FLASH FRIDAY is a weekly content series looking at the past, present and future of capital markets trading and technology. FLASH FRIDAY is sponsored by Instinet, a Nomura company.
In the August 2012 article titled “ECNs Hot”, new platforms for foreign exchange kept popping up. At that time, the number of new FX platforms exploded, and traders were gaining access to faster and more transparent transactions.
It’s been 10 years since then and ECN brokers (Electronic Communication Network brokers) continue to be among the fastest emerging brokerages in FX. But can the market sustain all the venues available?
Howard Tai, Principal, Frontline Global Markets, said that in the near term, future of FX trading platforms is “looking bright”, as both continued increase of electronic/algorithmic trading since the Covid-19 pandemic, amidst the return of FX market volatility had all drawn trading interest back into FX market.
“The recent slump of cryptocurrencies (ie. Crypto Winter) also played a role in FX market returns regaining some of that limelight in one’s trading/investing portfolio,” he said.
FX trading platforms are increasingly differentiating themselves based on the quality of their workflow, according to Francois Lamy Strategy Director, FXall, Refinitiv’s FX platform.
“While buy-side institutions are carefully vetting and partnering with those platforms that can accelerate their digital transformation and journey towards right-sized and more productive trading operations,” he said.
Pierre Perras, Product Manager at Finastra, said that simplification is key to delivering the best service to clients. “The access to the best liquidity must be accompanied with smooth service delivery,” he said.
Platforms integrated within TMS (such as eFX for Kondor) have the advantage of delivering optimal integration with financial institution solutions, he said.
Types of FX Brokers
For retail trading, there are four different types of FX brokers that have a different way of handling transactions and executing orders: no-dealing desk, market-making (or dealing desk), straight through processing brokers (STP) and ECN brokers.
Thomas Moser, Forex Platform Manager at Interactive Brokers, said that generally, differences between STPs and ECNs brokers are “tiny, and terms are sometimes used interchangeably”.
“ECNs often offer access to one pool, in addition to routing to existing pools where clients can match against clients using that ECN,” he said.
Moser said that advantages of the ECN model include quick access to additional liquidity with less market impact.
“Interactive Brokers has always offered an ECN type of Forex platform for this reason, as well as to provide transparency at low cost,” he said.
Meanwhile, according to Hitesh Mittal, Founder and CEO of BestEx Research, institutional traders execute in the following ways: Bilateral (part A) (Customer to Dealer, for example, Citi, Deutsche Bank, JPMorgan etc.). Dealers are earning the spread on it; at an ECN (for example Reuters, EBS, FastMatch etc.). Mittal said that in order to execute on an ECN, they need a prime broker in the middle (for example Citi). The order flow at an ECN is Customer -> Prime Broker -> ECN.
Mittal explained that at an ECN, trades happen between two Prime Brokers and Prime Brokers face their clients. “Each Prime Broker can say which Prime Brokers are they willing to interact with. So if you are represented by a smaller Prime Broker, you may get less liquidity,” he said.
Finally, dealers may themselves hedge their risks on ECNs by trading with each other, or directly with each other or by trading with electronic liquidity providers (for example XTP), Mittal said.
He added that on the Institutional side, trend is to use algorithmic execution of block order rather than trading manually with multiple dealers.
There are three types of algorithmic execution model, according to Mittal.
- Dealers themselves. The issue here, according to Mittal, is that the dealers cannot access other dealers liquidity efficiently and they would offer better liquidity to a client than to its competitors. “So while algorithmic execution provides convenience, it can make the liquidity issue worse off in this model,” he said. “The other issue is that dealers offering algorithms are acting as an agent and also as a dealer, so while they all claim they have Chinese walls there is the issue of information leakage and conflict of interest,” he added.
- In-house algos: Handful of top hedge funds build their in-house execution algos so they can enjoy the benefits of having an algorithm while also addressing the liquidity issues. Te problem however is the cost of building internal algorithms and maintaining algorithms and that is why only a few top hedge funds go for that model, Mittal said.
- Dealer Neutral Algos: This is the model BestEx Research falls under. “This addresses the liquidity issues as well as eliminates the cost of internal build for institutional clients,” Mittal said.
Future Trends
In terms of future trends, Moser expects some consolidation of FX platforms in general, due to regulatory requirements, economies of scale and the need to manage multi-asset portfolios from one platform.
“While a Forex-only platform may have its merits, I would not be surprised if the trend shifted in the direction of multi-asset platforms that excel at offering all asset classes, much like Interactive Brokers,” he said.
Perras added that in the corporate servicing world, there are established actors such as Fx All, Currenex and 360T.
“Smaller providers could be impacted if there is a contraction in the FX Market,” he said.
Tai said that M&A driven activities is a common occurrence in all industries, and FX brokerage space is no different.
“Economies of scale is crucial especially in today’s ultra competitive world of global finance, so it’s inevitable there will be more consolidations ahead,” he said.
Tai further said that in the long term, continued market structural changes will play an important role in how FX trading platform plays in facilitating FX transactions.
“Specifically, more transparency need to shine on FX trades, along with increasing electronification beyond just Spot FX (think FX swaps, NDFs, FX options, ability for venues to facilitate clearing of FX trades, etc.) all play critical roles toward future success in determining the viability of FX trading platforms,” he said.
Meanwhile, from an institutional perspective, Mittal thinks that there will be a rise of Dealer Neutral algorithmic platforms for FX.
While for exchange traded products (stocks, futures), banks can build algorithms that access liquidity in exchanges, for FX, which is largely bilateral (over the counter) product, it is critical that the algorithmic trading vendor is dealer neutral so it can access all liquidity sources (dealers and ECNs) on behalf of its clients and also provide all the benefits that algorithmic trading brings, he said.
“That is why we are building this model at BestEx Research,” he stressed.
The offering will include algorithms, smart order routers and TCA all under one umbrella of Algorithmic Management System (AMS), Mittal said.
“Clients will be able to customize which dealers and ECNs they want to source liquidity from and measure the performance via TCA, which is fully embedded in the system,” he said.
