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

As e-FX market matures, incremental growth driven by smaller institutions

Electronic foreign exchange (e-FX) trading is maturing. Among many of the large institutions that generate the bulk of FX trading volume around the world, the rapid uptake and growth that have characterized this industry for the past decade show signs of slowing. But the e-FX market has not yet lost its dynamism. Instead, electronic trading is simply making new headway among smaller FX players and the market’s most active traders.

First Published: e-Forex Magazine 56 / e-FX Industry Report / April, 2014

Nearly three-quarters of global FX trading volume (74%) for client accounts was executed electronically last year, up from 71% in 2012. The activity of retail aggregators accounted for a significant portion of that increase, with their share of trading volume executed electronically increasing to 98% in 2013 from 92% in 2012. This shift dramatically impacted the industry as a whole, given that retail aggregators generated 23% of overall FX trading business around the world last year. Removing these huge players from the equation, e-FX captured two-thirds of global FX trading volume last year, up only a single percentage point from 2012. 

Proportion of Total FX Market Volume Traded Online
Note: Figures include retail aggregators. Based on responses from 1,584 
foreign exchange users globally in 2013 and 1,622 in 2012

Proportion of Total FX Market Volume Traded Online

Note: Figures include retail aggregators. Based on responses from 1,584 foreign exchange users globally in 2013 and 1,622 in 2012

Meanwhile, results of Greenwich Associates research provide evidence that e-FX growth has stabilized among other very large FX players. Again excluding retail aggregators, electronic systems captured 68% of total trading volume last year among the market’s biggest participants – those generating more than $50 billion in annual trading volume, a share unchanged from 2012. Likewise, the share of these institutions trading online appears to have settled at a significant but unchanged 90%.  

For the moment, at least, it seems that any growth in e-FX is being driven by highly active retail aggregators and hedge funds on the one hand, and smaller, less active accounts on the other. Electronic trading platforms continued to attract new customers last year from the ranks of market participants generating less than $50 billion in annual FX volume. These gains were largest among companies and institutions generating less than $1 billion in annual trading volumes, a group that in the past saw little potential benefit in e-trading due to low levels of activity. Electronic FX trading uptake in this segment jumped seven percentage points to 48% of market participants in 2013 pushing the share of total volume executed electronically among this group to 26% from 22% in 2012. 

Proportion of Products Traded ElectronicallyNote: *Spots, outright forwards, and one-sided swaps over one week. Based on responses from 1,039 foreign exchange users globally in 2013 ans 1,032 in 2012.

Proportion of Products Traded Electronically

Note: *Spots, outright forwards, and one-sided swaps over one week. Based on responses from 1,039 foreign exchange users globally in 2013 ans 1,032 in 2012.

Regions: Europe down, Canada up, Others flat

Geographically, the world’s largest and arguably most mature FX market, Continental Europe, was the only region to notch a meaningful decline in the share of foreign exchange volume executed electronically last year, as a modest increase in online volume failed to keep pace with a bigger jump in total FX trading volume and e-FX fell to a total 68% from 73%. Meanwhile, Canada, a small market and a traditional e-FX laggard, saw substantial increases in the percent of market participants trading FX on electronic systems and in the share of total FX volume executed electronically. Usage in the United States was essentially unchanged at around 83% of market participants, but e-trading users made some dramatic increases to the share of their business routed through electronic systems. That shift pushed e-FX to 73% of total U.S. FX trading volume in 2013 from 63% in 2012.

Outside of Japan, online FX trading made little headway in Asia last year. Although the absolute amount of FX volume executed through electronic systems increased in Asia ex-Japan last year, that gain failed to match the growth in overall FX trading volume over the 12-month period, and electronic systems usage was flat at 57% of market participants. 

Japan, meanwhile, remains a classic tale of two markets. On the surface the Japanese FX market appears to be by far the world’s most electronic, with 87% of total FX trading volume executed through electronic systems. However, the vast bulk of that e-FX business is generated by the relative handful of retail aggregators that play such a large role in that market. Excluding retail aggregators, e-FX’s share of total Japanese FX trading volume actually contracted by 10 percentage points last year to just 45%. 

Sources of Future e-FX Growth: Emerging Market Currencies and Options

One trend contributing to the continued growth of electronic trading is the increase in trading volumes in emerging market currencies. Approximately 80% of FX market participants now trade some emerging markets currency. As one would expect, the fastest uptake has been in Asian currencies. About half of market participants trade Asian currencies against their own domestic currencies, the euro or the U.S. dollar, up from 45% in 2012.  In past years, the increased popularity of emerging market currencies produced only a marginal effect on e-FX due to the fact that many of these currencies did not trade on electronic platforms and offered market participants only limited liquidity if they did. Over the past 12 months, however, the share of emerging market currency cash trading volume executed electronically jumped to 56% from 52%. While this share remains small relative to the 79% of trading volume in G-10 cash currencies, both increased trading volumes in emerging market currencies overall and increased coverage of these currencies on electronic platforms point to bigger growth to come. 

Electronic FX volumes are also getting at least a minor boost from currency options, which are often traded through single-dealer platforms that allow for a maximum level of customization. The share of global FX market participants trading currency options electronically increased four percentage points to 28% in 2013 and the share of options currency trading volume executed through electronic systems increased three percentage points to 26%. 

Hedge Funds embrace Algorithmic Trading

Like retail aggregators, hedge funds have been aggressively stepping up their use of e-trading systems. Hedge funds executed 71% of total FX trading volumes electronically last year, up sharply from 58% in 2012. Much of that growth stems from hedge funds’ increasing use of algorithmic trading strategies in FX. Twenty-two percent of hedge funds active in FX trading used algorithmic strategies last year, up from just 12% in 2012. Hedge funds that use algos are executing about half their FX trading volumes through algorithmic strategies. Meanwhile, roughly one-in-five retail aggregators is now employing algorithmic strategies, which they are using for approximately 60% of trading volume. Due largely to adoption among these two groups, the share of all FX market participants using algorithmic strategies has climbed above 10% for the first time.

Global FX Electronic Trading: System Usage Trends
Note: Most recent figures based on responses from 1,030 foreign exchange users globally.

Global FX Electronic Trading: System Usage Trends

Note: Most recent figures based on responses from 1,030 foreign exchange users globally.

Single-Dealer System surge

Reversing a well-established trend, market participants last year reduced the share of their electronic trading business executed on multi-dealer platforms and increased the amount of business done through single-dealer systems. The decrease in the share of business done on multi-dealer platforms was driven entirely by a drop among the market’s $50 billion+ crowd to 31% in 2014 from 36% in 2012. That shift was in turn driven by hedge funds and retail aggregators, both of which sharply reduced the share of their business done on multi-dealer platforms and increased the proportion done through single-dealer systems. Regionally, the trend was most pronounced among market participants in the United Kingdom, who cut multi-dealer platforms’ share of their total volume by 10 percentage points to 39% while pushing single dealer systems to 22% from just 5%. 

This reversal is attributable in part to regulations. Last year, Greenwich Associates published a report suggesting that new derivatives rules such as the requirement for multi-dealer platforms to register as swap execution facilities in the United States would prompt FX market participants to shift business back to single-dealer systems. The good news for multi-dealer systems: The report said that this shift would be temporary and that as market participants adjusted to the new market framework they would resume their move toward multi-dealer platforms. 

One channel that won’t experience resurgence any time soon is the telephone. The share of global FX trading volume executed through phone transactions has dipped to just 12%. Latin America does the largest share over the phone at 30%; Japan does the least at 5%. Only 9% of market participants say they expect to be more active on the phone in the coming year, compared with 14% that plan to make more use of messaging systems on Bloomberg and Reuters and much larger shares that plan to increase their activity on single-dealer and multi-dealer electronic platforms. 

Conclusion

A couple of final data points support the notion that e-FX is maturing. Among market participants generating more than $50 billion in annual FX trading volume, half said they plan to increase their activity on multi-dealer platforms in the coming year, and 21% said they expect to be more active on single-dealer systems. Those shares are down from 56% and 28%, respectively, in 2012. During the past decade of strong growth for e-FX, one would have expected both of those proportions to hold steady or even increase in any given year. The fact that these shares are now shrinking suggests that growth could be slowing at the top end of the e-FX market.

Methodology 

Between September and November 2013, Greenwich Associates conducted in-person and telephone interviews with 1,584 financial professionals using foreign exchange at large, top-tier corporations and financial institutions in North America, Latin America, Europe, Asia, Australia, and Japan. To be considered top tier, a firm must meet one of the following criteria: be a fund manager, hedge fund, central bank, retail aggregator, Fortune Global 500 firm, or Treasury center; or have reported trading volume of more than $10 billion; or have sales of more than $5 billion.