The global FX market, the world’s largest and most liquid asset class, continues to grow and evolve. It has bucked the trend in volume declines over the past two years that were seen in other asset classes such as stocks and bonds – even with a bottoming in its own trading activity in Q3 2012, it has staged a strong comeback ever since.
Fueled by market volatility, massive adoption of electronic trading,increasing adoption of high-frequency trading (HFT), and retail market growth, the FX market has shown incredible resilience through the last decade, even through the aftermath of the global financial crisis of 2008.
Global FX trading volume has seen tremendous growth over the last decade. The most recent BIS figure indicates global FX volume of $5.3 trillion in average daily trade volume, representing a vibrant market compared with other asset classes. Electronic trading has become the main mode of trading in FX and now accounts for more than 60 percent of all trading done in the global FX market. Moreover, Aite Group expects to see electronic trading adoption to continue in the FX market, reaching 70 percent by the end of 2013.
New FX Venues
Over the last 12 to 18 months, the FX market has seen emergence of new FX trading venues that are attempting to take away market share away from incumbent players. There are numerous reasons for the entrance of new FX venues into a competitive landscape that had been fairly stable until a few years ago. Some of these reasons include:
- Traditional electronic venues such as EBS and Reuters have been gradually losing market share to HFT-oriented market-making or proprietary trading firms, providing much-needed hope for new entrants to build attractive levels of liquidity unthinkable even three years ago.
- Dealing banks have become increasingly dissatisfied with the current group of FX venues due to (1) what they perceive as certain practices that favor automated trading firms and (2) the outdated trading infrastructures of existing platforms. Both of these may lead to potential opportunities for new venues.
- New participants from non-FX markets have entered the space looking for faster, more streamlined, transparent FX trading venues similar to what they are used to in equities and futures markets.
- Continuing regulatory changes in the OTC derivatives markets across different asset classes such as fixed income, commodities, and equities are leading to growing expectations from global FX market participants that similar obligations will be eventually applied to the FX market.
- FX clients are becoming more sophisticated and looking for more choices and efficiency in trading FX electronically.
- The existence of an FX ecosystem has drastically lowered the cost of entry for new market players.
FX Going Forward
There are many new emerging trends that will impact the health and dynamics of the global FX market in 2013 and beyond. First, as the FX market has gone more mainstream and FX has become accepted as a legitimate asset class, a genuine, industry-initiated effort seeks to introduce enhanced transparency into the market and provide a fair trading environment for both institutional and retail clients alike.
Second, fueled by these industry-led initiatives, the next phase of competition in electronic FX trading market has begun. Over the last 18 months, new FX venues have emerged at a rapid pace often touting increased transparency, low latency, and cost-effective trading as key characteristics of their competitive offerings.
Third, banks rely increasingly on internalization of client order flow to manage their market risk. At the same time, they are leveraging their connectivity to various client-to-dealer platforms to manage their overall P&L and are relying less on the traditional interbank venues.
Fourth, thanks to new technological innovations as well as by market structural changes as a result of new demand-supply dynamics and new regulations, there are more choices than ever in electronic trading venues. Customers can choose to trade electronically via RFQ/RFS in single or multi-bank platforms, ECNs with streaming quotes and central limit order books, or exchange-style trading that supports pre-trade anonymity and full post-trade transparency.
Fifth, key findings by government-sponsored FX regulatory bodies indicate that the average trade size of spot FX transactions has already dropped two- to threefold over the last three years, while the number of trades has gone up more than 50 percent during the same period. With expected continued growth in HFT volume and increasing market participation by retail traders, the average trade size of spot FX is expected to decrease even more in coming years.
Finally, although using FX TCA to gauge execution quality remains in its early stages and is generally confined to the institutional investor community, the concept of defining and measuring execution quality will soon become a requirement of most electronic FX trading platforms. The whole FX industry must then ramp up its electronic trading activities.
In these turbulent times with little certainty, the future of FX does appear bright for traders.
Sang Lee is co-founder and managing partner of Aite Group, the market research firm. Follow him on Twitter at @aitegroup.
