Peter D’Amario Managing Director at Greenwich Associates
Peter D’Amario Managing Director at Greenwich Associates

Trading slowdown can’t stop the electronification of FX

Despite a modest slump in global foreign exchange trading activity last year, electronic FX trading systems attracted large numbers of new clients both in developed markets and in Asia, where market fragmentation and other factors had slowed the adoption of e-trading in prior years.

First Published: e-Forex Magazine 51 / e-FX Industry Report / April, 2013

Electronic trading is already standard operating procedure for investors and many large corporations in the U.S. FX market, but even in the United States electronic trading platforms managed to expand their customer bases last year by meaningful margins. The share of U.S. market participants trading foreign exchange electronically increased to 82% in 2012 from 76% in 2011. Electronic platforms also gained a few new customers in the United Kingdom, where the share of institutions and companies trading FX electronically increased to 82% from 80%, and in continental Europe, where the share of market participants executing trades electronically increased to 75% from 73%.

Even more impressive was the uptake of electronic trading last year by investors and companies in Japan.  Japanese market participants have been slow to adopt electronic trading in part due to concerns that a switch to e-trading would undermine personal relationships with banks that are seen as invaluable sources of market information, trade ideas, sales coverage and support and, of course, credit. While adoption rates in Japan continue to lag those of other markets by a considerable margin, the share of Japanese companies and institutions trading FX electronically jumped to 45% in 2012 from just 38% in 2011. 

Elsewhere in Asia, electronic trading systems continued their slow but steady advance. Electronic trading has taken root at a slower pace in Asia than in other markets due to variety of factors including the heterogeneous make-up of the Asian marketplace and the differing levels of development among Asian country markets and institutions. From 2011 to 2012, however, the share of Asian-ex Japan/New Zealand/Australia institutions trading FX electronically increased to 57% from 54%. 

Globally, two thirds of institutions most active in foreign exchange markets now trade electronically, including nearly 80% of participating financial institutions and over half of corporations.  Although e-trading volumes were stagnant at a top-line level last year amid a broader slowdown in FX trading activity, the influx of institutions and companies to electronic trading systems last year is a sign that foreign exchange continues its transformation into the world’s first truly global electronic market.

FX Trading Volume - by type of institution
Note: *Other Financials includes broker/dealers and credit companies. Based on responses from 1,736 global top-tier foreign exchange users in 2012 and 1,632 in 2011. 
Source: Greenwich Associates 2013 Global Foreign Exchange Services Study

FX Trading Volume - by type of institution

Note: *Other Financials includes broker/dealers and credit companies. Based on responses from 1,736 global top-tier foreign exchange users in 2012 and 1,632 in 2011.
Source: Greenwich Associates 2013 Global Foreign Exchange Services Study

For E-Trading Platforms, New Users Means Big Volumes

Every new institutional investor or company won over by electronic trading systems represents an important victory. The reason: Once market participants start using e-trading, they quickly shift the bulk of their trade execution to the electronic marketplace. In 2012 Greenwich Associates changed the methodology it uses to quantify electronic trading activity. Because short-dated trades and overnight rollovers have come to make up such a large part of the global FX market, Greenwich Associates last year included these short-term transactions in its e-trading count for the first time. On that basis, FX market participants that use e-trading systems execute an average 80% of their total trading volume electronically. In Japan, that share climbs to 90%, thanks in large part to the retail aggregators that generate a big portion of the country’s FX trading volumes and execute almost all of their business electronically. 

Proportion of FX users trading electronically - by region
Note: Based on responses from 1,736 global top-tier foreign exchange users in 2012 and 1,632 in 2011. Source: Greenwich Associates 2013 Global Foreign Exchange Services Study

Proportion of FX users trading electronically - by region

Note: Based on responses from 1,736 global top-tier foreign exchange users in 2012 and 1,632 in 2011.
Source: Greenwich Associates 2013 Global Foreign Exchange Services Study

The type of intense usage Greenwich Associates research identifies is pushing a growing share of foreign exchange trading volume online. In 2012 e-trading systems captured 71% of global FX trading volume, including short-term trades. Institutions executed 76% of trading volume in G-10 currencies electronically, as well as 53% of trading volume in emerging markets currencies and 23% in currency options.

So what exactly is attracting droves of large companies and institutional investors to electronic trading? For the past decade, global banks have been making big investments in electronic platforms. These investments have paid off in the form of fast, efficient and liquid trading venues. Indeed, when institutions are asked to name the most important reasons they choose electronic systems over telephone execution, “competitiveness of quotes” ranks only third on the list. The top two benefits: “speed” and “ease of execution.” 

Use of FX Channels
Note: May not total 100% due to rounding.  1 Based on responses from 1,146 global top-tier foreign exchange users in 2012.  2 Based on responses from 623 global top-tier foreign exchange users in 2012.
Source: Greenwich Associates 2013 Global Foreign Exchange Services Study

Use of FX Channels

Note: May not total 100% due to rounding. 1 Based on responses from 1,146 global top-tier foreign exchange users in 2012. 2 Based on responses from 623 global top-tier foreign exchange users in 2012.
Source: Greenwich Associates 2013 Global Foreign Exchange Services Study

E-Trading Volumes Poised to Resume Growth

Greenwich Associates expects e-trading volumes to return to a growth trajectory as foreign exchange trading regains steam and market participants continue dropping the telephone for screen-based execution. 

Among users of e-trading, the average share of FX transactions executed via phone calls between market participants and dealers declined to 23% of total volume in 2012 from 27% in 2011. Volume lost by telephone transactions shifted to alternative channels of execution — but not necessarily to the single- and multi-dealer platforms that make up the bulk of electronic trading volume. The share of volume executed on multi-dealer platforms did increase slightly to 44% in 2012 from 43% in 2011. The average share executed through single-dealer platforms actually decreased to 13% from 15% over the period. Trading volumes lost by phone execution found their way to direct-to-dealer APIs, which now capture 3% of global FX trading volume, and EBS and Reuters Matching, which currently capture 4% of total volume.  

Looking ahead, however, it is clear that FX market participants will use multi-dealer systems even more.  Among accounts already trading electronically, 60% of all market participants and 70% of corporations say they expect to make greater use of multi-dealer systems in the coming year.  Twenty-three percent of all FX market participants and 38% of banks predict that they will expand their use of single-dealer platforms in the next 12 months. In terms of overall foreign exchange trading volumes, 2013 is off to a strong start. If this level of activity holds, Greenwich Associates expects to see meaningful increases in both the absolute volumes executed through online systems this year and in the share of overall marketplace trading volumes executed electronically.

Dealer E-FX Strategies May Diverge

Although Greenwich Associates expects e-trading volumes to expand, this growth trend will not extend to all electronic trading platforms.  Building and maintaining a top-quality e-trading platform is an expensive and difficult undertaking. To compete broadly in electronic foreign exchange, dealers must deploy sophisticated systems that provide plumbing not just to their own proprietary trading platforms, but also to a range of multi-dealer systems, APIs and other trading channels. 

Over the past 12 months, several of the very largest global FX dealers, particularly those with meaningful financial institution client bases, have continued to invest in proprietary platforms.  Deutsche Bank, Citi, UBS, and Barclays, for example, have all either recently upgraded platforms or indicate that they will invest more heavily in them this year. However, other banks including many regionals, have shifted resources to multi-dealer systems.  These shifts have been driven by the confluence of new capital reserve requirements that have pressured bank balance sheets, the additional cost of preparing to meet new, complex regulatory requirements, and last year’s slowdown in foreign exchange trading volume. 

Proportion of products traded electronically
Note: *Spots, outright forwards, and one-sided swaps over one week. Based on responses from 1,084 global top-tier foreign exchange users in 2012.
Source: Greenwich Associates 2013 Global Foreign Exchange Services Study

Proportion of products traded electronically

Note: *Spots, outright forwards, and one-sided swaps over one week. Based on responses from 1,084 global top-tier foreign exchange users in 2012.
Source: Greenwich Associates 2013 Global Foreign Exchange Services Study

Based on these developments, Greenwich Associates expects the strategies of some FX dealers to diverge. At the top end of the industry, global banks such as Citi, Barclays, UBS and Deutsche Bank will continue to deploy sophisticated proprietary platforms. If FX volumes remain depressed, however, even some of these banks’ larger competitors may make take cues from smaller banks, combining their proprietary FX platform with their cash management system to service corporate customers and focusing on effectiveness over multi-dealer platforms and with APIs. Going forward, Greenwich Associates expects the competition among FX dealers to center largely around the quality and availability of APIs. 

 

Retail Aggregators Gaining Clout

Retail aggregators generated 20% of global FX trading volume last year. As a source of trading business, retail aggregators rank second only to banks, which generate about 26% of global volume. The difference: While hundreds of banks participate in the global foreign exchange market, all the volume generated by retail aggregators comes from a group of roughly 30 firms. 

That concentration makes retail aggregators obvious prime targets for FX dealers. But another factor makes retail aggregators even more attractive, and in some ways more important to global dealers: About 93% of these firms trade online and nearly all of these firms’ trading volumes are executed electronically. The sheer volume of the business they generate is giving retail aggregators tremendous clout. For example, retail aggregators are driving the accelerated development of direct-to-dealer APIs. Only about 10% of FX market participants use an API. But these trading interfaces are attracting the attention and investment dollars of global FX dealers because retail aggregators currently use these systems for about 42% of their total trading volume and half of aggregators say they intend to increase their use of APIs in 2013.

Most important reasons for trading online vs. by voice
Note: Based on responses from 812 global top-tier foreign exchange users in 2012. Source: Greenwich Associates 2013 Global Foreign Exchange Services Study

Most important reasons for trading online vs. by voice

Note: Based on responses from 812 global top-tier foreign exchange users in 2012.
Source: Greenwich Associates 2013 Global Foreign Exchange Services Study

Methodology 

Between September and November 2012, Greenwich Associates conducted primarily in-person interviews with 1,736 top-tier users of foreign exchange at large corporations and financial institutions in North America, Latin America, Europe, Asia, Australia, and Japan. To be considered top tier, a firm must be a fund manager, hedge fund, central bank, retail aggregator, Fortune Global 500 firm, or have reported trading volume of more than $10 billion or sales of more than $5 billion. Participants were asked about market trends and their relationships with their dealers.