Justyn Trenner CEO & Principal, ClientKnowledge
Justyn Trenner CEO & Principal, ClientKnowledge

LOOK-BACK 2004 - e-forex: the second wave breaks

e-forex: the second wave breaks

Distinct kinds of adopter of electronic execution in the wholesale market-place: true believers, executing typically 60% of their business online; and nibblers, trying deals, often over multiple systems, but only for a small margin of their trades. By 2003, the true believers category had grown modestly and the extent of their take-up had grown markedly but many of the nibblers had fallen away. Often, this was because they had failed to implement the other process changes required to achieve the full benefits of electronic execution – easier trade allocations and more reliable, less labour-intensive settlement. By 2004, a good deal more have made the necessary investment and a second wave of substantial adoption has taken hold.

“ClientKnowledge estimates that daily online volume now comfortably exceeds $100bn, of which around half is over single-dealer systems”

As a result, our most recent research, captured from among about 2000 market users in the period May-July 2004, shows around 30% of all client business now undertaken over electronic platforms, whether multi-dealer (such as FXall, FXConnect or Currenex), anonymised exchange-style (such as Hotspot FXi) or banks’ single-dealer systems. Expressed another way, ClientKnowledge estimates that daily online volume now comfortably exceeds $100bn, of which around half is over single-dealer systems.

LOOK-BACK 2004 - e-forex: the second wave breaks
A plural market with multiple winners
If the sheer breadth and volume of take-up is one key development over the last 12 months, the other must be the establishment of multiple credible channels for execution and the recognition that this plural market model is likely to stay. For example, many aggressive corporations and institutional investors have adopted FXall, both for its reverse-auction capability and for its Settlement Center while others find the execution and settlement capabilities within FXConnect more to their liking. Others still appreciate the streaming pricing and size that can now be achieved on a touch-and-trade basis on some single-dealer bank systems, and some corporations in particular just prefer the linkages to their cash management and trade finance that can be achieved in an environment where pricing is easy to compare to the wider market.

LOOK-BACK 2004 - e-forex: the second wave breaks
In the last year, adoption of Hotspot FXi’s liquidity-posting and hitting market-place has clearly won a creditable level of following, particularly among the leveraged community. It is very clear what is driving the growth. If the first wave of take-up was as much about experimentation, riding the e-wave and the (largely illusory) search for a marginally better price, this wave is much more about reaping the rewards of improved processing and lower cost and time of settlement.

Certainly, some are still seeking to shave pips from a deal, although truth-to-tell, much of that is about market-efficiency, too. It must be quicker to check screen rates and hit a streaming price in reasonable size than call two or three banks and risk a move against you as you do.

Aggressive investors leading to structural growth

ClientKnowledge believes that we are in the midst of a period of structural growth in the wholesale client forex market, in particular the institutional space. The number of leveraged and highly active funds (those trading more than $30bn per year) that we track increased by about 75% between 2003 and 2004 – and we only caught the middle of the spurt. For example, in other research, we have found the number of major traditional fund managers allocating money to hedge fund activities, internal or externally managed, increased from February to August for about 30% to around 75%. In many, though not yet all cases, this was accompanied by an increasing aggressive approach to currency overlay and/or the opening of pure currency funds. In the week preceding the writing of this article alone, we are aware of three such funds being opened. The connection to the growth of efx? First, many of the pure-play funds have only been enabled because of the growth in sell-side offers in prime brokerage or access to a wide range of sell-side pricing via prime-brokered portals; moreover, some of the traditional managers, who have no need of prime brokerage as institutions are adopting them as a means of ring-fencing the risk management of highly leveraged funds. Second, of course, more trading has driven and will drive growth in the plural market described above. Prices for all – liquidity redistribution For a number of years, liquidity, particularly in the more active pairs, has migrated to the leading names in the market. Over the past 2-3 years, in a move that will take another similar period to play out fully, many banks have recognised the limit benefits – or more often the true costs – of attempting to trade those pairs where they see insufficient flow reliably to make money. Those banks have become net liquidity takers from the market, either for some or all of their business. They continue to make credit-related spread from their clients but leave the market risk to others. Clearly, this is a development that has seen much of the eforex focus of the last year.

A number of banks have seen take-up of their single-dealer platforms by client banks, whether as desktop screens only or as true white-label solutions (much more limited), but a majority of this business continues to route via Reuters Conversational Dealing as well as the multi-provider portals. Banks, as their clients, will wish to realise the efficiency gains of a more interconnected world and we expect to see that business flow to the single-dealer and API-managed approach relatively rapidly.

Where next? This article has focused on the rear-view mirror. However, if 2004 has seen a second wave of take-up, major growth and deeper embedding of eforex, what will 2005 hold?

Some years ago, ClientKnowledge envisioned an eforex world without online portals, in which clients used digital dashboard or procurement-facilitating order management systems to pull prices in and send transactional and confirmation instructions directly to their bankers. Most banks now have the capability, either directly or via intermediating platforms, to offer this and an increasing number of clients have either adopted, or in some cases developed customised technology to achieve this. We believe this still represents the future.

A limited number of banks have developed electronic streaming pricing offers, in some cases to whatever size the client requires. We believe that this is the new market standard for wholesale clients, and the lack of book that may prevent some from offering this will push them towards a liquidity-taking profile.

Finally, we believe that dramatically reduced costs of tickets (and the concomitant error reduction), alongside a much more disciplined approach to market-risk (whether traded or outsourced) and credit-risk (with electronic real-time margin and position management) will allow most banks to make more money, more securely – in most cases with fewer people.