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Executive Summary
This note explores the recent and fast-moving changes coming to the global currency markets. An historically OTC marketplace, where dealing took place over the telephone between bank and customer, the FX markets are being rapidly transformed by the arrival of new players in the marketplace, bringing with them technology and high-speed electronic trading. From telephone to algorithmic trading, the currency markets have followed a rapidly-evolving path toward rules-based automated trading.
Hedge funds, in their global search for alpha, arrived on the FX trading scene, demanding direct electronic access through their prime broker relationships to the dealing desks of the major global banks. Once connectivity was established, there was no going back. Banks built algorithms to handle this new high speed flow, hedge funds built algorithms to capture alpha, and competitors built alternative trading systems, or ATSs, with real-time pricing displays and new order types.
TABB Group estimates that average daily trading volume in FX spot, forwards and derivatives will grow from just under USD 3 trillion per day to upwards of USD 5 trillion per day by 2010. Fueling this growth are five major sustainable trends:
1. The globalization of the manufacturing and service industries;
2. An easy-money environment leading to massive growth in investment capital into new markets and new currencies exposure;
3. The growth in hedge funds and alternative investment pools and their global search for alpha;
4. The exponential growth in credit and financial derivatives, with a coincident expansion in the need for hedging currency exposures; and
5. The advent of CLS and the near complete mitigation of FX settlement risks.
As traditional investment managers and fiduciaries begin to view FX as a distinct asset class to be managed and traded in-house, dealer and investment banks, as well as vendors and independent brokers, will compete for these new sources of revenue and order flow by delivering new FX technologies and tools to the buy-side trader. Following a path similar to that which we’ve seen in the equities markets, solutions providers will offer connectivity to the various liquidity pools, real-time and historical pricing data, EMS and OMS support for FX trading, benchmarks to determine best execution, and algorithms to achieve best execution. The early thought leaders in the space are today offering their institutional clients smart order routing, rules-based trading tools, and stealth algorithmic strategies to reduce transactions costs and maximize alpha.
The TABB Group Report on FX Algorithms: Bringing Best Execution to the FX Markets
This report is based on conversations with professionals representing currency dealing operations at global and US investment banks, FX investment funds, hedge funds, investment managers, ATSs, exchanges, and vendors of inter-dealer trading platforms and automated trading engines. It looks at the advent of electronic trading and connectivity in the currency markets, the arrival of hedge funds and investment managers, and the consequent seismic shifts occurring as this global OTC marketplace begins to move into the 21st century and discovers algorithmic trading.
Table of Contents
VISION 1
TABLE OF CONTENTS 3
INTRODUCTION 4
A BRIEF HISTORY 5
DRIVING THE NEED FOR ELECTRONIC FX 7
TRANSPARENCY, ANONYMITY, AND CONTROL 8
EMERGING ADVANCED ELECTRONIC TRADING SOLUTIONS 10
ELECTRONIC CONNECTIVITY AND DMA 10
PRICING AGGREGATION 12
MULTI-ASSET EMSS AND OMSS 12
HISTORICAL MARKET DATA 13
THE DEVELOPMENT OF BENCHMARKS 14
ALGORITHMS 15
CONCLUSION: EVOLUTION OR REVOLUTION? 19
Table of Exhibits
Exhibit Number Description
1 Average Daily FX Trading Volume
2 Penetration of Electronic Trading in FX Markets
3 Percentage of EMSs with Support for FX
4 Percentage of Average Daily e-FX Trading Volume |