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The public see HFT as the poorest incarnation of Big Finance. How would you change this perception?
LMAX Exchange CEO, David Mercer, comments that the recent public perception of High Frequency Trading as being the poorest incarnation of Big Finance could be the result of particular journalistic approach and the reality is that HFT is here to stay. David states, the markets require liquidity and the best liquidity providers are the best high frequency market makers, who incidentally are situated in banks and proprietary trading firms with no differentiator. It could be public perception can be changed with a combination of greater education and more responsible journalism.
David Mercer, LMAX Exchange CEO, shares insights.
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Is the impact of HFT good or bad for the FX market?
LMAX Exchange CEO, David Mercer, states that the impact of High Frequency Trading is good for the FX market. There is no better time to be a customer in the market, the cost of trading has been driven down, allowing prices to become more accessible whilst providing a greater degree of price discovery than ever before.
David Mercer, LMAX Exchange CEO, shares insights.
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Do the new regulations create reluctant market makers?
LMAX Exchange CEO, David Mercer, comments that despite new regulations it is uncommon for market makers to be reluctant in the FX market. David states incentivising market makers is still yet to be encountered in FX and currently the difficulty could be perceived as the onboarding of buy side clients.
David Mercer, LMAX Exchange CEO, shares insights.
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“Flash Boys†– Rigged or Imperfect?
David Mercer, LMAX Exchange CEO, shares his thoughts on the recent book release of “Flash Boys†and the sensationalist views expressed by its author Michael Lewis. David Mercer comments, algorithmic execution is a part of high frequency trading (HFT) and that all market makers and exchanges engage in HFT. Exchanges are very transparent venues with everyone having a choice as to whether they trade there or on another venue, and the notion that an author has uncovered rigging in the markets is false.
David Mercer, LMAX Exchange CEO, shares insights.
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UK share of global FX went up to 39% in 2013
Global FX volume traded on OTC markets for the 1995-to-2013 period saw tremendous growth overall, but the share from the top 10 nations remained intact at roughly 88%, following a dip to 84% during the 2001-to-2004 period. Certain factors, such as the emergence of the euro in 1999, the rise of high frequency trading in the mid-2000s, and the ensuing race toward creating low-latency environments, did create change within the share of top 10 nations. During the 18-year period from 1995 to 2013, the U.K. raised its market share in FX markets by 5.3% points, while Japan’s share fell by 4.1% points and the combined share of Germany and France dropped by 3.6% points based on FX client flows.
Volume by Region
Source: Aite Group ‘Global FX Market Update 2013: Increased Market Transparency, More Competition’, June 2013 -
Banks are no longer the largest counterparty in the FX market
One of the most significant changes that the FX market is currently undergoing is the substantial increase in trading activities from “other financial institutions” —included in this group are retail aggregators, high frequency trading firms, and smaller (Tier-2, Tier-3) banks. Banks with an FX expertise (dealers, reporting dealers) accounted for 64% of all trading in 1995, but that figure declined to less than 40% by 2010. Non-financial customers (primarily corporate clients) as a group have more or less kept pace with growth in the FX market and held on to a 13%-to-18% share of FX volume. Trading from non-bank financial institutions (such as high frequency firms, smaller banks, and retail aggregators) increased from 20% in 1995 to 48% in 2010, thereby becoming the largest counterparty in the FX market. Principal reasons for this large jump in activity follow:
- The growth and popularity of electronic trading platforms that started in equities markets two decades ago has gravitated to the FX market.
- The lack of steady, profitable returns from traditional asset classes such as equities and fixed income have propelled FX and commodities as the new alternative asset classes, thereby attracting fresh investor money flow into the FX market itself.
Volume by Market Participant Type
Source: Aite Group ‘Global FX Market Update 2013: Increased Market Transparency, More Competition’, June 2013 -
Average Trade Size Declines for Spot FX
A key insight from semi-annual surveys by the London Foreign Exchange Joint Standing Committee (FX JSC) and U.S. Foreign Exchange Committee is that the average trade size for parts of FX markets is decreasing over time. Lower currency volatility, the rise in interest for HFT, and fierce competition in the FX liquidity part of the market have reduced the average size of spot FX trades two- to threefold, to around US$1.1 million in both the United Kingdom and the United States. The average trade size of other FX products is much higher than that of spot FX, however—outright forwards currently sit at US$3.0 million, FX options at US$25.1 million, and FX swaps at US$47.1 million. 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.
Average Trade Size Declines for Spot FX
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4 key fundamentals to consider when choosing an FX venue
While FX as an asset class might be straight forward, customers that play in the FX market have different needs and requirements.
For those corporations and traditional asset managers that view FX transactions as a byproduct of their core business (e.g., cross-border transactions), for example, overall costs associated with execution might be less of an issue; these customer segments would also view access to large size as important, leading them to trade on RFQ-based MDPs and SDPs. On the other hand, statistical arbitrage and actively trading hedge funds and HFT firms might care more about cost of execution since they deal with smaller-sized but more frequent transactions, leading them to use ECN/MFT-type execution venues.
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Is the growth in Spot FX expected to continue?
According to the recently published report by Aite Group ‘Global FX Market Update 2013: Increased Market Transparency, More Competition’, June 2013, the spot FX volumes will continue to grow on the back of prime-brokered clients (retail FX brokers and hedge funds/HFT firms) for the foreseeable future. Other FX products not impacted directly by regulations, such as outright forwards and FX swaps, should experience similar growth trajectory. Aite Group expects the spot FX market to reach US$2.2 trillion in daily turnover by 2016, up 35% from 2010 levels.
The largest daily trading volume in foreign exchange has traditionally come from the FX swap part of the market, but there are clear signs that new regulations on both sides of the Atlantic— particularly related to higher margin requirements for OTC FX swaps—will temper volume growth as market participants unable to secure margin to maintain or roll FX swaps choose to let them expire or look for alternative hedges on the futures/on-exchange side of the market, something that is now being termed “the futurization of FX swaps.”