Electronic foreign exchange trading volume has doubled in each of the past two years, but new research from Greenwich Associates suggests that current growth rates could appear modest if the consortium of banks supporting the main interbank FX trading system holds together through its planned expansion into the wider market.
For the past several years, the FX market has been bifurcated between enthusiastic electronic traders and those that refrain from eFX completely. Most FX users that have not yet traded electronically tell Greenwich that they simply see no compelling reason to change the way they trade. However, the cost-benefit calculations of these FX holdouts could change radically if the EBS Prime trading system is able to overcome hurdles (such as the decision of Deutsche Bank to opt out of the project) and successfully extend its service to the FX buy-side.
“In its current incarnation, many FX users see the benefits of e-trading as simply not worth the risk of losing direct contact with salespeople from whom they receive market color and other valuable information,” says Greenwich Associates consultant Peter D’Amario. “In addition, some users do not feel that the benefits of e-trading outweigh the costs of getting started with the technology. But that analysis could change dramatically if suddenly users were granted access to an electronic system that promised to provide even more liquidity and tighter spreads.”
Greenwich Associates found that electronic foreign exchange is growing at a pace far exceeding that of global FX trading as a whole. Overall FX volume grew by about 25% from 2003 to 2004, with much of this growth attributable to cyclical market factors including U.S. dollar fluctuations, global political uncertainties, and rising commodities prices. “Growing corporate FX activity and the active trading of a new class of ‘professional’ FX investors – including hedge funds and ‘customer’ banks – are also serving to inflate foreign exchange trading volumes,” says Greenwich Associates consultant Woody Canaday.
eFX growth rates in 2004 easily topped this market-wide expansion, with electronic volume more than doubling from $7 trillion in 2003 to almost $16 trillion in 2004 among foreign exchange customers interviewed by Greenwich Associates in late 2004. In particular, sharp increases in bank e-trading volumes helped drive the growth: Globally, increased eFX volume on the part of banks accounted for more than $6 trillion of the total increase.
To date, electronic trading’s biggest draw has been its speed, efficiency, and convenience, as opposed to better pricing. When asked by Greenwich Associates to name the benefits that they have realized from trading electronically, 65% of eFX users cite faster executions and almost 60% note convenience, efficiency, and increased productivity. Companies and institutions with FX trading volumes under $1 billion seem especially interested in the efficiency and productivity gains delivered by electronic trading, since professionals at smaller companies and institutions often have multiple responsibilities, as opposed to those at larger FX users, which generally have dedicated staff.
In many respects, FX customers’ unique needs serve to explain why the eFX market has yet to witness long-predicted consolidation, and why, by contrast, the ranks of electronic trading service providers continue to expand. “What we are now witnessing in the market can best be termed a redefinition, as opposed to consolidation, as new providers customize their business models to serve segmented markets such as hedge funds and retail customers,” says Peter D’Amario.
It remains to be seen if the business models of the market’s niche providers – or even those of the larger, mainstream providers – will be strong enough to withstand the expansion of EBS Prime, assuming the company is able to convince its bank consortium to continue to provide liquidity to the system in return for what will amount to credit charges. Already some smaller competitors that targeted middle-market FX users have found that success in the niche market is largely dependent on finding a niche market that produces sufficient trade volume to support their business. “If the inter-bank system is able to execute its expansion plans, its extension into the customer side of the business will have profound implications for these service providers, and indeed for FX as a whole,” says Tim Sangston.