The emerging market (EM) FX industry has been boosted significantly by the use and evolution of electronic platforms. New technology can reduce the complexity and manual intervention that is typically more prevalent in EMs. Similarly such platforms can also help with liquidity access and management as well as operational risk.
Technology has also played a part in the growth of the non-deliverable forward (NDF) market and could still be a factor in the digital assets and crypto markets in EMs. What remains to be seen is what comes next in terms of digital workflow innovation and automation in EM FX platforms, particularly on the post-trade side, and whether this will help to release the full potential of EM FX trading.
Multi-dealer platforms
“For many EM countries, e-FX solutions provide a convenient transition from voice to electronic trading, and cover a wide range of currencies and instruments,” says Tod Van Name, global head of foreign exchange electronic trading at Bloomberg. “Multi-dealer platforms like Bloomberg provide access to all major and regional liquidity providers for both onshore and offshore markets.”
Multi-dealer platforms also provide many enhancements that make trade EM negotiation more efficient, says Van Name. “This is through features such as default fixing source and date for NDF trades, curated calendars for selecting automated settlement dates, and algorithmic capabilities for NDF trading that reduce or eliminate the need for manual intervention.”
“Eventually EM countries could benefit from central bank digital currencies and workflows, but this will require greater regulatory clarity and a high degree of jurisdictional cooperation.”
Tod Van Name
A further benefit of electronic trading platforms is the way they help to access FX liquidity in emerging market currencies, says Van Name. “In many cases the challenge with supporting emerging markets is not the technology, rather it is access to local communities. Bloomberg has established a network of liquidity providers in more than 140 countries, with a very strong presence in onshore markets. This not only provides access to liquidity, but also better transparency for all market participants.”
Electronic platforms can also help to reduce the operational risks that are potentially greater in EMs where liquidity is thinner and volatility is greater, says Van Name. “Emerging markets are occasionally susceptible to decreased liquidity and increased volatility, and e-FX solutions provide a clear, consistent method for market participants to negotiate trades with the same suite of solutions available to developed markets, including real-time deal capture, straight through processing, and complete audit trails that increase efficiency and reduce risk.”
Access to emerging markets has also been increased by the electronic trading of NDFs and the evolution of the asset class. “In the past, automating NDF trading was limited by inconsistencies in fixing sources and available liquidity,” says Van Name.
“Today, those friction points have been solved, and clients can now trade NDFs 24/5 via both request-for-quotes (RFQ) and streaming liquidity, from a wide range of banks and non-banks. Many offer algo trading and options for NDFs. These developments also allow for better price transparency for off-shore investors, who can confidently trade and then mark-to-market their positions.”
There will be further benefits, especially on the post-trade side, as digital workflow innovation and automation in emerging FX platforms develops, says Van Name. “Eventually EM countries could benefit from central bank digital currencies and workflows, but this will require greater regulatory clarity and a high degree of jurisdictional cooperation.”
When it comes to the issues that can influence a suitable choice of EM trading provider with whom to partner, Van Name highlights the role of accessibility. “Access to multiple liquidity providers is essential, particularly those who are able to provide reliable pricing (spreads) and liquidity in both on-shore and off-shore currency pairs and instruments. FXGO provides liquidity from over 800 regional and global banks.”
Liquidity challenges
One of the most significant challenges when it comes to FX trading in emerging markets involves liquidity. “Adding a new pair of emerging market currencies to a platform is easy. Providing good liquidity on that emerging market pair is not,” says Clinton Norton, head of sales, Americas at Euronext FX. “Emerging market currencies are best priced locally by informed market participants. The platform needs to have the reach, the functionality and incentives to attract both makers and takers.”
It’s important for an FX platform to have a diversified pool of liquidity providers that spans all regions and allows for specialization to be readily available to the taker, says Norton. “A niche emerging market player may not necessarily have the credit and distribution web to reach the taker flow he would find beneficial.”Technology can also help to reduce the complexity and manual intervention that can be prevalent in the emerging market FX process. “Manual intervention typically takes place when trades need ‘special care’,” says Norton.
“In the case of emerging market pairs, typically more volatile because liquidity is thin, takers want to rely on the expertise of the physical trader to get done with limited market impact and tighter spreads. Technology is increasingly allowing traders to supplant the manual process. At Euronext FX for example, where over 20% of our trading is emerging market, we provide a safe environment for niche currency players to offload risk undetected.”
Other ways to achieve best execution through electronification is to utilise the same tools developed for the more liquid pairs and adapt them to the specificities of emerging market currency trading, says Norton.
“Uncontrolled taking can rapidly ruin any good pool of liquidity. The volatile nature of EM trading makes it all the more important to ensure that takers and makers are matched off appropriately in a compatible way. Our liquidity management team at Euronext FX manages bespoke liquidity pools for each client based on trading needs and trading style. In a way, the manual intervention happens up stream, ahead of trading, and is informed by transparency, communication and data analysis.”
Although remote niche LPs can supply very competitive prices, they often lack the tools to check and monitor the quality of takers to ensure they match their pricing model appropriately, says Norton. “Again, our LM team can step in to create, manage and monitor interactions in a systematic and automated way with a range of automated tools and analytics.”
“Uncontrolled taking can rapidly ruin any good pool of liquidity. The volatile nature of EM trading makes it all the more important to ensure that takers and makers are matched off appropriately in a compatible way.”
Clinton Norton
When it comes to maximising access to liquidity, FX platforms need to be connected to the best emerging market market-makers possible, says Norton. “They are typically not the traditional tier1 banks but rather the few tier 2 banks and local broker dealers that specialise in trading their specific set of currency pairs derived from natural local interest.”
“Tight prices are derived from informed market-makers that have access to local markets and uncorrelated flow. FX platforms need to find a way to connect these sometimes remote liquidity providers and create a safe and easy access for makers and takers of emerging market liquidity to interact. This means finding these potential makers and then using technology to adapt to their needs that are typically unconventional,” says Norton. “Since these special makers often lack credit to the street and the capability to widely distribute their liquidity, they will rely on the FX platform partner for access and connectivity.”
Electronic NDF market
In 2020 Euronext FX launched NDF trading out of Singapore, through the RMO license approved by the MAS and operated by Euronext Markets Singapore Pte Ltd. The electrification of the NDFs market is a natural extension of this trend, says Norton. “Technology has allowed for the faster and wider connectivity of makers and takers to the point where it is blurring the lines of conventional buy and sell side interactions. The proliferation of venues complying with the various interpretations of global regulations has increased access to NDF trading which is now reaching mainstream. Both liquidity providers and takers have had time to adjust to this peculiar market and now better understand the rules set by regulators such as Dodd Frank and MiFID around trading and reporting and are better able to decide on the best way to access NDF trading.
While electronic platforms can help to reduce operational risks that are more pronounced in the EM universe, it is still important to tread carefully says Norton. “What works for G10 currencies does not automatically transfer to EM where liquidity can be thin and markets volatile. It’s important to be able to adapt trading to the quickly changing environment of NDF trading. Our local liquidity management teams understand this, and use automated analytical tools that are quick to detect anomalies in the market that could impact our clients’ trading. Thinner liquidity and greater volatility in EM mean that traders should adhere to a stricter trading protocol than in G10 so as to not harm participants.”
Electronic product innovation
Electronic product innovation in the EM FX trading space is an ongoing process. For example, Euronext FX has introduced its ‘LSP 0’ functionality (Leak Sweep Protection with 0 hold time) which performs the price check on behalf of the taker against its best bid offer (BBO). This mechanism protects the maker from off market trades while at the same time prevents information leakage since the taker’s intent to trade is not disclosed, says Norton.
Full amount (FA) trading in EM is encouraged to avoid market impact, says Norton. “The larger FA trade becomes a genuine risk transfer to the maker and leaves the act of hedging to the experienced liquidity provider to perform in his own time. Our EM FA volumes have more than tripled YoY and stand at a record high in June 2022. To protect the maker, we are creating a lock-in period mechanism, adjustable by size and currency pair, to ensure a repeat trade in the same pair within a certain time frame can only go to the same liquidity provider. Should the same taker come back for more before the end of the lock-in, he will be sent to the same liquidity provider who potentially has not yet finished hedging the earlier trade,” says Norton.
Choice of provider
Norton identifies four important factors that should influence the choice of EM trading provider – speed, liquidity, data driven service, and flexible functionality.
“Speed helps to avoid trading on off market quotes. Both sides benefit from speed of trading. A taker enjoys better fill ratios and a more precise execution with fills in line with the market at the time of trade. Speed allows a maker to be more aggressive in his prices without the fear of being inadvertently picked off or triggering Last Look rejects. Speed can be achieved through better technology as well as working to reduce the distance between counterparties trading together,” says Norton.
In terms of price discovery, EM currencies are best priced by local participants who are informed and directly involved in the trading of their niche EM currency, says Norton. “A suitable EM trading platform needs the right set of specialized liquidity providers on board to price accurately and aggressively but also needs the flexibility to allow them to price on their own terms. The platform also needs to solve for possible limited credit with the street as well as technology concerns that can make it difficult for remote EM LPs to bring their prices to the market.”
Euronext FX employs a local liquidity management team, says Norton. “We understand the EM players, their different needs and trading styles and we understand the market in which they interact. Through regular dialogue with both makers and takers, through data analysis we share with the highest level of transparency possible, our LM teams create and manage bespoke liquidity pools with interests from both sides of the trade at heart.”
Understanding the needs of clients is one thing but having the functionality and the flexibility to accommodate multiple trading styles simultaneously is crucial, says Norton. “This means allowing for the expected traditional two-way last look lit pricing, but also providing the capabilities to trade via algos, to trade skew-safe, to use passive orders (dark or lit) or aggressive price taking, to trade full amount or sweep, to trade on last look or firm liquidity. All these trading styles are appropriate in certain conditions. It is important for EM FX traders to have these tools available and understand how and when to use them.”