By Ivy Schmerken, Editorial Director
It’s hard to escape the headlines about FX trading lately. Words such as rigging, currency manipulation, chat rooms and billion dollar fines are grabbing attention and alarming many buy-side customers.
It’s an environment that could give pause to investors, so it’s interesting to note that, in spite of these transgressions, the $5.3 trillion foreign exchange market is growing, driven by new market participants, beyond dealers.
According to the latest Bank for International Settlements Triennial Survey of Central Banks, small banks accounted for 24 % of the turnover, followed by institutional investors such as pension funds and insurance companies at 11%, and hedge funds and proprietary trading firms another 11%.
As such, following are seven trends in currency trading that buy-side firms need to be aware of:
1. FX ECNs and Dark Pools
The last 20 years has seen the rise of electronic trading in FX venues, including specialized FX ECNs and dark pools. Venues such as Thomson Reuter’s FXall and State Street’s FX Connect are popular with the buy-side. This gives the buy-side more direct access to electronic trading venues. In 2014, 75 % of client FX trading was done electronically, slightly up from 74% the prior year, according to Greenwich Associates. Kevin McPartland, Head of Market Structure Research, says FX is the most electronic market that the firm tracks from a percentage of dollar volume perspective.
Exchanges are also jumping into foreign exchange trading, and more could follow. The acquisition of Hotspot by BATS Global Markets for $365 million from KCG is a sign that exchanges are tapping into the demand for more transparency. Other e-FX venues are also attracting new backers. In 2013, BNY Mellon invested in FastMatch ECN, joining Credit Suisse Group and FXCM as partners, suggesting that banks are helping clients capture alternative sources of FX liquidity.
As FX trading becomes more electronic, buy side firms are turning to algorithms to execute more sophisticated strategies. The trend is toward more sophisticated trading platforms and trading tools, including algorithms — whether they are supplied by brokers or EMS providers. What’s more, currency-focused hedge funds that use algorithms scored some of the highest gains recently. Barclay Hedge Ltd reports that hedge funds using computer algorithms to identify market trends earned the highest profits in January.
4. FX Hedging
Buy-side firms are engaging in currency trades to hedge their foreign equities exposures, while others are trading FX as an asset class. A February 2015 Greenwich Associates report shows that 68 percent of equity, fixed-income and FX traders operate in multiple asset classes. Institutions are also trading in multiple asset classes to generate alpha on their portfolios.
Volatility has also returned to currencies with the U.S. dollar strengthening against the euro. Since the financial crisis, currency markets have been calm, as central banks moved in a similar direction, making it hard for macro-managers that bet on broad economic movements. But, with the Federal Reserve signaling it plans to raise interest rates, the dollar has jumped against the euro, while the euro has plunged against the dollar due to the ECB’s stimulus program to weaken the currency. Now that there is a divergence in monetary policies, hedge funds that rely on complex- automated trading strategies are scoring profits. A common strategy is for funds to short the euro against the dollar, though this could backfire if the Fed decides not to raise rates.
6. FX TCA
Lawsuits filed in 2010 by leading public pensions systems, charging custodian banks with providing unfair prices, have ledge to the development of transaction cost analysis (TCA) platforms in FX. There are many different TCA offerings in the market, including those offered by single dealer platforms, multi-dealer platforms, and third parties.
7. FX EMSs
As FX markets become more fragmented, buy side firms are considering execution management systems or EMSs to source liquidity and manage risk across platforms. Multi-asset, broker- neutral platforms offer connectivity to single dealer and multi-dealer trading platforms.
How FlexTrade Can Help
At FlexTrade we offer buy-side firms award-winning FX execution management via our FlexFX solution, which combines cross asset trading with streaming and RFQ prices from more than 50 liquidity providers. Also, with such an array of liquidity providers, our FlexTCA solution provides the ideal transaction cost analysis for traders seeking greater market transparency and the ability to better gauge the performance of the their FX trading.
For a complete review of your firm’s FX trading requirements and a demonstration of FlexFX and FlexTCA, please contact us at email@example.com.