Peter D'Amario is a London-based consultant with Greenwich Associates, a financial services consulting firm located in Greenwich, Connecticut, U.S.A. He advises in the foreign exchange markets.
Peter D'Amario is a London-based consultant with Greenwich Associates, a financial services consulting firm located in Greenwich, Connecticut, U.S.A. He advises in the foreign exchange markets.

Electronic Systems Are Making Their Case In Forex - Again

Peter D’Amario outlines research from Greenwich Associates which reveals that despite a substantial camp of conscientious objectors to the online revolution, online FX trading does has a bright future.

First Published: e-Forex Magazine 11 / e-FX Industry Report / July, 2003

How high the moon? Not long ago, when contemplating the future of online foreign exchange trading, it was common to envisage a speedily-integrated global market where corporate and financial institutions processed most if not all of their forex orders electronically. This is no longer the dominant school of thought, and hasn't been for a couple of years. The internet revolution is approaching its first decade, and there's still plenty of space on the e-bandwagon. Greenwich Associates research reveals that there remains a substantial camp of non-users, not simply fence-sitters but conscientious objectors in the online revolution who still prefer to conduct business via more traditional channels.

But taking a longer view, it is hard to miss signs of robustness; evidence that online trading does have a bright future. Greenwich Associates late-2002 research reveals that a quarter of institutions are trading online, up from one in six just the year before. While the proportion of e-FX users is especially robust in the United States and Europe, numbers are rising all over the world, both in adoption and in volume. Greenwich Associates competitive data also reveals that while multi-dealer sites like FXall, Currenex, and FX Connect all displayed growth in the proportion of institutions using them for foreign exchange trading, the single-dealer sites continue to be broadly accessed, with usage up over 2001 as well. Increasingly, larger banks are “white labeling” e-trading platforms for smaller banks, obviating the need for the latter to invest significant amounts in establishing an online presence.

A rising tide for all boats, in users and volume

Whether you are an institution in the United Kingdom, in Japan, or in the United States, or just about anywhere else, the odds got better in 2002 that you transacted at least part of your foreign exchange volumes through online channels. As can be seen in graphic 1, the liftoff of users in that single year has been impressive.
Electronic Systems Are Making Their Case In Forex - Again
Graphic 1 – Show Global Use of FX Trading

But an even bigger tale is that of volume. An institution need only trade the smallest fraction of their foreign exchange volume to be counted as an e-trader, but in fact users tend to commit a significant amount of volume to e-trading. Instead of just putting their toes in the water, users are wading in right to their hips.
Electronic Systems Are Making Their Case In Forex - Again
Graphic 2 – Show Global Use of FX Trading Volume

Greenwich Associates research also reveals that the average institution trading foreign exchange online routes nearly a third of its total volume this way, up from one quarter in 2001. Further, institutions tell Greenwich Associates they expect to do 40% of their volume online by the end of this year. Both the usage and volume numbers gathered by our research-based consulting firm are in sharp contrast to the more measured pace of change we recorded in 2001 and 2002. Online trading is not only much more popular than it was a year ago, but it is gathering momentum.

A market of many for many

It was a bumpy road indeed for online forex providers in 2001 and 2002, as banks and third-party platforms invested significant amounts in e-trading capacity with no assurance that the investment would be repaid. With four greatly-hyped multi-dealer platforms in the market (Atriax, Currenex, FXall and FX Connect), there was a sense of “overprovision.” Thus the fall of one of these–Atriax–was not entirely unexpected. Many expected more shoes to drop, especially for the single-party bank platforms that were expected to be replaced soon by multi-dealer platforms. This has not transpired, and Greenwich Associates research reveals that many platforms (including single-dealer sites) have been investing in making a stronger case for themselves. When speaking to financial institutions, in fact, the platform drawing the most forex customers was not FXall or Currenex but UBS Warburg's, attracting 30% of users. FXall does have the largest share of corporate users, just over one in four, but Citibank is not far behind at 20%. Other multi-party platforms like FX Connect and Currenex gained user share in 2002 among either the financial or corporate institutions if not both, but so did Deutsche Bank, Bank of America, SEB Merchant Banking, and Dresdner Kleinwort Wasserstein.

The persistent profusion of available providers may well promote more universal uptake in the near-term. It stands to reason that the more services that are out there, the more options will be available, and the more attractive online trading will be to those considering it.

Given the costs inherent in establishing an on-line portal, or setting up a multi-dealer platform, it is interesting to consider how Forex users intend to reward dealers for their technological investments. Greenwich Associates research shows this may be addressed by the buy-side, albeit not in a readily perceptible way. About one third of institutions trading online say they “pay” for the technology by executing more trades with the online service provider, while one in six say they execute larger trades. Still, a quarter say they don't believe an incremental reward of any kind is necessary to compensate dealers.

The conversion factor

There are many doubters still out there on the buy-side; a majority of institutions, in fact. Greenwich Associates research reveals 55% to 60% of the total institutional market globally not only do not trade online at present, but also say they do not intend to do so. This resistance is not only not going away, but when compared to previous year's research we collected, hardening somewhat.

While the largest institutions have the necessary heft and internal resources to make online trading viable for them, and the smallest have the motivation of gaining access to dealers who might be hard to reach on a more personalized basis, the middle ground is populated by forex users hesitant to trade online. Some (including many in Europe) cite the possible negative repercussions online trading might have on their traditional dealer relationships. Others (including many in Japan) have questions about platforms' reliability. Can these non-users be turned around? The evidence strongly implies so. For one thing, as can be seen in Graphic 3, the benefits of electronic trading reported by users are not only varied, but in some cases directly contradictory to the rationale of non-users. For example, over one third of online FX users say they are experiencing fewer trade errors.
Electronic Systems Are Making Their Case In Forex - Again
Graphic 3 – Benefits of Electronic Trading

Graphic 3 also shows us that much of the benefit to users has been logistical or operational in nature, not price related (the supposed chief selling point for online trading). Only 25% of users reported narrower spreads as a benefit of their online activity, less than half the percentage that cited faster trade execution. Usage tends to be its own best argument in such matters, and the fact is that when something works as well as online trading appears to for those using it, the more resistant will be won over in due course. It is entirely possible that a majority of the institutional market will be converted into online users in the next few years. Greenwich Associates studies many facets of financial service provision, including equities trading, where in the United States today 80% of institutions trading NASDAQ stock and 75% of those trading listed stock do at least some online trading. Could online foreign exchange have a similar future? It is generally a more commoditized product than equities, and while forex is usually traded in greater size, the fact is a rising proportion of online equity trading in 2002 was in the form of 10,000-share-and-greater blocks.

Future not a question of if, but when

It is worth noting that a not-insubstantial percentage of non-users around the world, one in five in fact, say they expect to be trading online next year. In the past couple of years, there has been ample opportunity for non-users to consider trading or not trading online, and a tremendous opening up of the floodgates when it comes to being able to consider online trading from an operational standpoint.

In short, any forex user worth their salt needs to get a read on trading online, and when looking at usage and volume figures, it is clear those who are getting a read like what they find. Assuming they continue to be as satisfied with their experience as they have been so far (average volume shoots up even as the total pool of users widens, for example), it stands to reason we shall see more users very soon, and perhaps even a larger commitment of their total volume.

We will probably never get to a fully-automated system of currency exchange, but the potential for future e-forex expansion is more clear and present today than ever before.