Money managers are expected to benefit from intense competition by liquidity providers in the foreign exchange market in the coming years, according to a new report by GreySpark Partners.
The British consultancy maintains that declines in volume coupled with an increase in trading venues is forcing down spreads. These trends will continue for the next four years, ultimately producing an equities-like foreign exchange market. It all works to the benefit of the buyside.
This developing “all-to-all” market structure for currency trading “will allow for a more fluid, exchange-type matching model for buyside investors that will require them to interact with the market more independently than they have in the past,” said authors of the report titled Trends in FX Trading 2013.
The years since the financial crisis have witnessed keen interest in making currency trading more customer-friendly, according to the report. That is manifested in an explosion of new trading venues as well as improvements to existing ones.
Multi-dealer platforms—those that allow the buyside to access liquidity from several banks—sit side-by-side with single dealer platforms—those that only permit trading with the owner of the system. The trend has fragmented the market, giving buyside users more choices.
At the same time, as macro economic factors such as quantitative easing have reduced volatility in the foreign exchange market, volume has declined. From 2011 to 2012, according to the report, average daily volume fell from about $4.1 trillion per day to $3.6 trillion. GreySpark expects volumes to stay below 2011 levels for the next four years.
The combination of declining volume and fragmentation is leading to better pricing for asset managers and other customers. Indeed, data from Credit Suisse shows a sharp drop in USD-EUR spreads in 2012. (See graph.)
Spreads are expected to tighten further in the coming years as banks fight for market share. Banks will be “quoting ever-tighter spreads in an effort to generate the minimum profits necessary to cover the fixed expenditure associated with upgrading their platforms each year,” GreySpark reports.
Driving much of the change is competition between the single-dealer platforms and the multi-dealer platforms. In the past eight years, multi-dealer platforms have grabbed market share from their single-dealer competitors, and now account for nearly twice as much volume. New players such as Tradeweb, LMAX and SurfacExchange have emerged in the past two years.
By 2017, according to GreySpark, buyside customers will be able to transact in a single unified “all-to-all” marketplace where liquidity is provided in multiple venues by banks and hedge funds. Still for the equities-like model to develop, technology is needed to aggregate disparate pools.
At the present time, “there is no consensus yet among different multi-dealer platforms on how to present the liquidity streaming on the platforms in a consistent manner, which creates a challenge for buyside firms seeking to aggregate their pricing across all relevant platforms,” GreySpark reports.
