Nicholas Pratt

What’s behind the explosive growth of e-FX across Australia?

March 2023 in Regional Perspectives

Nicholas Pratt looks at the development of Australia’s e-FX market, including the growing use of algos and the evolving digital asset space.

For the corporate users of FX, the commodity markets has been the key influence on currency volumes, says Cameron Peter, managing director of Sydney-based consultancy Peter Lee Associates. “Corporate volumes were up by 30% between 2021 and 2022 and reported volumes among natural resources respondents up 85% over the last two years and especially since the outbreak of the Ukraine/Russia war. Coal and iron ore have been the biggest drivers of increased FX volumes.”

For the financial institutions in the FX market, the growth of pension funds and asset managers has been the primary catalyst of increased FX volumes. “Increased funds under management in the superannuation sector and increased ‘insourcing’ from this growing sector have been the major driver of increased institutional volumes over the last three to four years and will continue to drive volumes in the future,” says Peter.

“The corporate use of algos has been driven by large natural resources companies and commodity traders who tend to use FX spot to hedge their currency risk.”

Cameron Peter

Broadened portfolios

As a result of this growth, Australia’s FX providers have sought to broaden their portfolio of FX products and services as well as enhance their electronic trading platforms. According to Peter, firms have been investing in two specific areas. “Firstly, they are investing in emerging market currencies and non-deliverable forwards (NDFs) which are steadily growing in volumes. Secondly, they are investing in algo trading. Major institutional users are expanding their panel of banks through which they use execution algos and a steadily growing number of corporates are also using algos,” says Peter.

The increased use of FX algos has been driven by numerous factors, says Peter. “The corporate use of algos has been driven by large natural resources companies and commodity traders who tend to use FX spot to hedge their currency risk. Of the six Australian corporates that use FX algos, five are either natural resources companies or commodity traders,” says Peter.

For the financial institutions, increased demand for algos has been driven by increased volumes and an increasing desire for best execution, says Peter. “But we are not seeing Australian participants using electronic trading platforms for options trading at this point.”

The growth of superannuation funds has influenced growing demand for electronic and digital trading services among the Australian buy-side community

Another influence on the development of FX services has been an increasingly tech-savvy client base and the rise of new digital banking and payment platforms. “Australian banks are enhancing their transactional banking offerings, in terms of both core platforms and host-to-host functionality, to more seamlessly allow FX transactions,” says Peter.

It is likely that usage of electronic FX services will continue to grow among corporates, says Peter, as commodity prices stay strong and treasury staff in corporates become more comfortable with algo trading and the benefits of trading algos become more understood. And among Australia’s financial institutions, algo trading and transaction costs analysis (TCA) will continue to grow as they better realise the execution benefits, says Peter.

High FX flows

There are numerous factors that have influenced the currency flows and FX trading activity within the Australian market, according to ANZ. For example, interest rate divergence, inflation, rising commodity costs and increased volatility have necessitated an increasing number of firms review their FX hedging strategy . In addition, Australia’s status as a net exporter, allied with these macroeconomic factors, has mean’t that FX flows have stayed high.

There are also other influences on Australia’s FX market, says Luke Marriott, global head of fixed income, commodities and currencies at ANZ. The Reserve Bank of Australia (RBA) Term Funding Facility (TFF) provided additional liquidity to the ADI’s in response to funding and liquidity pressures during the pandemic. The additional liquidity was welcomed by the ADI’s, substituting traditional offshore funding programs. That said, volumes have remained consistent with AUD/USD being the sixth most traded currency pair according to the BIS Triennial Central Bank Survey.

So what are the implications for FX service providers and how have they adapted their offerings to cater for a growing use of electronic trading platforms? “ You have to ensure there is breadth and depth to your FX strategy,” says Paul Scott, head of eFX at ANZ. “We have focused on order management and client self-service delivery through major ECNs in terms of breadth. We also have our own internal corporate FX engine to address the depth of the product offering and to add more functionality.”

“People want to know how to trade and to limit market impact. The output is TCA and it is the litmus test for your order routing.”

Luke Marriott

There has been an evolution of FX services, says Marriott FX service providers used to focus on the cross-border and wholesale market but then there was a shift from manual trading to self-service platforms. Now the adoption of those electronic platforms is spreading to corporate treasurers at both large corporates and SMEs while the use of FX algos is increasing among the larger and more sophisticated corporates.

For the service providers looking to tap into this demand for e-trading in FX, it is essential to have a robust infrastructure that can operate at scale and with 24/7 availability, says Scott. It is also essential to offer analytics as a way to deepen the relationship between the client, venues and service providers, says Scott.

For example, these analytics can be used to refine a trading strategy or to gain insight into liquidity provision or to inform product development. “Transaction cost analysis (TCA) has been in demand for some time but we are now seeing more interest in pre-trade analytics,” says Marriott. “People want to know how to trade and to limit market impact. The output is TCA and it is the litmus test for your order routing. But the pre-cursor to that best execution (BE) obligation is pre-trade analytics.”

“You want the clients using your algos to have a good experience and to know when is the best time to execute,” says Scott. “When you have more advanced algos, it can help them to make better decisions around parent / child order logic and timing.”

The crypto and digital asset space is also rapidly developing, says Marriott with several local banks in Australia working on their own stablecoins. In fact, ANZ was the first commercial bank to complete a permissionless stablecoin transaction in the public domain in 2022, albeit a pilot transaction intra day with a regulatory overlay. ANZ also has a share in Lygon, a blockchain-based network for bank guarantees. Meanwhile, the Digital Finance CRC is currently coordinating the RBA’s central bank digital currency pilot of which ANZ is a participant.

Regulatory clarity

What is needed for the digital assets market to progress is more regulatory clarity, says Marriott “The BIS issued a guidance paper, the Prudential Treatment of Cryptoasset Exposure, in June 2021 but we are waiting for regulations to evolve further. We need clear technical definitions, aligning to regulatory guidance. If you are issuing a payment token onto a network, does that require a clearing licence? There are two regulatory schools of thought emerging, is it a financial market product or a payment?”

The FX market in Australia is also being influenced by other fintech developments such as the growth of digital banking and the digital payments market as well as the emergence of blockchain-based projects and proof-of-concepts. “Payments remain a big factor in the Australian market,” says Scott. It is an island with a huge cross-border element (G20 report on 2017/18 cross-border transactions – Australia ranked as the 17th most expensive).

“Atomic settlement is very important in Australia but we have one of the biggest intraday lags – it is a massive capital expense so the idea of a blockchain-based settlement is very important.”

Paul Scott

Consequently, there is a lot more regulatory scrutiny into the process and the feasibility of applying blockchain technology, says Scott. “Atomic settlement is very important in Australia but we have one of the biggest intraday lags – it is a massive capital expense so the idea of a blockchain-based settlement is very important.”

In terms of ensuring further growth of the e-FX market in Australia, much of the work to date has focused on pre-trade processes like pricing as well as execution. According to Scott, the future focus will be on ensuring straight-through-processing, especially for buy-side participants like funds and corporates, says Scott. For example, how can netting be made more efficient? Can we provide holistic margining?

The FX market remains hugely fragmented and with the buy-side becoming an increasingly bigger player in terms of volumes this may precipitate a move to an exchange-like market.

Another influence will be regulatory capital management, says Marriott. For example, the uncleared margin rules are pushing the case for greater use of FX futures by the buy-side, which, in turn, has seen exchanges look to introduce a hybrid execution process.

“A few large exchanges LSEG, CME, SGE and Deutsche Boerse have all recently purchased or invested in OTC exchanges. Building financial markets ecosystems, has the potential for integration of OTC markets into exchanges, to further improve capital management,” says Marriott. “And we are already seeing that to some degree in terms of LSE (Refintiv); CME (Nex -EBS); Deutsche Boerse (360T).”

“Fund managers at super funds have intensified their focus on leveraging tools and accessing liquidity sources that ensure their transactions leave the smallest possible footprint,”

Vanessa Bailey

Minimising market impact

Flows in AUD have been influenced by interest rate differentials and the fact that central banks have been dealing with inflationary forces in different ways, says Emma Norman, global head of FX trading at Westpac.

“We’ve seen volatility in commodity prices driven by Russia’s invasion of Ukraine, resulting in significantly higher USD revenues for Australian miners,” says Norman. “This in turn has led to dividend hedging flows increasing due to higher corporate profitability. We’re also seeing super fund portfolio rebalancing, particularly in FX Forwards, due to the price volatility in global markets.”

The crypto and digital asset space in Australia is also rapidly developing

The use of FX algos has also grown, says Vanessa Bailey, head of digital distribution at Westpac. “Usage has especially increased during less liquid times of the day when a model-driven approach to minimising market impact, whilst still meeting volume objectives, becomes particularly valuable. Utilising algos which aim to minimise market impact with synthetic crossing capabilities will help Australian customers achieve the best results especially when execution is required in the less liquid times of the day,” says Bailey.

Bailey also cites the growth of the superannuation funds as a factor in the growing demand for electronic and digital trading services among the Australian buy-side community. “In Australia we continue to see the significant growth of superannuation funds, both with respect to inherent system growth from compulsory contributions and the trend towards fund amalgamation. The same can be said of our New Zealand franchise, with the growth of the Kiwisaver scheme,” says Bailey.

“Fund managers at these super funds must provide investors with transparency and best execution. As such they have intensified their focus on leveraging tools and accessing liquidity sources that ensure their transactions in the market leave the smallest possible footprint,” says Bailey.

“The inherent growth in funds under management combined with high levels of market volatility has led portfolio managers to execute more frequent and larger volumes of hedge rebalancing, making access to liquidity and ease of execution critical. In this context, two-way pricing alone can be insufficient in meeting best execution needs,” says Bailey.

“…it is key to ensure we are able to show consistent prices to our customers especially given the electronification of FX Markets.”

Emma Norman

Risk management tools

Westpac has developed a range of algos, which Bailey says will provide clients with a range of risk management tools, including synthetic crossing capabilities that aim to provide deeper liquidity while minimising slippage.

Westpac has also broadened its portfolio of e-FX products and services by developing its customer pricing strategies to deliver higher levels of internalisation and more competitive pricing. “This focus, especially in our core AUD and NZD currencies, delivers more than 75% of client flow netting internally for AUD and 90% for NZD, which means our market impact has significantly reduced, something we know is important to our buy-side customers,” says Norman.

“In the past two years, we have added NDFs to our e-FX offering and continue to invest in expanding our currency pair offering. Furthermore, in the FX algo space we have uplifted our TCA report to include additional metrics to empower our customers in assessing the impact of their algo performance,” says Norman. “We have also heavily invested in our distribution platform, most recently creating a new Institutional Bank Digital and Customer Platforms team to provide a higher degree of support and resources into our broader client coverage network when providing customers with digital solutions.” According to Bailey, Westpac has been active in algorithmic trading for more than a decade, offering bespoke algos for benchmarks and, since 2016, self-execution algos. “Over the last six plus years we have focused on using our eTrading experience to refine and improve our Algo functionality. We do this on the back of our client’s requests and needs rather than overwhelm with a huge algo suite that may make it difficult for clients to find the best algo for them,” she says.

“We deliberately chose a small algo suite based on our execution expertise and our clients’ execution needs. Continuing investment in these strategies is based on whether we assess it to improve the client execution outcome, whether that be price or usability. We are also focused on delivering API enabled solutions that allow us to integrate with clients where they prefer to access our liquidity whether it be on new platforms or integrating into in-house systems,” adds Bailey.

Lessons from Covid-19

Australian sell-side FX providers have learned lessons from the Covid-19 crisis in terms of how the buy-side responded and how this might shape the focus of future investment in digital services. “Over time the e-FX spreads shown to clients have become extremely competitive however when the market experiences a shock, such as we saw over the Covid-19 crisis, many liquidity providers widened prices significantly to manage this,” says Norman.

“This did not go unnoticed by the buy-side clients who expect support during these periods of volatility, so it is key to ensure we are able to show consistent prices to our customers especially given the electronification of FX Markets. In order to do this, it is essential that we focus on strategies to attract diversified flow, capture spread, internalise and minimise market impact as much as possible,” says Norman.

Covid-19 also reshaped working patterns for Westpac and its clients. “Clients started working from home and wanted more access to electronic execution – both in the size of clips and the portion of flow they wanted to put through electronic venues. Whilst working patterns have moved some way back to the state before the pandemic – we are all back in the office a lot more – the habit of executing larger tickets electronically has stuck.

Covid-19 was the first major liquidity crisis where algo volumes increased, allowing our models to be truly tested and our algos delivered value in extremely volatile conditions. Outside of pricing, this also means being attentive to the ongoing resilience of our platform,” says Norman.


So what should be expected in the next evolution of the Australian e-FX market? “The last number of years has seen the implementation of the FX Global Code and the necessity to ensure the right behaviours have been embedded into market practices,” says Norman. “With this now firmly in place the focus has now moved to execution and delivery, with data security also a visible concern for Australian firms of all kinds.”

Westpac is also investing in its digital distribution platforms to make it both reliable and safe for customers to use, says Norman. “As a highly liquid market, clients are spoilt for choice when it comes to FX execution so we need to make it as easy as possible for them to trade with us. We are committed to offering the right price, at the right time, in the right places.”

RBA explores CBDC pilot

The Reserve Bank of Australia (RBA) has announced its intention to launch a ‘live pilot’ for a central bank digital currency (CBDC). The central bank will be working with the fintech association Digital Finance Cooperative Research Centre (DFCRC) on the project.

The pilot will also involve selected industry participants that will demonstrate potential use cases for a CBDC using a limited-scale pilot CBDC with a genuine digital claim on the RBA.

The central bank also announced the use case proposals which have been selected to participate in the pilot. Dr Brad Jones, assistant governor (financial system) at the RBA, welcomed the number of submissions from a diverse band of industry players looking to take part, from small fintechs to large financial institutions.

“The pilot and broader research study that will be conducted in parallel will serve two ends – it will contribute to hands-on learning by industry, and it will add to policy makers’ understanding of how a CBDC could potentially benefit the Australian financial system and economy,” said Jones.

According to Dilip Rai, program director of CBDC with the DFCRC, they variety of proposed use cases cover a range of problems that could be potentially addressed by CBDC, including some that involve the use of CBDC for atomic FX settlement of transactions in tokenised assets. “The process of validating use cases with industry participants and regulators will inform further research into design considerations for a CBDC that could potentially play a role in a tokenised economy,” said Rao.

A report on the project is expected to be published around the middle of the year.

Dr. Brad Jones