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About GAIN: News & Events |
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The Unchanging Face of FX Trading
By Ross Butler
FOW, May, 2001
With the introduction of the euro and the onset of globalisation, the fx options market should be in the throes of mass upheaval. Right? Surprisingly not. Ross Butler profiles a market that is taking change in its stride.
The last few years should have seen the foreign exchange options market in a state of flux, but all the upheaval has left the market's protocol largely unaffected. Contrary to expectations, market consolidation and the inception of the euro have had broadly benevolent effects, while the technological explosion that was expected to reshape the industry has, like most significant transitions, been gradually assimilated into the existing structure. How smooth this transition will be for the banks, the electronic exchanges or the brokerages in the future is still uncertain.
"There is not going to be an immediate rush to use these electronic platforms, " says Mark Galant, founder and the CEO of the online exchange, Gain Capital. "But the promise is huge. Over time, a tremendous amount of business will transfer," he adds. Insiders believe that a much smaller amount of fx deals is traded electronically than anyone imagined a year ago, when most platforms were set up. "It is harder than it looks to transfer a business that is primarily done on the telephone to the Internet," say Galant.
On the inter-bank side, VolBroker's chief executive, Dirk Ward, accepts the difficulties of the situation. " We went slowly at first, but our market share has doubled three times since November," he claims. "The difficulty stems from people's perceptions; you can't expect massive growth overnight in any market." It would seem that the technological growth has only been slow relative to unrealistic expectations. However, this is not entirely the case.
"To date, smaller companies have probably done a better job than the banks at moving into this area," says Galant. Most of the banking industry's online exchanges that were established over a year ago are still waiting to go live. Such slow progress on the part of the banks in the face of this potential electronic boom is baffling to Ward. "Last year VolBroker had five competitors who said that they were rolling products out, and if you look now, there are still five competitors who are rolling products out," he says. "A number of people said they were moving into the electronic arena before us and we have been out for nine months on our own."
The investment banks do not generally seem to be rushing into the arena and there are some understandable reasons for this, since the emergence of electronic trading presents a real challenge. The big banks are wary of the Internet arena, and understandably so. However, while the voice broking service still seems relatively secure, banks cannot afford to stay out of the technology sector for long. Electronic systems are squeezing their margins, narrowing the spreads and increasing price transparency. In terms of client relationships, a salesman is not likely to promote a product that could put him out of a job. However, the banks know they must tap the market so that they can defend and increase their market share and influence. In the long term electronic trading will increase the efficiency of bank systems and free salesman from the time-consuming relaying of prices, thereby allowing them to focus on better customer relations.
It is in this direction that banks seem to be moving toward. In an attempt to differentiate themselves from the competition, banks are now repositioning themselves as repositories of wisdom.
Jack Jeffrey, head of global fx at the Citibank, explains: "At Citifix we are becoming much more embedded in the customer's activities. We are seen as an advisor to them, rather than just a transaction of business and provider of price." As arbiters of tailor-made solutions, Citibank has established an Engineering Group, whose job is to work and advise on fx strategies. "Particularly significant in this area is strategic exposure, where cross-border M&A activity has significantly impacted the fx options market," says Jeffrey.
The speed of on screen transactions will allow more time to be spent on such endeavors. When CFOweb, the Internet trading platform owned by software company Integral, stopped trading in early March, it was this advisor role that its competitors eyed, as well as the actual trade volumes. Six thousand people on the buy-side regularly logged on for market data, research reports, trade modeling and risk management facilities. Meanwhile, rival portal Currenex recently launched a currency option pricing and analysis tool from GFInet's FENICS product, deepening the market information, research and analytics available. The ability to provide such a quick, convenient and accessible service is a good way for electronic platforms to differentiate themselves from the competition. But, as CFOweb discovered, it is volume of trades that count. The trading platform ceased operations, reputedly as a result of an inability to attract enough liquidity.
Providing liquidity on demand is the major challenge facing the buy-side screen exchanges. For this they must rely on market makers. However, the foreign exchange options market is highly concentrated. Industry consolidation by the likes of JP Morgan and Chase Manhattan increases the gap between large and small market players. This makes the online trading platforms eager to announce any allegiances with their benefactors. "We have seven banks providing us with liquidity, with another ten interested," said Gain Capital's Galant. "Most of our deals are $1m or less, so they are not very large amounts but we always create very tight spreads." However, the question remains, how do you secure liquidity? Having the right dealers who are strong and committed is a significant factor and if the banks like the look of the set up, the cost of entry and so on, then they may be attracted. There are other ways to gain liquidity. An order flow can be paid for, it can be built with strong enough backing, or it can be 'glued' together, tapping existing liquidity by gaining access to the market makers liquidity. But, at the end of the day, the only thing that is guaranteed to attract liquidity is liquidity.
The main reason why market makers have been slow to move from voice to screen trading is that they have different client base. Gain Capital's Galant explains: "Banks go after very large corporate and funds; we go for clients lower down the pyramid. Large corporates, who already get tight spreads and quick service over the phone will not adopt electronic trading until it is easier and more efficient." In effect, electronic trading gives smaller investors access to a level playing field. VolBroker's Dirk Ward suggests that voice broking itself restricts the market's liquidity base. "If you have a certain number of voice brokers, they must prioritize their time. Outside of the top 15-20 institutions it is very hard to get equal access in a purely voice broking world." In derivatives trading, he believes this position is untenable. "The World of derivatives trading is becoming increasingly electronic," he claims. "The voice-side will not be dominant, as the extent of its client reach is limited, being so people dependent." Screen trading would increase accessibility to the system to a vast number of potential new traders and this would increase the liquidity base of the overall market. For this to happen the institutions will have to go through the cultural change to electronic trading platforms, but Ward believes they are eager to do this as it will eventually increase the size of the market.
As well as the advantages of increased accessibility due to very low transaction costs, leading to increased liquidity, online trading has also allowed increased price transparency. New delivery mechanisms, by operating live streaming quotes, have turned the 'request for quote' around, allowing true price transparency along with speed and anonymity. These are clear advantages in trading electronically, even if some are, at this stage, still theoretical. But for all this talk, the fx voice brokers still seem to be thriving.
Mike Plant, head of fx trading at Marshall Harlow, the fx alliance between Garban Intercapital and Prebon Marshall Yamane, recognizes the continued demand for voice brokerage. "When the electronic systems emerged we lost a lot of market share, and the voice broking that was redundant disappeared straight away," he says, "but we are still here." In the electronic market with EBS and Reuters, Marshall Harlow has the advantages of flexibility. "The main issue is that of credit, and the fact that a bank can deal on every price by a doing a switch. Electronic credit must enter at the start of trading, in order to match up. We show one price, and this can be dealt on before credit limits are checked. If a bank's credit rating means it cannot do business with another, we can effectively 'upgrade credit', by introducing a third party that can deal with both," he explains. Also, machines can only display specified amounts, but with a voice broker you can request a price, making the whole procedure more flexible. "There are many electronic systems about to go online, like Atriax and Fxall," says Plant, "but customers still want a strong voice broker".
The electronic brokerages look unlikely to take business from voice brokers. They may, however, create their own customer base. Whatever the outcome, a successful fx options business is likely to involve elements of both voice and electronic brokerage. GFInet is on example of an inter-dealer that has combined the best of screen and the voice trading in hybrid model. It has the service of the FENICS pricing tool and it can still tap into the fx options market, where the majority of activity is still undertaken through voice broker.
Human, all too human
Far from trying to shape the foreign exchange markets in their own likeness, the electronic platforms are keen to present human face for their interface. Tom Binks, European head of the electronic brokers, Icor Brokerage, which is going live with fx options following beta-testing, explains the user-friendliness of the Icor system. "As in voice brokerage, you know your account manager, and if you have a problem you speak to a local base and not just a call center."
Gain Capital is also eager to provide back-office help; with customer service staff constantly on hand that understands both the technology and the markets. What this amounts to is an attempt to replicate the intimacy of voice brokerage while handling much smaller deals in vastly increased volumes online. The increase efficiency via screen will allow this customer service to deepen. On the other hand, the ability to do 'switches' and cope with complex products looks likely to remain a voice broking prerogative.
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Overview