Willis Bruckermann London-based Consultant at GreySpark Partners
Willis Bruckermann London-based Consultant at GreySpark Partners

The more things change, the more they stay the same

In late 2016 and early 2017, GreySpark Partners documented a profound shift in the infrastructure for flow FX liquidity provision in which the vast majority of multi-dealer platform (MDP) brokerage liquidity pools permitted direct or indirect spot FX price-making by firms traditionally classified as buyside.

In late 2016 and early 2017, GreySpark Partners documented a profound shift in the infrastructure for flow FX liquidity provision in which the vast majority of multi-dealer platform (MDP) brokerage liquidity pools permitted direct or indirect spot FX price-making by firms traditionally classified as buyside. This finding led GreySpark to question the continued utility of the blanket terms sellside and buyside within the context of the currencies trading landscape, insofar as the applicability of those terms to counterparties within the spot FX market.

In the intervening 18 months, GreySpark witnessed the further secular transition toward all-to-all (A2A) trading flow FX models, although not necessarily in a linear fashion or as exclusively as expected by casual market observers. Using an updated dataset compiled in Q3 2018 of 14 MDPs containing 38 liquidity pools, it is now clear that the historical assumption of A2A proponents and evangelists – that, in time, currencies markets would evolve into single-tiered, central limit order book (CLOB)-like structures in which all participants hold the same rights to make or take liquidity, regardless of whether they are banks, brokers, prop trading firms, asset managers, long-only institutional investors or any other type of firm – was incorrect.

Instead, a second pathway toward A2A spot FX trading has emerged that is both more deferential to the historic, multitiered market structure and yet concurrently undermines one key premise thereof. Specifically, in this second paradigm of A2A spot FX trading, different categories of brokerage venue participants remain distinct based on their ability to make or take prices – there are pricemakers, price-takers and price maker-takers, which means that the FX market remains multi-tiered – yet market participants’ eligibility for the different categories is divorced from their regulatory status as an investment bank, dealer, asset manager or institutional investor. As a result, A2A spot FX trading in 2018 takes place on both single- and two- / multi-tiered markets.

The upshot thereof is that the clear distinction between dealer-to-dealer (D2D), dealer-to-client (D2C) and A2A trading venues has further eroded and no longer provides a comprehensible shorthand for venue structure and functionality. In 2018, GreySpark’s understanding of the concept of a multi-tiered market versus that of a singletiered market takes the place of D2D and D2C markets, which – for several years – have no longer accurately illustrated the liquidity flows on such multitiered venues (see Figure 1).

Moreover, since Q1 2017, FX brokerage venues have overwhelmingly come to publicly acknowledge – both through their promotional materials and in statements at conferences and in the media – the obsolescence of the traditional division between dealers and clients based on the designation of bank / broker as the former and buyside firm as the latter. Non-bank liquidity providers now compete directly with – or even out-compete – traditional brokerdealers even outside of the MDP venue structure by providing institutional trading services directly to liquidity takers. This shift is illustrated in the 2018 edition of the annual Euromoney FX Survey, which has seen steady growth in the number of nontraditional liquidity providers in the ranking of top-50 flow FX liquidity providers; nontraditional liquidity providers also continue to improve their highest ranking achieved in the Euromoney list.

Figure 1: 2016 Share of Volume on D2D Spot FX Trading Platforms by Counterparty Type
Figure 1: 2016 Share of Volume on D2D Spot FX Trading Platforms by Counterparty Type

Liquidity fragmentation & aggregation within venues

The fragmentation of spot FX liquidity has been a persistent conversation point in capital markets since 2010. Yet, despite the proliferation of spot FX brokerage trading venues, liquidity fragmentation across those venues – as measured by the market share of multidealer platforms in Euromoney’s FX Survey – decreased in 2017 before expanding again (see Figure 2). Somewhat surprising in this context is the fact that, over the past three years, the market share of the top-five spot FX brokerage venues grew relative to the market share of the next five largest venues. At the other end of the market, virtually imperceptible in terms of market share, a long tail of low volume brokerage venues serves niche currencies markets and buyside or non-bank client bases.

Notwithstanding this concentration of spot FX MDP market share, flow currencies liquidity fragmentation continues, albeit in an evolved form: liquidity fragmentation has shifted from between venues to within them as the range of liquidity pools within the largest MDPs proliferate. This trend is particularly pronounced in the spot FX market, where market share concentration in 2018 may mask a multitude of different matching methodologies and liquidity flows within a single brokerage venue (see Figure 3). Indeed, the larger an MDP’s market share in spot FX, the more likely such internal liquidity fragmentation becomes.

GreySpark’s analysis of the breadth of functionality offered through differentiated liquidity pools with the top five brokerage trading venues by market share shows this to be more than one-and-a-half times as great as that offered on the next five largest brokerage venues by market share.

Figure 2: Spot FX Multi-dealer Platforms Market Share
Figure 2: Spot FX Multi-dealer Platforms Market Share

GreySpark hypothesises – and practitioners across the breadth of market participants affirm – that the large market share persistence of the largest-byvolume spot FX brokerage trading venues results from market participants electing to move their trades between different liquidity pools within those same venues. The proliferation of liquidity pools within a single venue thus acts to counteract the centrifugal liquidity fragmentation resulting from market participants seeking – and finding, across a multitude of venues – specific matching methodologies and work flows that best suit their overall currencies trading strategy or any particular trade at a given time.

From the perspective of market participants, the proliferation of flow FX liquidity pools within a single venue benefits them in a number of ways. At the most basic level, liquidity pool proliferation within existing, leading MDPs eliminates the need for the market participants to be onboarded onto multiple venues and maintain the relationship with each in order to access particular matching methodologies and work flows for a given trade. This results in cost savings for technology overhead, service provider management and data feed subscription costs, with the most technologically sophisticated buyside firms or liquidity takers benefitting most in these regards.

On the other hand, for pure liquidity consumers that do not possess their own order management system (OMS) and execution management system (EMS), this diversity of matching methodologies and liquidity providers across multiple venues complicates spot and flow FX liquidity aggregation, adding another step to the trading workflow. These buyside or liquidity-taking firms must now aggregate liquidity within a venue in addition to between venues, which exacerbates an already highly manual and time-consuming process reliant on graphical user interfaces (GUIs) of the investment bank single-dealer platforms and MDPs on which they trade, or on those whitelabelled solutions provided by their brokers.

In an effort to capture a greater share of these low tech, pure liquidity consumers by smoothing these traders’ workflow, the vast majority of venues with multiple liquidity pools provide aggregation of the different matching methodologies within their venues through a single view.

Although often referred to as liquidity pools on the part of the venues, these are not liquidity pools in their own right, but rather aggregation tools that clients can access via the GUI and, in many cases, via an application programming interface (API). However, users must still compare the aggregated liquidity picture of the venue in question with the liquidity picture of other, similarly internally-aggregated venue feeds or GUIs.

Figure 3: Leading Spot FX MDP Liquidity Pool Offerings
Figure 3: Leading Spot FX MDP Liquidity Pool Offerings

The persistence of the dealer-to client relationship 

Despite clear presence in 2018 of two pathways toward A2A flow FX trading, traditional bankcentric, two-tier market structures and disclosed trading continue to play a disproportionate role in the currencies market. GreySpark understands that traditional FX liquidity consumers – such as asset managers, institutional investors and non-financial corporates – continue to use disclosed RFQ and RFS trading both on- and off-venue for a number of reasons. These reasons include both quotidian concerns over the ability to execute block-size flow FX trades rapidly and efficiently – which is to say, with minimal information leakage that could result in slippage – and more strategic concerns related to the maintenance of dealer relationships in FX that typically cascade into other asset classes.

On the latter point, GreySpark believes that in 2018, liquidity consumers continue to maintain a number of relationships with large flow liquidity providers due to concerns over the functioning of fast-paced, A2A markets during times of uncertainty and stress. GreySpark understands that these consumers wish to ensure access to flow or spot FX liquidity in markets that become uni-directional, and which consequently may lose much or all of the liquidity that these markets source from non-traditional liquidity providers during more normal trading sessions. These strategic, block-sized trading relationships with traditional bank dealers may therefore act as a drag on trade performance under normal market conditions, acceptable to trade execution decisionmakers in return for the hope of access to liquidity even in uncertain, more illiquid market conditions. However, this trade-off remains untested and unquantified, putting in question the degree to which this choice can be maintained in the face of any expansion of transaction cost analysis services or capabilities within the spot FX market, either by banks, by brokerage trading venues or by new, neutral technology providers.