What are the current key themes in the FX Swaps market?
The fragmentation of liquidity and market data, the availability of new data sources, increased electronic trading and market velocity, have all combined with growing client demand for FX Swaps. These themes are driving the evolution of the market and prompting banks of all sizes to look at whether their FX Swaps technology is fit for purpose in 2024 and beyond.
How is fragmentation impacting the market?
Bank to Client trading is already highly fragmented. Now interbank FX Swaps trading is migrating away from brokers and voice-based trading, and onto e-channels like 360T SUN and LSEG FX Forwards Matching. While we are seeing an increase in interbank liquidity, the market has become even more fragmented, which leads to banks facing challenges when capturing market data for use in their pricing engines.
Why is market velocity increasing?
The adoption of e-trading, automated workflows and the growth of matching platforms are increasing the velocity of the FX Swaps market. E-trading has increased access and transparency, which has led to spreads narrowing. As a result, pricing along the curve needs to be even more accurate and the supporting technology to have minimum latency.
Market velocity creates potential issues for trading firms which need to react faster to events and more frequently than previously. A recent example of this was a CPI publication during July that was better than anticipated, with lower inflation projected. As a result, the marked gapped significantly. These movements are driven at very high velocity, meaning that high performing systems need to react instantly to these changes. This also translates to data. When relying solely on broker data and simple models, the FX Forward curve will update slowly and often won’t update consistently along the whole curve, where 3M might update, but 4M and 5M does not. Trading firms need fast, scalable, and robust technology to manage this change.
What data sources are banks connecting to?
Accurate pricing requires better data. A key source of reliable FX swaps data is provided by the DIGITEC/360T Swaps Data Feed (SDF), which enables clients to build fully automated and accurate real-time curves. The SDF is based on participating major FX banks’ raw pricing, which represents interbank quality. Today, the SDF has established itself as a reliable data source used by many banks and FX swaps market participants in their active pricing of currency curves.
In addition we are also seeing some of the more sophisticated trading banks trying to achieve pricing reliability by subscribing to and managing in real time multiple direct LP connections.
Many trading firms also want to incorporate high frequency data. This requires advanced technology and new pricing models due to the need to build accurate forward curves at very high speed, with a price that adheres to regulatory requirements (pre-trade market mid mark) and is inside a very narrow acceptable spread range.
All these transformations increase the demand for advanced FX Swaps pricing solutions like D3, which are capable of handling multiple data streams of high frequency. But even this is not enough. As trading firms look to improve pricing, they increasingly go beyond existing market data, building ever more sophisticated pricing models which include yield curves and inferred FX swap points.
DIGITEC D3 FX Swaps Pricing Solution
How do your bank clients manage this complexity?
Many of our clients resolve the issue of pricing tight spreads while managing high speed data and connectivity by turning to D3 curves. It is a tool that allows them to build and compare multiple models of the same market. These models provide different views of the market, by tapping into a basket of market data including FX Swaps and Forwards, FX Spot, STIR Futures, OIS, IRS and Cross-Currency Basis Swaps. This allows them to combine high frequency with lower frequency data, and isolate and control effects such as end-of-year turns and central bank decisions. Building safety mechanisms and checks on such a granular level is crucial to pricing aggressively and staying competitive in the market.
Are changes also taking place in banks pricing their clients?
Achieving an accurate forward curve which reflects a bank’s core price is only part of the solution. To accurately price client trades an additional layer of modelling is required to incorporate request-based and volume-based price adjustments. This is often divided by tiers, channels and by currency groups. Speed is still key in pricing clients, where reactively pricing manually and on an individual level is slow, inefficient and subject to error. Again technology provides a solution, where an active strategy can be set up, with a low-touch tool managed from a Trader cockpit.
Establishing a core price and modelling adjustments (based on platform, volume, and tier) removes manual and repetitive activities, which avoids reaching capacity issues limited by the speed of humans.
How do you think the market will evolve in the future?
At DIGITEC we see significant demand for automated end-to-end workflows, which continues to drive the evolution of the FX Swaps market. The market is maturing quickly, with banks capturing more and more market data, which needs to be modelled to improve pricing accuracy. Among the most sophisticated banks we see that levels of competition are increasing, not just in G7 or G10 currencies, but also in other currencies where central bank effects play a significant role. The FX Swaps market is already very advanced, and for many market participants the trend is clear – there are growing volumes of market data, and more detail to find and leverage in swaps curves to improve pricing accuracy.
