FX Liquidity – Three Maxims to Live By
Monday, August 27, 2012
Michael Speranza, SVP, Product Management and Marketing
Global liquidity is fragmented.
As markets tectonically shift in this new environment, one asset class is quickly emerging as the largest, the trendiest and perhaps the most widely misunderstood: FX.
Today, FX markets account for more than $4 trillion in trading volume worldwide. To put it into perspective – that’s more than the annual, combined GDPs of Canada, Spain and Indonesia – traded every day. But what does this vast growth mean at the granular level? How can trading firms exploit this opportunity, taking advantage of unfamiliar ground as it were, while remaining in compliance, staying transparent and, at the end of the day – still making a profit?
These questions will become increasingly more important as new rules are put into place under Dodd-Frank and MiFID II. One thing we do know for sure is that regulatory and market uncertainty not only presents an unusual amount of risk, but also a huge opportunity for market participants.
To take advantage of that opportunity, here are three FX maxims that every trading firm should live by:
- Liquidity Wants to Be Found
FX is highly liquid. And yes, that liquidity is fragmented by the sheer nature of how it’s traded. It’s spread throughout hundreds and thousands of market participants – behaving in the same way equities once did. Sourcing that liquidity means trading high volumes and aggregating from multiple venues. And, the more volume, the more risk. The good news is that when one firm gains access to large providers, that firm can act as a magnet – attracting more liquidity. Ultimately, this exponential networking will be critical in creating large FX communities.
How does this happen?
As FX trading becomes increasingly automated, algorithms will become more and more dominant. And for the algorithmic beasts to grow and breathe, they will need more touch-points to source liquidity; the more touch-points – the more complex the algorithm. So, if you increase your connections to other market participants, your network grows, allowing you to source more liquidity.
Under Dodd-Frank, FX contracts are defined as swaps. That means more reporting, standardization and transparency. It also means that FX transactions will have to be centrally cleared, which translates to everyone playing in the same liquidity pool. If market participants will be drawn towards the same pool, they will want, and need, the same rules – and that’s what Dodd-Frank does in this instance – for everyone in the FX ecosystem.
What else does this mean?
More intermediaries during the trade lifecycle = more market participants and less post-execution risk. With less risk, trading firms have the increased ability to expand to more counterparties without undue exposure.
By nature, FX is a global asset class – its products are defined by currencies around the world – traded on exchanges in multiple time zones. You can trade FX at any time of any day; it’s a 24/7 market.
How do you keep up?
The most immediate answer would be to create global footholds in major financial centers. But, many firms may not have the resources, elasticity, or the desire to physically spread to new economic growth centers, especially when it comes to mitigating risks in emerging markets. In this instance, it will be critical to find proxy partners, with a global reach, to get you connected on single source platforms so that you can draw liquidity from multiple, international venues.
This playing field is still growing and changing; therefore, the right network, the right systems and the right partners are essential for successfully competing in this complex marketplace. Trading firms can take advantage of the lucrative opportunities the FX markets have to offer by following these three maxims − grow your network, increase your connections to market participants and stay ahead of global growth patterns with strategic partners who can bolster your core business.
- Michael Speranza, SVP, Product Management and Marketing
- Kevin Acott, SVP, Managing Director, EMEA
- David Brown, SVP, Global Network Operations
- David Dodd, SVP, Managing Director, APAC
- Simon Jones, Senior Product Marketing Manager
- Ganesh Iyer, Senior Product Marketing Manager
- Jonathan Morton, VP Product Marketing
- Matthew Parker, Product Manager, Trading Systems
- Bart Bartolozzi, Senior Product Marketing Manager
- Brett Berkowitz, Senior Manager, Product Management
- Bob Williams, Research Director-Capital Markets Practice, CEB TowerGroup
- David Anderson, RTTRT Program Director, FISD
- E. Paul Rowady, Jr., Senior Analyst, TABB Group
- Tim Carmody, VP, Global Network Engineering
- Matthew O'Donnell, Director, Product Management
- Joe Esposito, Director, R&D Services