The number of electronic communications networks geared to trading currencies has exploded this year.
In one short stretch in the middle of the year, the new entrants included FastMatch, TraFXPure, JFX.com, Molten Markets, LiquidityFX and FXSpotStream. The value of electronic trading in pairs of currencies was demonstrated when Thomson Reuters agreed to acquire FXall for $625 million. FXall has both a multi-dealer platform and an ECN and was founded by seven banks, including Credit Suisse First Boston, Goldman Sachs, and J.P. Morgan.
But if you listen to Thomson Reuters, among others, the key to getting the best prices when you trade currencies is not to connect with all possible purveyors of prices. The better approach is to build relationships with the banks.
“If you’re looking strictly at ECNs, you’re really getting what the rest of the market’s getting,’’ said Saul Nadata, product manager for Thomson Reuters’ Dealing Aggregator, which pulls together prices and orders across the foreign exchange market for high frequency proprietary traders and buy-side desks seeking to minimize the impact of their trading on the prices they receive. “The big win is bringing the banks in.”
The four top foreign exchange banks – Deutsche Bank, Citigroup, Barclays and UBS – conduct roughly half of all currency trading, for instance, according to the 2012 and 2011 Euromoney rankings. The top 10 account for more than three-fourths.
So, getting the best prices is not just about “costing networks,’’ Nadata contends. “It’s about building a relationship, and aggregating single banks.’’
Given the volumes handled by each of the big banks, he notes, you don’t need relationships with 30 or 40 institutions. Three, four or five should do.
If you build good relationships with banks, “you will consistently get better prices,’’ than with a strategy of simply aggregating all the prices on all the electronic networks, Nadata said in an online discussion this month hosted by Tata Communications.
With the rise of so many ECNs, electronic trading in currencies “is clearly fragmented,’’ said Ben Ernest-Jones, a systems architect for the Capital Markets Group of Progress Software. “There are a lot of different venues out there for foreign exchange, trading the same thing.’’
Unlike stocks or derivatives, he said, there are no significant differences in the basic products being traded. In spot trading, you’re still just trading one currency for another, he said.
“There’s certainly different business models for each of the exchanges, but the actual instrument itself is pretty much the same across the board,’’ he said. That said, a trading firm needs to build up its choices, by either aggregating pricing venues or its relationships with the top trading banks.
“ I have yet to see a situation with our own customer base where they say that one venue consistently has the best price, and there’s no need to look at others,’’ said Ernest-Jones.
If your goal is to “ask for a certain amount of liquidity for small deals” and you’re trading in major currencies, “you can execute those small deals at some well known ECNs, and that can be the (way of the) day,’’ said Nadata.
But if you’re trying to get costs savings on a large deal and not move the market, “that’s when aggregation plays a real role in spot FX,’’ he said.
You can almost look at “this as a gray scale, almost white to almost black where you could just go to a single liquidity provider and you’re done,’’ for smaller deals, said Sassan Danesh, managing partner of consultant ETrading Software. But on the other end of the spectrum, “you need to be very sophisticated, and aggregation definitely is part of the mix.”
Tech-savvy clients, he said, are happy to use programs to slice and dice their larger FX orders, Danesh said. But, in the end, the algos are there to “support the trader,’’ and if a client wants to work the trade through an aggregation of banking relationships rather than ECNs, that is its choice.
A top liquidity provider provides “deep and relatively consistent pricing, so why would anyone want to go anywhere else?,’’ he asked. Nonetheless, Morgan Stanley, Bank of America Merrill Lynch, Citigroup, Commerzbank, Goldman Sachs, HSBC and J.P. Morgan all are liquidity providing banks to FXSpotStream, for instance.
When using an electronic network, you may want to determine if a price is going to stick around for “a reasonable amount of time” on one venue or whether high-frequency trading firms dominate another or whether the counter party at yet another has the last look at details of a trade. Profiling the differences does matter, Danesh said.
It’s not that you need to look at five different venues for every single one of your trading strategies, according to Ernest-Jones. In some cases, one will do.
But you still will need different options for the different ways you want to handle different trades, he said.
