Fragmentation and liquidity in FX - is it worth upsetting the balance?

There is already significant fragmentation of liquidity in Wholesale FX which has facilitated the evolution of a competitive marketplace creating venues that have developed features appropriate to different user types. Justyn Trenner and David Poole, Co-Principals at ClientKnowledge examine the risks of creating stagnant pools of liquidity within FX if the current delicate balance of fragmentation is upset.

After much fluctuation, FX is in a period of reasonable stability of liquidity pools. While EBS and Reuters are still recognised as the leading inter-dealer brokers and some marketplaces have come and gone, there are still several growing and increasingly significant venues. So far, natural market dynamics have allowed venues offering sufficient liquidity and necessary services to flourish, while new venues who do not offer it, or whose model has not suited their target clients have failed. When we consider how participants trade, important distinctions are to be made between three clearly different modes: voice-to-voice, manual-to-screen and a computer trades with another computer. Nonetheless, the fundamentals of the market are the same with each, even if the workflow is different. Using any of these methods to trade, in the overwhelming majority of cases banks acquire risk from clients; clients only limitedly trade risk between themselves; banks need to hold and lay off risk and clients will pay banks...continued

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