By Nicholas Pratt

e-FX on the up down under

January 2022 in Regional Perspectives

Australia’s FX market continues to grow in both corporate and institutional markets thanks to rising commodity prices and more activity from the country’s super funds. There has also been an increase in the use of algorithmic trading. Nicholas Pratt looks at how e-FX adoption can be further encouraged through the major FX providers’ offerings, a post-Covid recovery and a developing regulatory landscape.

According to financial research group Peter Lee Associates, the reported volumes in its corporate FX study of Australia were up by 7% to A$323 billion in 2021, the highest level in 13 years. “The increased volumes were mainly driven by a sharp lift in resource prices, particularly iron ore,” says Cameron Peter, chief executive of Peter Lee Associates.”The reported volumes from natural resources respondents were up by 38% to A$131 billion, the highest ever reported.”

Both Australia and New Zealand have imposed strict lockdowns to limit the spread of Covid-19, which has helped to reduce infection rates. But the pandemic has also impacted the region’s FX market. In particular, it has led to a sharp lift in volumes transacted through e-FX platforms, says Peter, albeit a trend that started before the pandemic and has either continued or accelerated since. “The proportion of total volume executed through platforms increased from 49% in 2019 to 58% in 2020 – the highest ever reported.  Over 2021, the proportion was maintained.”

Another feature of the region’s FX market has been the greater investment in the provision of emerging markets and non-deliverable forwards (NDF) products, although the number of banks that can provide a competitive service across these products is limited, says Peter. “In Australia there are the likes of HSBC, ANZ and Westpac. However, there are also the Japanese banks focusing on these products as well.”

This year’s research also picked up the first meaningful usage of algorithmic trading by corporates, says Peter. “Algorithmic trading by corporates is still a nascent trend, but it is on the increase.  Of the 167 respondents in the 2021 research, only five stated they use algorithmic trading.  The FX currency option market is not particularly active.  Only 16% of the 173 respondents (27) report using currency options,” says Peter.

“It is also anticipated that platform usage will steadily increase amongst corporates in Australia, as more companies see the benefits of straight through processing and finer pricing, in addition to boards/executive requiring greater transparency and diversification in relation to their FX sell-side panel,” says Peter.

When it comes to the institutional FX market, the reported FX volumes in the PLA study were broadly stable, increasing by 3% to A$3,115 billion in 2021. However, says Peter, the underlying trend was actually down by 5% due to a less volatile trading environment than in 2020 when there was a 22% underlying increase thanks mainly to a sharp lift in volumes during March and April when pandemic-induced lockdowns were imposed worldwide.

“A big influence on current and future trading activity is the increasing volumes reported by industry super funds,” says Peter. “The reported FX volume of industry super funds has grown substantially over the last five years. It has more than tripled, and is likely to continue to grow at above trend for the foreseeable future.  This is due to increasing insourcing and growth in funds under management.”

“A big influence on current and future trading activity is the increasing volumes reported by industry super funds. The reported FX volume of industry super funds has grown substantially over the last five years.”

Cameron Peter

Unlike the corporate market, there has been little impact from Covid on the proportion of FX volume executed through institutional e-FX platforms. However, this is most likely because there is already a high proportion of volume on these platforms. In 2021, the percentage was 89% and the level has been consistently around 85-90% for the last five years, says Peter.

Algorithmic trading continues to grow in Australia within the institutional market, says Peter. “Of the 30 respondents that report total FX volumes of A$10bn or more, 11 report using algorithmic trading, and the proportion of their total volume is also growing.”

The use of transaction cost analysis (TCA) also continues to grow in Australia, says Peter. “Of the 30 respondents that report total FX volumes of A$10bn or more, 17 report using TCA.”

Amongst the financial institutions, there is a greater spread of sell side players executing emerging market non-deliverable forwards (NDFs) on platforms, says Peter. It is no longer just the domestic banks and HSBC but also the likes of Citi, BNP Paribas and JP Morgan. There are also more buy-side firms doing the same.

Expanding the breadth of products that the buy-side are willing to use through platforms will be key to growing the eFX market in Australia, says Peter, referencing NDFs, options and emerging market currency pairs.

Commodity price rises

The rise in commodity prices over the last couple of years has certainly had a large influence on currency flows, says Jonathan Woodward, head of FX, Asia Pacific, Capital Markets at London Stock Exchange Group. “However, the superfunds continue to grow their assets under management annually through contributions and asset growth which means that they must expand their international investments.”

The Covid-19 crisis has tested the resilience of regional eFX providers and their trading services which have ultimately stood up to this challenge. “There were initial challenges with getting traders set up at home but everyone adapted quickly to working from home. The interbank voice brokers probably suffered due to the lack of sophisticated home telephony systems and more flow was directed to the e-channels,” says Woodward.

In order to cater for the growing appetite for eFX, leading Australian FX providers been broadening their portfolio of FX products and services and launching more flexible and powerful electronic trading platforms, real-time pricing solutions, currency research services and pre and post trade FX toolsets.

“Certainly the Australian banks have continued to improve their systems so that they are more efficient internally and the last two years has increased the importance of the eFX functions,” says Woodward. “These improvements will flow through to the clients with improved liquidity. The next interesting regulatory change will be the Average Aggregate Notional Amount reduces from US $50 billion to US $8 billion and institutions will have to decide whether to clear trades, pay the increased margin or reduce their exposure.”

So why has demand for FX algo trading and electronic FX option trading continued to grow across Australia and what factors are at play here? “Algos have been a growing segment of the flow for many years and will continue to do so as more products, such as NDFs, are introduced,” says Woodward. “The take up of FX options in Australia has been behind many other developed markets but momentum is starting to build.”

“The Australia e-FX market will see strong growth in the future as the banks seek to work more efficiently and deliver more product and services electronically.”

Jonathan Woodward

The latest fintech developments in Australia have had a relatively limited influence on the adoption of eFX so far, says Woodward. “To date blockchain has not had any impact on FX globally, apart from diverting some substantial retail investments into digital assets,” he says. “There are a number of initiatives looking to launch in the next couple of years that may have an impact especially in the corporate space.”

Future growth of the eFX market across Australia will deliver further advantages for buy-side firms and investors over the next few years, says Woodward. “With the investment community continually looking to expand their international investments the Australia e-FX market will see strong growth in the future as the banks seek to work more efficiently and deliver more product and services electronically. Competition for business will be fierce and that will continue to make the environment extremely efficient and innovative,” he says.

Regulatory developments

Australia has taken a leading role in the development of the FX Global Code, not least because Guy Debelle, the deputy governor of the Reserve Bank of Australia, has been chair of the Global Foreign Exchange Committee (GFXC) for the last two years.

The code was launched in May 2017 as a direct response to the lack of trust in the FX industry that had resulted in numerous instances of misconduct and a number of multi-billion dollar fines. It has since been adopted by the major capital markets as their primary reference for oversight of the FX market, including the UK, China and Australia.

An update was issued in July 2021 in line with the committee’s rule that the code would be reviewed and amended every three years in order to keep pace with the ongoing evolution of the FX market. The first review was launched two years ago. According to Debelle, the strong guidance from the market was that any changes should be contained to a few specific areas.

“The FX Global Code has been updated to remain current with the ongoing evolution of the FX market. It will continue to serve its important role of setting the standard for good practice.”

Guy Debelle

“The GFXC identified a few key areas requiring review to ensure that the Code continues to provide appropriate guidance and contributes to an effectively functioning market, and remains in step with the evolution of the market,” said Debelle in a speech given at the TradeTech conference in September 2021. “The GFXC also saw the opportunity to provide greater consistency and usability in disclosures. In total, 11 of the 55 principles have been amended, said Debelle. “The GFXC has also developed disclosure cover sheets and templates for algo due diligence and TCA to assist market participants in meeting the Code’s principles for disclosure and transparency. Additionally, the GFXC has published guidance papers on the practices of pre-hedging and last look to support market participants in applying the Code’s principles in these areas.”

One area that reflects the development of the market is the role played by anonymous trading. The Code has been amended to encourage greater disclosure by those operating anonymous platforms, including of their policies for managing the unique identifiers of their users. Anonymous trading platforms are also encouraged to make available the code signatory status of their users.

So how have participants reacted to the updated rules? “Almost 1,100 entities globally have signalled their adherence to the Code’s principles by signing a Statement of Commitment,” said Debelle. “With the publication of the updated Code, the GFXC is encouraging market participants to consider renewing their Statements of Commitment, having regard to the nature and relevance of the updates to their FX market activities,” he states.

“The GFXC acknowledges that the changes to the Code will affect certain parts of the market more than others. For those most affected by the changes, we would anticipate a period of up to 12 months for practices to be brought into alignment with the updated principles. We would expect that the disclosure cover sheets would be posted alongside the Statement of Commitments on a similar timeframe, if not sooner. The FX Global Code has been updated to remain current with the ongoing evolution of the FX market. It will continue to serve its important role of setting the standard for good practice. But to do so, it requires that you as market participants continue to reflect the principles of the Code in [their] activities in the FX market. In the end, we all have a strong common purpose in ensuring that the FX market continues to operate effectively and with integrity,” says Debelle.