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, derivatives and fixed income 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, derivatives and fixed income markets.

Trends in eFX: Crucial role for STP

eFX providers should be looking ahead to the one development with the potential to expand their market exponentially - the arrival of straight-through processing, argues Peter D’Amario.

Electronic foreign exchange is booming, with e-trading volumes surging, new users logging on, and a host of service providers competing for slices of the growing business. But since almost half of all FX clients still maintain that they have no intentions of trading online, eFX providers should be looking ahead to the one development with the potential to expand their market exponentially: the arrival of straight-through processing.

FX trading volumes doubled in 2003. Our research shows this growth driven by meaningful increases in e-trading volumes on the part of institutions that in past years had experimented with electronic trading, and by the business of some new online traders. While both of these trends are likely to continue in the coming year, a closer look suggests that this current phase of e-forex expansion might not be sustainable.
Trends in eFX: Crucial role for STP
Virtually all of 2003’s eFX volume increases came from institutions that were already trading electronically in 2002, or were making plans to start. To date, eFX providers have made limited headway in penetrating the more than 45% of institutions that consistently say they have no interest at all in trading online. As a result, today’s market is split nearly in half, with one group indicting that it could be trading as much as 50% of its FX volume electronically within the next 12 months, and the other with online trading volumes of zero. Simply put, eFX providers will need to win some converts among these skeptics in order to support current rates of growth.

Fortunately for eFX service providers, these e-trading holdouts might prove more ambivalent than hostile to the notion of online trading. When we ask non-e-traders why they haven’t taken the electronic plunge, about two-thirds simply reply that they have no need for it. Such a response implies that, to date, these institutions have not been presented with a sufficiently compelling reason to closely examine their trading status quo. That will likely change when current e-trading technologies are coupled with true straight-through processing (STP) solutions that streamline back-office procedures and, above all, cut costs.

Growth, quick and dramatic

That is not to say that e-trading in its present incarnation does not offer some compelling benefits — it does. The advantages of e-trading are most convincingly illustrated by the fact that once institutions try it, they tend to shift volume from traditional trading methods to their online systems quickly and dramatically.

Global eFX volume among customers climbed to $8 trillion last year. In 2002, online traders executed an average of 32% of their volumes and 37% of their tickets electronically. Those numbers jumped to 43% of volume and 47% of tickets last year, and the same users say that their numbers on both counts could easily top 50% in 2004.
Trends in eFX: Crucial role for STP
These new trading volumes are supporting a host of eFX service providers far more diverse than most FX traders expected just a few years ago. Despite expectations of industry consolidation, eFX proliferation continues as new entrants find traction within specific market segments and established names expand and form alliances. UBS and FXall are leading this e-trading charge, and each now boasts trading relationships with almost one-third of eFX users.

Among multi-bank portals, Reuters Matching approaches FXall’s footprint as a market leader, while several smaller systems are deepening their market penetrations among targeted customer bases. FX Connect, for example, works largely with fund managers, while EBS Trader is building on its relationships with financial institutions and Currenex enjoys particular strength with corporations. Companies like Hotspot FX have made headway among hedge funds and retail investors.

These multi-dealer sites are competing against single-dealer systems that are proving surprisingly resilient in the face of long-standing predictions of their demise. Proprietary systems remain attractive in part because in many cases they offer superior access to online research.

Just as importantly, proprietary sites have made the most progress in developing real STP solutions, often incorporating customized links with their clients’ systems. This allows potential customers to consider these systems as facilitating the complete life cycle of a foreign exchange decision, from research to execution and fulfillment — a model that is yet to be offered by the multi-bank platforms. With providers like Citigroup and UBS, customers experience something approaching an end-to-end decision, execution and settlement solution — without tickets.

Courting the e-holdouts

Systems that offer such cradle-to-grave trade processes will sport a huge advantage in attracting customers and liquidity — a task that could become more difficult in the months to come. Globally, almost 40% of the largest global institutions traded FX online last year, up from just 32% in 2002. During the same period, however, the percentage of participants in our eFX research indicating that they intend to start trading online in the next 12 months fell from 20% to 14%.

These results indicate that the pool of potential customers open to e-trading experimentation is actually shrinking, and that eFX providers will soon have to turn their sales efforts to more reluctant prospects.
Trends in eFX: Crucial role for STP
While many institutions fall back on the over-simplified “no need” explanation of why they’re not trading online, some users provide a more detailed explanation for their reluctance to embrace eFX. While these reasons vary from region to region, several important themes do emerge. Almost 30% of institutions engaged in FX cite worries about e-trading security as a main reason for staying offline. (Companies in Asia and Latin America voiced this concern most often.) About a quarter of FX users say that they are worried about losing the valuable market color provided by their customer dealers, and a similar percentage are concerned about the possibility that moving trade volumes online will harm their personal relationships with their dealers. (North American companies are most worried about losing market color, while European FX users most fear damaging their relationships.)

Many users — particularly corporates — indicated that the lack of a true STP solution was a major factor in their decision to remain offline. (More than a quarter of U.K. institutions that do not trade online cite the lack of STP as the prime reason.) But STP might be even more important to the development of e-trading than these responses indicate.

For many FX users, the primary appeal of electronic trading is its potential for process enhancement and error reduction. Short of a comprehensive STP solution, online trading systems seem much less appealing when weighing their potential benefits against the possible negative effects of diminished personal interaction with bankers, or even security risks. It is exactly this cost/benefit threshold that eFX providers have not yet been able to clear with the significant group of institutions claiming “no need” for e-trading, and it is precisely the tangible rewards of STP that will eventually tip the scale in favor of eFX.

Many FX customers who spurn eFX today are able to dismiss the technology as little more than an enhanced telephone, minus the advantages of personal contacts and relationships. When eFX systems add true STP into the mix, however, users will be better able to quantify benefits like error elimination, back-office staffing reductions and overall cost cuts. At that point, the value proposition of electronic foreign exchange trading will become much more difficult, and costly, to ignore.