Report Forecasts Change to Structure of FX Market

Electronic commerce (e-commerce trends), macroeconomic forces and new capital markets regulations in the European Union (EU) and US are challenging the investment bank-dominated foreign exchange (FX) market, a report issued by GreySpark Partners notes.

According to the London-based capital markets consultancy, these forces are giving buy-side customers more choice and control than they have ever had before in their FX trading activities.

GreySpark’s report, entitled
‘Trends in FX Trading 2013’,
explores the changes to the market structure for FX trading. It notes that since 2010, the proliferation of so-called dealer-to-client (D2C) multi-dealer platforms (MDPs) has meant that the buy-side has enjoyed more choice in where they trade FX than ever before.

As the number of these platforms – many of which will be registered in the US as swap execution facilities – grows, FX liquidity will naturally fragment away from the concentrated, bank-to-bank dealer-to-dealer (D2D) platforms onto the new D2C platforms.

Spot and forward spreads between major currency pairs in the D2D venues will grow increasingly tight every year as a result of the decimalisation of pricing introduced in 2012. Also, since 2010, banks have begun directing increasingly larger amounts of proprietary and client FX liquidity onto D2C venues in an effort to make currencies dealing an integral part of their capital markets business following the 2008-09 global financial crisis. This movement of currencies liquidity away from the D2D platforms is a clear indicator that the long-standing FX market model of bank-to-bank trading venues housing the majority of global liquidity is under threat.

The report suggests that in the next three years the lines will become blurred between the characteristics of D2D and D2C venues, and an all-to-all (A2A) market for FX liquidity will arise. An A2A FX trading venue is an equities-like market in which all counterparties share unrestricted access to currencies liquidity. The emergence of A2A venues will continue from 2017 onward as the blurring of the divide between the characteristics of D2D and D2C FX trading venues continues.

Banks must be prepared to adapt to this shift in the FX market’s structure in an effort to retain client business that could be lost as the A2A market encourages buy-side FX investors to trade directly with one another, breaking the mould of their traditional relationships with inter-dealer brokers.

“In the FX market of the future, there is no one-size-fits-all solution for banks as they look to adapt their currencies dealing models to make them more suitable for an equities-like, electronically-traded FX environment,” said Frederic Ponzo, GreySpark managing partner and lead author of the report.

“Banks must focus on putting their clients at the centre of their plans to utilise single-dealer platforms for FX liquidity while also ensuring they have the technological sophistication necessary to maintain strong profits from proprietary currencies trading.”

Russell Dinnage, GreySpark analyst consultant and report co-author, added: “New regulations will incentivise the utilisation of innovative new technology in the design of multi-dealer platforms, bringing to an end to the banking industry’s attempts to maintain good-governance principles for the FX market.”

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