In 2020, global capital markets consultancy GreySpark Partners observes that overall FX market structural dynamics significantly impact trading franchise business models and drive decision-making across the different segments of market participants in different ways.
The impact of these changes are felt throughout the business, with the technology stacks underlying operations in a period of associated transition borne out of both secular changes and the more immediate purchasing cycle.
FX trading technology stacks on both the sellside of the investment banking institution and non-bank brokerage firm industry and on the buyside of the asset management and institutional investment firm industry comprise an often-diverse set of vendor offerings and in-house technology solutions targeted for the specific business using the stack.
Consequently, the design and deployment of technology stacks for the use of different market participants and ever-changing FX business models is far from uniform, although GreySpark Partners – a global capital markets consultancy – categorises different user groups’ buy-vs-build behaviour as follows:
1. Tier I investment banks are willing to retain the full breadth of universal bank services are increasingly challenged to provide their buyside clients with a consistent and seamless user experience across these various channels, and even support clients making use of more than one channel or moving between channels during the lifecycle of any given trade. These actors must assemble their technology stack across an increasingly broad array of distribution channels and services.
2. Tier II and Tier III investment banks are shifting from the universal banking model to focus on niche markets while maintaining the client relationship and franchise for flow products. They do not provide liquidity directly for those flow products, and they utilise a significantly simplified technology stack compared to universal banks. While managing the client relationship across the full spectrum of distribution channels, the non-niche specialisation execution services are outsourced to bulge-bracket, Tier I institutions; and
3. Buyside market participants that are no longer willing to act exclusively as price-takers – dependent on their Tier I, Tier II or Tier III bank or non-bank broker execution services provider – must move beyond the broker-dealer-provided technology that once connected them with those service providers. Taking advantage of the increasingly A2A market structure, asset manager flow and FX market participants that wish to be more liquidity provider-agnostic construct their own FX technology stack;
these asset managers focus on liquidity aggregation and execution from a range of sources; specifically, both bank-provided single-dealer platforms (SDPs) and non-bank broker-provided multi-dealer platforms (MDPs) as well as direct bank and non-bank liquidity provider connections.
Growth in platform market & activity
Since 2018, the changing structural dynamics of the currencies market drove a flurry of activity in the FX space focused on replacing or implementing fit-for-purpose e-trading solutions. This equipment cycle differs from its predecessors in two meaningful manners, leading to an unprecedented number of institutions seeking to implement FX trading platforms during the 2018-2022 period:
The first difference is the growing number of investment banks below the second tier observed as investing in acquiring an FX e-trading technology stack, incentivised by the increased electronification of dealer-to-client (D2C) trading, in general, and increased electronification of niche markets on a currency or product basis (see Figure 1). This technological sophistication is taking place where, just a few years ago, these same Tier III to Tier V banks could still utilise in-house builds or rely on voice trading in order to access flow or non-flow liquidity.
The second differentiating factor of the current FX e-trading equipment phase is the number of buyside desks arming themselves with fit-for-purpose e-trading solutions. Proactive technology stack procurement by buyside desks act as a clear signal that the e-execution tools historically offered as part of sellside execution franchise are no longer sufficient for mid- to large-size clients. Thus, the stickiness of tooling offered as part of services is diminishing, shifting the calculus for investment in such offerings, particularly as part of SDPs while the market increasingly shifts toward MDPs as a whole.
GreySpark-observed request for proposal (RFP) activity by region reflects the sophistication of the European FX marketplace relative to both the Americas and, most pronouncedly, APAC (see Figure 2). Specifically, EMEA is the most active FX e-trading region, which is to say that electronification is more progressed in EMEA than in other regions.
Consequently, many e-trading functions viewed as competitive differentiators elsewhere are hygiene factors among European investment banks beyond Tier I and Tier II. Furthermore, GreySpark surmises that the electronification and maturity of client expectations in Europe may also reflect a highly sophisticated retail market in which banking incumbents, retail FX brokerages and established or start-up fintech vendors compete furiously for wallet by pushing innovation, and they have subsequently influenced institutional expectations for e-FX trading.
Unlike the cash equities and fixed income asset classes, the market for FX trading technology lacks a dominant player; instead, a wide array of different fintech vendors – some established players, others new entrants to the market – vie for the client wallet represented by the serviced addressable market (SAM). Combined with the shift from a preference for pure in-house built technology to include increasing amounts of vendor technology going forward, the current equipment phase drives a tumultuous market landscape in which vendors compete both on functionality and price.
This competition is driving increased value to cost for purchasers of vendor-provided technology, in turn increasing the appeal of vendor technology. In total, GreySpark estimates that there are some 400 clients globally with spend above USD 1mn annually on FX e-trading platforms across front-, middle- and back-office functions.
To understand the dynamic shift underway in the distribution of FX trading technology spend, GreySpark delineates technology spend within capital markets participants into two relevant categories:
1. the total addressable market (TAM) for any given client segment comprises the total spend by the in-scope segments of the market on their FX e-trading platforms; and
2. the SAM comprises the share of TAM spent on external vendor technology.
Using proprietary data and modelling for the e-FX market, GreySpark can reveal that the total TAM is creeping toward USD 3bn, representing an annual compound growth rate (CAGR) of 1-2% over the coming five years. Yet SAM growth outpaces overall growth by a significant margin, with CAGR of 5-7% over the same period.
As a result, total vendor spend on e-FX technology by capital markets participants will significantly exceed USD 500mn by the middle of the decade.
The Nature of the challenge & the solution
Capital markets participant e-FX technology spend is intended to overcome not only business challenges in a changing commercial environment, but also the structural changes that occurred since the financial crisis.Specifically, the global FX market structure evolved markedly, increasing in complexity:
1. Instead of a historical, two-tier market with inter-dealer trading and D2C trading distinct from one another, market participants in 2020 face a more convoluted structure that includes non-bank liquidity providers and the growth of all-to-all (A2A) trading – on dedicated venues, MDPs and in primary market venues.
2. Workflows have, consequently, also become more complex (see Figure 3).
The rapid evolution of the FX market structure necessitating new e-trading functionality in order to keep e-FX franchises competitive did not align with the purchasing lifecycle for e-trading platforms. Consequently, new functionalities were incorporated into the technology stack of individual investment banks through various means, including vendor functionality addition, system bolt-ons generated both in-house and vendors and the implementation of discreet e-trading systems to meet specific functionality needs.
Therefore, trading technology stacks in 2020 on both the sellside and buyside of the FX marketplace increasingly comprise a range of functions assembled from a diverse set of vendor offerings and in-house technology solutions. In designing and deploying the technology stacks used to meet different market participants and everchanging FX business models, the buy-vs-build behaviour varies significantly on an individual company basis. Yet, in aggregate, all market segments but Tier I banks are shifting toward buying technology (see Figure 4).
Whatever the behaviour of individual market participant institutions, in 2020 virtually all technology stacks include some vendor components. The means of implementation for these vendor-sourced technology components fall into three broad categories:
Off-the-Shelf Solutions: A fully off-the-shelf solution covering a standard set of functionalities offers the primary benefits of deployment simplicity and cost. As set functionality prohibits customisation, the speed of deployment is enhanced, and upfront implementation costs are reduced. Cost savings persist throughout the system’s lifecycle, as the simplicity and robustness of the core functionality package results in RTB costs that are less onerous.
Development Frameworks: These frameworks comprise a toolbox made of elementary software components that require user assembly and customise to create a deployable solution specific to the bespoke demands of the purchaser. They provide the ability to create competitive differentiation without the need for a fully bespoke in-house build of the trading system. Development frameworks carry a high total cost of ownership for their users and the organisation remains reliant on the maintenance of inhouse capacity to develop, deploy and maintain the system.
Buy & Build: These solutions are intended to combine the advantages of both packaged software and development frameworks: off-the-shelf set functionality is delivered in a software architecture that accommodates a high degree of customisation and expansion to each component. Not only do the systems function from the time of initial deployment without the need for customisation, but over time users can expand or customise the system to create competitive differentiation for themselves in line with their business needs and available investment budgets.
Regardless of the category of vendor systems selected, market participants must ensure their technology choices are designed to optimise competitive differentiation, not merely replicate existing run-the-bank (RTB) functionality and workflows. In the past half-decade, GreySpark bore witness to investment banks’ and brokers’ increasing awareness and, more recently, adoption of this maxim.
Even as the maxim is adopted more widely on the sellside, a clear consensus on what parts of the technology stack offer competitive differentiation remains elusive; commoditised versus differentiating components of the FX e-trading technology stack continue to be defined on an institution-by-institution basis. Some difference of view on these matters results from different business models, market coverages and client bases of different franchise operators.