Hedge funds driving foreign exchange markets on to electronic platforms, says Celent

Electronic trading of foreign exchange continues to grow fast, and the market could increase from close to US$3 trillion to US$4 trillion of daily turnover by 2009–2010, with 75% of the interdealer spot market volume and 50% of the dealer-to-client volume traded electronically. Hedge funds lie behind the drive on to electronic platforms, and will accelerate it.
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Electronic trading of foreign exchange continues to grow fast, and the market could increase from close to US$3 trillion to US$4 trillion of daily turnover by 2009–2010, with 75% of the interdealer spot market volume and 50% of the dealer-to-client volume traded electronically. Hedge funds lie behind the drive on to electronic platforms, and will accelerate it.

These predictions are made by consultants Celent in a new report, Electronic Platforms in Foreign Exchange Trading. In the report, the firm analyses the state of the for­eign exchange market in terms of volume growth, adoption of electronic trading, and drivers for evolution.

The report also examines the interbank platforms Reuters Dealing 3000 and EBS and the dealer-to-client platforms FX Connect, FXall, Currenex, and Hotspot FX. The collaborative effort between Reuters and the Chicago Mercantile Exchange – FXMarketSpace – is discussed briefly in the report as well.

Celent says that, despite the overall growth of the FX market, a detailed look reveals interesting nuances. The firm suggests that “real money” trading, notably from cor­porations covering the currency risk of their international trade business, has experienced an important but smaller increase compared to the volume of spec­ulative trading from the hedge fund industry.

Although everyone is concerned about hedge funds, says Celent, the term covers a more diverse reality. Hedge funds can trade using different strategies from model trading, direction trading, momentum trading, and so on. There­fore, their needs will vary widely according to their trading strat­egy, as will their favorite trading venues and functionalities, says Celent.

“The importance of new market partic­ipants on the buy side and their ability to improve and generate liquidity is blowing the wind of change in FX markets,” says Axel Pierron, Celent analyst and author of the report. “The segregation of the market between interdealer and dealer-to-client is already being attacked, with the two major interdealer platforms breaching the wall to attract these profitable new cus­tomers. The question to ask is not whether the FX market will adopt an exchange model, but when.”

The development of interdealer electronic platforms has driven the smallest banks out of the market because it has generated visibility on the market and less volatility, narrowing the margins, says Celent. Today the FX market is a business of high volume and low margins, which only leaves room for very large institutions and specialists. Celent estimates that 75% of the interdealer spot market volume and 50% of the dealer-to-client volume is traded electronically.

“The acquisition of Currenex by State Street could signal a wave of consolidation in FX e-trading platforms, but I doubt it,” says Pierron. “This acquisition is a specific answer to State Street / FX Connect issues, such as outdated technology and expansion into new customer segments. In fact, there are many projects to develop FX platforms such as Lava plan to launch an interdealer FX platform and FXAll, a new dealer-to-client platform. The market is large, with various customer segments and numerous single dealer platforms, so market participants will hold the consolidation mantra for a while. As ICAP’s acquisition of EBS and Knight Capital’s acquisition of HotSpotFX demonstrate, if consolidation happens it will be complementary, to provide multi-asset trading facilities.”

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