Aggregation played a pivotal role in the creation of the modern e-FX marketplace. Nicholas Pratt investigates in what ways it will continue to influence and shape its future evolution.
Aggregation had a marked impact on the FX market in the early days of electronic trading. As with other classes, the electronification of execution meant that liquidity became much more dispersed. Not only were there new liquidity providers, there were also new ways for the old providers to distribute liquidity..
Consequently, liquidity aggregation tools emerged to help banks track liquidity and enable their own clients to access liquidity. But as the market has developed so has aggregation. The tools are no longer based solely on price and take on a far more considered view of liquidity and best execution based on broader criteria and more data.
The use of data may also hold the key to how aggregation services develop in the future, allowing firms to analyse their executions and their liquidity. And aggregation may also find it can have an equally profound effect on the rapidly developing world of crypto and digital assets where liquidity is similarly fragmented and market participants are struggling to manage their liquidity.
Aggregation has changed significantly in the last five years, says Noor Mohammed, business development manager at Tradepoint. “Previously, aggregation consisted of bring multiple feeds together with aim of finding the best price. Aggregation would be treated as a sweeping tool, going down the book looking for the best price. That has changed a lot. It is not just about the price anymore. Instead, aggregation has become a fundamental part of liquidity and risk management,” he says.
The fundamental driver for this development has been the liquidity providers and their negative reaction to the crude techniques of the early aggregation techniques. The method of sweeping in search of the best price would mean, for example, that faced with an order for $10 million, firms would divide the order and give ten firms $1 million each, rather than giving the full order to one liquidity provider.
The problem was that liquidity providers found they were making little money from this approach, says Mohammed. “Any liquidity provider that is giving you prices is also profiling you and your profitability as a client. Whenever the client trades, the liquidity provider wants to know if they will make money on that client. It comes down to how the client trades and how the liquidity providers perceive their flow.”
In the last three to four years, more clients have understood that aggregation is now about more than just ranking orders by price. There are other factors to consider – such as fill ratio, market impact, hold-time and spreads.
“Some liquidity providers will fill at 50% but some will fill at 100%, so you have to consider the likelihood of a liquidity provider filling your order,” says Mohammed. “They are interconnected. A happy liquidity provider will give you a better spread.”
Aggregation services also now focus more on profiling the liquidity providers, says Mohammed. “Not all liquidity providers are equal. Some have big order books and are able to internalise orders and create zero market impact for clients. The smaller ones can’t absorb that, so traders have to consider which liquidity provider is likely to absorb the order and which ones will hedge that order. Aggregation is now about two order books working together rather than the adversarial approach of before,” says Mohammed.
The use of algorithmic execution has also increased and become a much greater part of aggregation. “The overarching theme is managing liquidity algorithmically,” says Mohammed. “FX margins have been really compressed over the last 5 years – staffing has been squeezed and the desks have shrunk and more decision making is done algorithmically and that has driven the use and development of aggregation.”
Aggregation has also become more important because of the reduced use of primary markets, says Mohammed. “In the last seven to eight years this trend has exploded. Hedging used to be done on primary markets but as they lost market share, there was more liquidity fragmentation and the need for aggregation increased. And of course, technology providers have to keep up with that. There are 80-90 connection points now.”
When it comes to selecting an aggregation tool, Mohammed says that ease of use, flexibility and granularity are the most important elements. “When you are developing new functionality, you have to be able to roll it out quickly and efficiently. It is a process of constant development rather than new implementations. It is the ecosystem approach so when we add new asset classes they automatically inherit the existing sophisticated logic of the system.”
The future development of aggregation services may centre on greater use of data. “Aggregation analytics has evolved significantly,” says Mohammed. As aggregation becomes more integrated with liquidity management, the data can be used for more than just smart order routing – for example, clients can simulate how their trades may be perceived by liquidity providers or to analyse long-term market trends and give direction on how and where to react.
Spark Systems is a low-latency eFX aggregator based in Singapore and serving a client base largely made up of regional banks in Asia. The platform has seen its volume rise markedly in the last year and has won financial backing from the likes of Goldman Sachs, Citi and HSBC.
Although it has expanded to New York and London in the last year, Spark is primarily looking to grow the FX market in Singapore for institutional traders and regional banks.
According to chief operating officer Jason Wang, the geographic development of the market has been one of the prominent trends of recent years and one that has further fragmented FX liquidity.
“A growing number of FX brokers are now setting up in multiple global data centres rather than just a single location,” he says. “For example, in Asia, many brokers are now located in Japan, Hong Kong and Singapore rather than just in Tokyo. They have set up regional hubs in Hong and Singapore and used Tokyo to execute any yen-based business.”
As a consequence, aggregators have set up their IT infrastructures in more international data centres to provide a hub in every timezone and to reduce latency. “If market-makers are looking at three different locations to serve the buy-side, you have to aggregate three times,” says Wang.
The geographic expansion has been driven by globalisation, fragmentation and the reduced cost of technology, he says. “It is easier to set up in more data centres. We can set up an exact replica in any international data centre. It is the same business logic. Even though the client segment and geography may differ, the technology is essentially the same,” says Wang.
Another factor in aggregation has been banks’ decision to focus less on the multi-bank venues and more on their own franchise. Liquidity has moved from the likes of Currenex, HotSpot and FXall to the single dealer platforms. This is where the combination of aggregation and smart order routing become so important, says Wang.
“We take multiple streams from ECNs, directly from liquidity providers and form other sources. We have clear rules that respect the different sources and the traders’ objectives and route to the most appropriate liquidity,” says Wang
Aggregation services now also have to cater for new asset classes such as NDFs, swaps and options as well as added functionality like multi-stream handling, slicing and dicing orders for algo execution and applying relevant speed-bumps.
Ensuring that aggregation services follow both explicit and implicit rules has become much more important in order to preserve the relationship between liquidity providers and takers, says Wang. ““It used to be a direct relationship between the liquidity provider and the liquidity taker,” he states. “It is now a three-way relationship between the liquidity provider, liquidity taker and the aggregator. We sit in the middle and we want to listen to both sides. We want to be part of the solution. Some aggregators have a cookie-cutter approach which is based on scale and high volume. Others are more focused on client experience.” When it comes to picking an aggregation service, firms will have to examine their options in more depth, says Wang. “People talk about the FX aggregation space as being highly commoditised. You can sit through a demo and they will all look the same in the first 15 minutes so you have to drill down deeper. You have to look at the relationships with liquidity providers, the support structure and the technology stack. You have to look at the quality and quantity of feeds, the frequency of pricing updates and how that all stacks up in technology terms.”
Wang also agrees that aggregation could have a role to play in the future development of the crypto currency and crypto assets world. “Crypto is less mature than FX but I see a lot of similarities. The FX market has learned a lot and we can use that experience. Fragmentation provides the opportunity for aggregation so it is definitely a possibility.”
For some, it is not aggregation alone that will transform the industry but the provision of liquidity and access to credit. According to David Vincent, co-founder and chief executive of smartTrade Technologies, “We believe that aggregation is already a mature solution that needs to be enhanced with core analytics around liquidity providers’ performance, whether technological, functional or financial,” says Vincent.
“This will allow for dynamic liquidity providers’ selection. However, aggregation is only useful in so far it is helping banks to build their core price so that they can distribute the best price to their corporate banking franchise.”
Demands for aggregation are evolving differently among both retail and institutional clients, says Vincent. “Within their credit limit the clients of our customers (the banks) are looking for greater level of guarantee of fulfillment which puts some pressure on their banks and therefore the liquidity providers to better understand the characteristics of the flow they send or receive.”
Consequently, says Vincent, the aggregator and its derived data are becoming central to the engagement between the liquidity providers and the banks. “The better the data, the better the relationship. The better the price you get from the liquidity providers, the more you can generate revenue from your client franchise,” says Vincent.
It is also about more than price, says Vincent. “FX aggregation is only part of the bigger value chain which delivers a tradable price to the client whether it be an institutional or retail one. The ability for the trading solution to derive a distributable price from the core price is essential. It is also important to ensure that an aggregation service is tightly integrated to the distribution which allows for greater alignment between the various stakeholders in the bank,” he states.
Liquidity aggregation is also becoming more complex in order to integrate new functionality such as multi-stream handling. “Creating a comprehensive picture of the market is getting ever more complicated because of the various stream sizes, order types and venue nature. This is nothing unmanageable but it something that require greater understanding of market structure,” says Vincent.
Data is key to managing the changing nature of liquidity relationships in FX, he says. “The aggregator has always been a data consumer. Now it is now becoming a data source of its own, alongside smart order routers, risk management systems and execution algos. The more data you gather and harvest, the more granular you can become at getting the right quote from your liquidity providers so that you can put the right price in front of your client.
Aggregation data is also essential to ensuring firms are able to run their own execution algos, says Vincent. “If you are relying on algos from your liquidity providers, you have capitulated and outsourced your trading to large firms. In that context the aggregation becomes secondary as you send your aggregated flow to your preferred liquidity provider.”
The true added value of liquidity aggregation lies when combined with other advanced applications such as a smart order routing system, he says. “The aggregator is a piece of a larger engine that needs to interact at scale with a vast amount of data and parameters.
When it comes to the functionality from the latest generation of liquidity aggregation systems, greater analytics, automated recommendation and selection of the best LPs’ for the flow you get from your client franchise are such features.
For those considering an upgrade of their existing aggregation solution, Vincent says they should consider the reduced TCO that comes from selecting a vendor that offers an end-to-end solution. “Save yourself the pain of integrating and managing multiple vendors. New solutions are unproven and with decreasing margins costs controls are more important than the latest technology. You should also speak to references and consider how long the vendor has been around. For example, did it fare well in 2020 when volatility and volumes were extremely high?”
Multiple FX venues have exacerbated the fragmentation problem, says Scott Wilson, vice president of sales at market data provider Exegy. Although there are signs that their use is starting to wane in favour of single dealer platforms. Furthermore, says Wilson, the relationship between liquidity providers and aggregators has become less adversarial. “That method of sweeping the market would leave the last man standing is less prominent. Smart order routing has become more thoughtful. It is not just executing at the best price but also helping liquidity providers to offset their risk,” he says.
Aggregation in the FX market has started to take on some of the properties of the equities market, despite the obvious differences in regulation and market structure. As a market data provider, Exegy caters for low latency but this has yet to become a critical factor in FX aggregation. “We come from the HFT and equity world where latency is important. Right now, with last look in the market, the latency issue is not really there.”
Like others, Wilson also believes that aggregation could have a key role to play in the development of the crypto assets market. “A noticeable difference with crypto assets and other asset classes is the fact that a lot of the biggest liquidity providers are non-banks and that could mean there is a role for aggregators.”
A more near-term development is likely to be addition of settlement and credit/netting to aggregation solutions, says Wilson. “This makes FX trading a more straight-through process.” Another step is adding more analytical tools to allow for transaction cost analysis and standardised reporting,” says Wilson. “Providers in the market are trying to do that but it is a real struggle with FX. It is difficult to compare prices in the same way that you would with equities where there is a centralised exchange or a consolidated tape.”
Wilson says it has become easier to judge what a good price is these days, however there are still restraints that require firms to do more work on assessing pricing data. “There is not a tape on that third market, so instead of getting an hourly rate on prices, you have to do a lot of your own homework. In terms of aggregation services though, this means there is plenty of room for development.”