Following new regulatory requirements and market structure changes in 2018, navigating the global FX market has become more complex. Against this background, how are buy side market participants finding smarter ways to trade FX in 2019?
In 2018, the FX industry made progress towards greater transparency and fairness, yet various regulatory and technological changes to the trading landscape are also creating more complexity.
The focus on accessing deeper liquidity and achieving greater operational efficiencies is driving the sophistication of buy side market participants.
Electronic trading platforms are well positioned to become the buy side’s partner of choice for independent trade analytics.
Recent developments in the global FX market were largely seen as positive, since they enable greater transparency, fairness, and access to the market. Among the main developments to impact the FX trading landscape in 2018 were:
- The regulatory-driven fragmentation of liquidity in Europe, as derivatives trading in the European Economic Area moved to regulated Multilateral Trading Facilities.
- The growing adoption of the FX Global Code of Conduct, which is enforcing higher standards of conduct across the industry.
- Liquidity providers continuing to invest heavily in their algorithmic trading capabilities, helping investors access the FX market in more efficient ways.
- The ongoing wave of consolidation in the trading technology sector, which has spurred further M&A activity by both strategic buyers (including exchange operators) and financial investors.
Yet these developments also result in more complex market structure and added costs that participants must now factor into their decision-making.
The buy side is becoming more sophisticated, amid pressures to find smarter ways to navigate this complex and changing liquidity landscape, as well as smarter ways to achieve operational efficiencies and lower costs.
Starting 2019 with a crash
Early in 2019, following a period of very thin liquidity in the FX market, buy side market participants were reminded that they need to constantly refine their liquidity sourcing strategies.
On 3 January, investor concern about the health of the global economy triggered a mini flash crash that was accentuated by low liquidity between the New York close and the Tokyo open (on a Japanese holiday), causing the Japanese Yen to soar against the U.S. and Australian dollars, the British pound, and other currencies.
US Dollar / Japanese Yen FX Spot Rate (hourly price chart from 2 January to 3 January 2019)
As geopolitical risk still looms in 2019 (especially as we approach the 29 March date set for the United Kingdom’s exit from the EU), market events such as this flash crash will prompt participants to ensure they are connected to consistent and reliable liquidity, even during market turbulence.
Here at Refinitiv, we remain committed to offering market-leading liquidity for over-the-counter FX trading. In 2018, daily trading volumes averaged US$426 billion across all Refinitiv FX platforms, an increase of 14 percent compared with 2017 levels.
Smarter ways to access liquidity
In their search for more transparency and best execution, buy side participants have now largely moved to electronic trading platforms, where they can access a range of advanced execution tools to help them access liquidity in smarter ways.
At the forefront of these smarter tools are execution algorithms.
FX algos will play an even greater role in 2019, as regulation and competitive pressures prompt investors to focus more on the quality of their trade execution, as well as to minimize market impact and information leakage (especially for larger trades).
Early adopters will continue to increase their usage of algos and fine-tune their TCA tools used to assess algo performance. In parallel, more and more new users will start experimenting with these automated execution strategies, attracted by the potential benefits of algo trading.
As they seek to connect to deep and diversified sources of liquidity, the more sophisticated participants will consider accessing primary markets, where deep liquidity will allow them to efficiently transfer risk with a high certainty of execution.
Those with sufficient credit can become direct participants on the primary markets, which have historically been structured as central limit order books where participants benefit from pre-trade anonymity and price transparency.
Others, however, will prefer indirect access to primary markets through a careful selection of broker algos that aggregate and opportunistically source liquidity on these platforms.
To meet the diverse liquidity needs of the FX ecosystem, Refinitiv offers a comprehensive range of solutions: investors can access primary markets via Matching, as well as source relationship-based liquidity via FXall.
Achieving greater operational efficiencies
Among those smarter ways of conducting FX trading, 2019 will see participants make further progress towards automating portions of their trading activity.
Expected benefits of automation include allowing the execution desk to focus their time on more value-add tasks or more complex trades (whether larger in size, or for illiquid currencies).
While some of the most advanced participants may look to build fully automated trading systems in-house, for most players on the buy side, automation will be available to them via electronic trading platforms and in the following forms:
- Rules-based auto-execution workflow: a set of rules that automatically take orders from their resting state in the order management system, to the execution stage, and executes them according to pre-set conditions (e.g. all EUR/USD orders under US$1 million in my order management system will be executed via RFQ, with a predetermined panel of four banks, and will auto-execute at the best price).
- Broker algos: the use of broker algos to automate the execution of orders based on a set of parameters entered manually by the trader (e.g. a trader will choose to execute a US$500 million order with a TWAP algo, which will split the order into smaller slices, and spread them evenly for execution over a specified time period, in order to achieve the time-weighted average price and minimize market impact).
Algo trading on FXall (sample order entry window)
The buy side is also getting smarter in its understanding of how to leverage post-trade analytics to measure and minimize transaction costs.
Rather than relying solely on analytics and scorecards generated by their liquidity providers, participants are increasingly leveraging their trading platforms to gain independent insight into provider performance (such as like-for-like comparisons of providers’ pricing competitiveness or RFQ response latency), as well as into market conditions, spreads and liquidity.
By putting their wealth of price and execution data to better use in 2019, trading platforms are well positioned to become the buy side’s partner of choice for the analysis of execution quality, and the identification of opportunities to enhance execution performance.
FXall Trade Performance Analytics – Comparison of client volumes to overall market volumes and spread
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