest at almost 20%. Overall, the biggest increase in electronic trading volumes last year came from retail aggregators, whose total e-forex volume grew 43% year-over-year. E-trading volume increased by 25% among corporate users and by 10% among financials.
New eFX customers
A modest inflow of new e-forex customers helped expand 2008 trading volumes. Globally, the proportion of foreign exchange traders using electronic systems for at least a portion of their FX trading business increased to 57% in 2008 from 55% in 2007. Driving the growth in the e-forex client base was an increase in the proportion of corporate FX traders using electronic systems, which climbed to 45% from 42%. Usage was highest among the world’s largest foreign exchange traders — institutions and companies generating at least $50 billion in annual FX volume — of which 82% trade FX electronically.
Seventy percent of U.S. FX traders used e-forex systems in 2008, up from 67% in 2007. Usage rates increased to 69% from 64% in continental Europe and to 68% from 64% in the United Kingdom. In Japan, electronic trading adoption rates continued to lag those seen in these western markets, despite the fact that the share of Japanese FX traders using e-trading systems increased to 40% in 2008 from 34% in 2007 (primarily due to the influence of retail aggregators in that market). Across the rest of Asia, e-forex use increased modestly to 46% from 45%. Canada remains the one true outlier in this business. Only about a quarter of Canadian FX traders trade FX electronically — less than the proportion using eFX in 2007.
The research results do suggest that usage might be reaching a natural plateau among existing e-forex users. Around the world, the typical eFX user executes just short of two-thirds of its total foreign exchange trading volume through electronic channels — a share that was unchanged from 2007 to 2008. In fact, the proportion of total FX trading volume routed to electronic systems actually declined in some regions. In the United States the share of total FX volume executed electronically by users of e-forex systems dropped to 61% in 2008 from 68% in 2007; in the United Kingdom it fell to 64% from 67% and in non-Japan Asia it declined to 63% from 67%. The only regions to see increases were continental Europe, where the average rose to 67% from 63%, and Japan, where it increased to 75% from 70% among a much smaller group of eFX users.
Shrinking Pool of “Undecideds”
The study results suggest that the pool of e-forex “undecideds” is shrinking. Most established FX users have either experimented with electronic trading systems or come to some conclusion about the pros and cons of e-forex relative to their own business needs.
Worldwide, the proportion of eFX “holdouts” saying that they have plans to start trading electronically declined to 8% in 2008 from 11% in 2009, while the share saying they don’t expect to trade electronically at all inched up to 35% from 34%. Only one in 10 companies participating in the study has plans to start trading electronically, down from 13% last year and the proportion of pension funds/fund managers planning to begin using eFX declined to 11% in 2008 from 16% in 2007.
Although the share of companies saying they have no intention of trying out electronic trading was essentially stable at 45-46% from year to year, the proportion of pension funds and investment advisors indicating that they have no interest in e-trading increased to 32% from 28%. Even in eFX’s core market of very active FX traders — those generating more than $50 billion in annual volume — the proportion reporting plans to begin trading foreign exchange electronically fell to 5% in 2008 from 8% in 2007.
The Multi-Bank movement
The study results reveal a continued trend of corporate and institutional FX traders shifting from single-bank or proprietary e-forex systems to third-party or multi-bank systems. After dipping below 50% for the first time last year, the proportion of global FX traders using single-bank or proprietary eFX systems fell to 46% in 2008, while the share using third-party or multi-bank systems increased from less than three-quarters to nearly 80%. In Europe, 83% of FX traders now use third-party or multi-bank systems; in the United States, 86% do so. Worldwide, the share of study participants using both types of systems fell to 29% in 2008 from 34% in 2007. Banks are the sole exception to this trend: almost three quarters of them use single-bank or proprietary systems to trade FX and 60% use both types.
There are a few causes of this trend. As eFX users become more sophisticated in their use of electronic platforms, they may feel comfortable removing the “training wheels” that single-bank platforms may have initially represented. On the flip side, some FX dealers are reducing the size of their customer bases, including customers that had been using their proprietary systems.
Overall, single-bank or proprietary systems accounted for only 13% of worldwide foreign exchange trading volume in 2008, while multi-dealer platforms captured 40%. That split was even more pronounced among corporate FX traders and pension funds/fund managers, both of which executed 7% of their trading volume through single-bank systems while directing a respective 45% and 50% of their trading volume to multi-dealer platforms. This is in part — but not entirely — explained by the fact that single-dealer sites often offer the ability for clients to execute more complex FX transactions in smaller size. Also, the most active users tend to concentrate more eFX business in single-dealer sites: FX users generating more than $50 billion in annual trading volumes executed a larger-than-average 18% of their volume though single-bank systems and a lower-than-average 33% of their volume through multi-dealer platforms.
There is evidence to suggest that the extreme levels of volatility seen in the market at various points in 2008 prompted some customers to shift business from single-bank to multi-dealer platforms. In particular, individual banks appear to have become less willing to quote FX electronically when prices began moving too fast for e-trading pricing engines to keep up. Not only have these disruptions subsided, conversations with FX dealers and Greenwich Associates Research Partners suggest that trading volumes for e-forex soared to record levels in November and December. That growth should continue through much of 2009 and third-party platforms should be the biggest beneficiaries as credit risk concerns persist worldwide and because spreads remain wide.
Execution Channels Old and New
In addition to single- and multi-bank sites, the world’s largest FX customers also executed 12% of their foreign exchange trading volume through messaging systems on Bloomberg and Reuters, with smaller amounts executed through ECNs and APIs. These companies and institutions have also continued to use the telephone for a meaningful proportion of trading: Over a third of volume is still executed “by voice” over the telephone.
More complex trades are often executed by voice because electronic platforms are not sufficiently customized. These trades fall into two groups: Some are generally small in size and do not account for the substantial volumes transacted by voice. But it is the jumbo trades, still executed by phone, which continue to give life to the telephone as a means of transacting. Corporates use the telephone for 43% of their FX trading volume, while pension funds, fund managers and hedge funds all use the phone for 36% of their total volume. Again, the major outliers in this respect are companies and institutions in Canada, where FX users as a whole rely on the telephone for some 61% of their FX trading volume while using single-bank and multi-dealer e-trading systems for a total of just 28%.