Thomas Price Senior analyst at TowerGroup
Thomas Price Senior analyst at TowerGroup

INDUSTRY REPORT: Consolidation: threat or opportunity for FX execution venues?

Thomas Price outlines why as the FX marketplace is maturing we can expect a consolidation of the myriad FX execution venues to occur over the next two to three years.

The FX marketplace is maturing and with that maturity we can expect that a consolidation of the myriad FX execution venues will occur over the next two to three years. When markets mature, the number of execution venues contracts and for evidence, we need only look at the equity markets: NYSE and ARCA, NASDAQ and Instinet, and in due course a global central order book.

But while existing venues contract, new platforms will be introduced as trading methods that were successful in other asset classes are adopted for the FX markets. One such innovation would be a blind block-trading platform for FX, which emulates equity block-crossing networks like Pipeline and Liquidnet.

Every dealer has a single bank platform for their clients to transact FX and other asset classes. There are also three leading multi-bank platforms and at last count about seven ECNs. The reason why there are so many available execution venues can be attributed to new market participants generating higher volumes and to grab a share of that volume new execution venues have cropped up. The following exhibit highlights the execution venues.
INDUSTRY REPORT: Consolidation: threat or opportunity for FX execution venues?

To understand the reason for the diversity of venues we need to look at the players in the FX markets. Each trading entity has a different motivation to trade and that motivation determines the method they employ. As we see in the following exhibit the majority of the players could potentially utilize all available methods.

The types of players that engage in foreign exchange trading range from national central banks to dealer banks down to the day traders in an arcade. The myriad players have myriad strategies and goals determining their motivations for FX transactions. Fundamentally, some engage in trading for profit whereas others engage in FX trading necessary for currency conversion to pay for goods and services or to control the currency risk associated with future corporate events. These motivations determine whether the FX contract is treated as a separate asset class and where and how the trade will be executed. The traditional method of voice trading still plays a large role, but as in the equities markets, it has been eclipsed by electronic trading. Eventually, voice trading will be utilized only for large blocks and illiquid currencies usually associated with emerging countries. Not all of the trading entities establish connectivity to each of the venue types and why should they if certain venues provide the best market for a particular player why subscribe to all of them.
INDUSTRY REPORT: Consolidation: threat or opportunity for FX execution venues?
Transaction volumes for foreign exchange trading have risen over the past five years, returning to levels not seen since the late 1990s. Global total FX average daily volumes will exceed $3 trillion (USD) by 2007. The market has also seen a fundamental shift in trading patterns: The electronic FX (e-FX) market has come to represent 40% of all FX trade volume and I expect it will grow to more than 44% of the total volume by 2007. A number of forces are driving electronification of the FX markets, but the two biggest are more buy-side participation in the market and the growing treatment of FX as an asset class by all participants. The following exhibit illustrates the growth in global average daily FX trading volumes.
INDUSTRY REPORT: Consolidation: threat or opportunity for FX execution venues?
New execution venues

Most of the growth in e-FX volumes has been the result of buy-side participation in the market, largely due to the commoditization of FX products. New execution venues have appeared, making it easier for traders to enter the FX market and reducing the risks associated with FX. The emergence of each new execution venue has further fragmented market liquidity. With the third-party vendors looking alike, users are asking themselves: "Why should we subscribe to all of them?" The multitude of venues is likely to consolidate and as a result, fragmentation will diminish.

Seeking opportunities for alpha, the buy-side firms are treating FX as an asset class and will utilize the same trading tools and methods they have employed successfully in the equities markets. Venue aggregation and algorithms will become commonplace, and electronic orders sweeping the venues will force a change in the FX dealer banks' approach to the market. FX trading volume is already shifting from interdealer business to trading by buy-side institutions. This trend is driving many dealers' strategies. One change to the dealers' strategy has been to deemphasize single-dealer (single-bank) portal distribution of data and products. Instead, dealers are concentrating on branding, client-specific focus, and portal content.

In the FX markets, transactions are communicated and executed in two ways: by voice and by keyboard. The FX market has already moved away from traditional voice methods and left a forwarding address. Interdealer portals, single-bank portals, multi-bank portals, and electronic communication networks (ECNs) have all contributed to the success of electronic FX (e-FX) trading, and now 60% of the spot transaction volume is being done electronically. Request-for-quote (RFQ) portals and ECNs represent two approaches to price discovery, each appealing to a different segment of the market. The lines are blurring as each portal races to become the solution for a variety of market segments. RFQ providers will add ECN structures to their product set to compete with existing ECNs. TowerGroup believes that in the end, survival of the e-FX platforms will be based on their ability to attract liquidity, maintain an orderly market, and extend the innovative technology demanded by the buy side.

Single-bank portals

Single-bank portals work well for clients that want to leverage their respective relationships with their primary banks, and these portals will continue to be viable as the banks, leveraging their ability to extend credit, offer more asset classes through them.

Interdealer portals

The interdealer portals, with their deep pools of liquidity, provide banks a means of managing the risk they may have incurred in FX, and the current vendor duopoly provides a safety net in the event that either vendor experiences systems failure. For the dealer banks, interdealer (inter-bank) portals like EBS and Reuters offer a tremendous amount of liquidity (albeit not necessarily at the order sizes they might like). There have been allegations that allowing the buy side to participate has exposed the banks to algorithmic market manipulation (program trading looking for stale prices). But the reality is that with a portal like EBS Prime, the buy side can only trade in multiples of up to $5 million. This is hardly enough to manipulate a market as large and liquid as spot FX. TowerGroup believes that if sniping (picking off stale quotes) occurs, the banks have only themselves to blame. The traditional model of streaming prices to multiple venues no longer works when new technology allows market aggregation across the multiple liquidity pools offered by execution management systems. If the banks elect to limit their exposure by offering liquidity only to select venues, this would also work to further consolidate the FX markets.

Multi-bank portals

The multi-bank portals offer an array of quotes to clients seeking best execution, but the offerings are consolidating, and in the end there will only be room for two or three vendors. These portals offered clients the opportunity to utilize their bank credit lines without having to shop multiple single-bank portals in their search for liquidity at the best price. The multi-bank portals have carved up the market, each specializing in a particular client segment. While differentiation among the providers may have been sufficient for them to coexist, the environment is changing as each of the platforms tries to compete for all market segments. Additional pressure on these portals has come from the emergence of FX ECNs, which offer bid-and-offer pricing, anonymity, and prime brokerage. TowerGroup believes that existing multi-bank portals that do not yet offer bid-and-offer models will begin to do so, but proliferation of venues will create only a mirage of liquidity. New tools that enable aggregation of liquidity pools provide the buy side the ability to sweep the market, leaving the FX dealer banks to cope with the resulting exposure.


The ECNs offer a bid-and-offer alternative to request for quote (RFQ), but their consolidation seems inevitable since there are seven ECNs. FX ECNs represent the next stage in the evolution of the FX markets and will become the platform of choice for entities that treat FX as an asset class. The ECNs offer a bid-and-offer alternative to request for quote (RFQ), but their consolidation seems inevitable since there are seven ECNs. Investments in infrastructure, new partnerships, use of prime brokerage relationships, central counterparty clearing, and collateralized trading have all contributed to the rise of ECNs. TowerGroup expects that over the next three years, ECNs will experience significant growth in volume and participants. At the same time, we expect to see a decrease in the overall number of execution venues as the marketplace consolidates, embracing the more mature exchange model offered by the ECNs.

Each of these venues has its pros and cons. In the FX marketplace, suitability of the venue depends on the motivation for the trade. That is, the trader's purpose determines which venue is most appropriate. Whether the trader is exchanging currency to pay for goods or treating FX as an asset class to be traded for profit, there is a venue catering to that need. The buy-side institutions' appetite for global market products is growing. Treating FX as an asset class requires access to a bid-and-offer marketplace that has liquidity. Therefore, I expect that the surviving ECNs will be instrumental in consolidating a fragmented marketplace.

The foreign exchange markets are undergoing transformation. The adoption of electronic foreign exchange (e-FX) has changed the nature of the market by increasing the number of participants and creating advantages of scale for trade processing and management. Trading FX as an asset class requires rapid access to pools of liquidity for highly liquid positions that are processed in a low-cost, straight-through processing (STP) environment. Electronic screen-based trading allows for a redirection of human resources to higher-value services and away from simple transaction execution. But voice communication will still play a role for large blocks and illiquid currencies.


As part of the chorus of venues, single-bank portals will try to differentiate themselves by offering clients multi-asset-class platforms that incorporate best-of-breed electronic communication networks (ECNs). TowerGroup expects that the dealer banks will change their tune in order to deal with aggregation tools and algorithms. Streaming liquidity to every available venue creates a mirage of liquidity and leaves the dealers vulnerable. A two-part harmony is required: pricing for relationship and pricing for profit.

Trying to be heard amid the cacophony of voices, the multi-bank portals initially differentiated themselves by appealing to a particular market segment or by offering lots of bells and whistles. As the curtain goes up on the next act, TowerGroup believes that these platforms will become homogenized and when the singing stops, only two or three will be left standing.

The ECNs offer a value proposition that changes the tempo of the marketplace. The ability to post bids and offers allows participants to create spreads, not just take them. The roles of the players blur in this venue as buy-side participants create liquidity and the banks compete with clients. TowerGroup expects that, as happened in the equity markets, a contraction in the number of ECNs will occur in the FX markets as market forces consolidate the fragmented pools of liquidity. The stage is crowded, and it is time for some of the players to exit.


When the curtain goes up on the final act, e-FX will be center stage. The FX markets have matured and offer great alpha potential as asset class. TowerGroup expects that the buy side will utilize e-FX aggregation and algorithms to realize alpha and the dealer banks will have to adjust their models. Rather than being disruptive, e-FX is innovative, and the starring roles in the FX markets will go to the players that adapt to the new tempo.