Electronic trading venues top Spot FX execution methods

The outlook for spot FX execution methods is both fluid and evenly split. The first BIS reading of execution method market share came in April 2010. Using execution venue data from the U.S. FXC and FX JSC semi-annual surveys, Aite Group constructed an estimate of how the market share of various execution methods has changed since April 2010. Aite Group estimates that between April 2010 and October 2012, the industry witnessed the following market share changes:

• Electronic trading venues: Aite Group estimates that SDPs and MDPs have seen a (substantial) 4.0% market share gain since the April 2010 BIS survey. An estimated US$520 billion (32% of the spot FX market) was executed daily through electronic trading venues in 2012, making this the largest type of spot FX execution venue.
• Customer direct execution: Trading between a reporting dealer and a client or non-reporting dealer via direct telephone conversation or RCD has likely fallen from 21.3% to 17.9%. This change denotes a slight shift toward electronic trading venues.
• Electronic broking: Trading executed via electronic broking venues increased slightly in notional terms, from US$389 billion in April 2010 to US$402 billion in October 2012, but it saw some market share tussle with electronic trading venues in 2012.
• Voice brokers: The ongoing trend away from voice broking in the spot FX market likely continued between 2010 and 2012, with the share of this execution venue falling from 8.5% in April 2010 to 6.4% in October 2012.
• Inter-dealer direct: Direct activity between two reporting FX dealers saw a noticeable increase between April 2010 and October 2012, from 14.8% to 18.4%. Higher bank capitalization in the United States and Europe appears to be boosting trading activity among financial institutions.

High Frequency Trading accounts for over 40% of FX trading

Within the context of the FX trading the terms “high frequency trading” and “automated trading” are interchangeable. Automated trading represents trading activities driven by systems that (1) automatically determine when and where to trade based on input of internal and external data and (2) trigger order flow into execution venues via APIs. Automated trading firms continue to make their presence felt in the FX market―slightly more than 40% of trading volume in spot FX is currently represented by high frequency trading.

Unlike the equities market, however, it is unlikely that automated trading could account for more than 50% of overall volume. Indeed, the sheer diversity of FX market participants and their varied reasons for participating in the market would make it difficult for a single group of FX market participants to overwhelm the rest. It should also be noted that at least half of the 40% HFT presence in the spot FX market is represented by banks themselves.

Evolution towards transparency – the new wave of FX venues

Price discovery and trading models in electronic FX have evolved over the last decade, and current market structure supports multiple formats.

• RFQ/RFS: The most primitive method of price discovery and trading is the RFQ, a model that was adopted by first-generation client-to-dealer platforms. While most FX venues have evolved and added requests for streaming as well as order book information, FX Connect continues to dominate this particular marketplace, driven by its large asset management client base and its ability to provide support for extensive post-trade service, including netting.
• Streaming quotes/order book: Most FX ECNs currently support some combination of streaming quotes and order-book-style price discovery and trading. Despite the emphasis on anonymous, transparent trading, most FX ECNs have hidden markups and provide only limited post-trade transparency in terms of the counterparty; the identity of the prime broker is only disclosed if the trade has been prime brokered.
• Exchange style: Currently, only LMAX Exchange has launched a truly exchange-style trading model that provides pre-trade anonymity but full post-trade transparency. LMAX also does not support last look. Both Molten Markets and ParFX are slated to have price discovery and trading methods similar to LMAX Exchange.

Adoption of electronic trading

Electronic trading has become the main mode of trading in FX and now accounts for more than 60% 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% by the end of 2013.

This reality does not predict the end of voice trading, however. Typically, voice has a bigger role when large trades are being done. In addition, during times of severe market volatility, it is common for clients to rely on their relationships with banks to get much-needed color into where the market is headed and to get it via voice. This was certainly the case in 2009, when, following the record volume of 2008, the dramatic dislocation of the general global economy created much uncertainty in the marketplace, leading to widened spreads and lower trading volume. During this time, reliance on high-touch, voice-driven trading became crucial for clients seeking to navigate market uncertainty.