TradeTech FX: Is the eFX spot market on its way to an oligopoly?

Panellists warned the top liquidity providers were now accounting for over 60% of the market, with that number rising.

Speaking at a TradeTech FX panel, participants clashed over whether the eFX spot market structure was leaning towards becoming an oligopoly.

“If we talk about the specific flows of the large buy-side clients, the top three to five sell-side players have market share that is well above 50-60%. That is increasing,” said one panellist.

However, others were quick to argue against this, claiming that competition in this pace remained strong. While others suggested a lack of fixed pricing and a tendency to under-price risk were not characteristic of an oligopolistic market.

“If you look at the Euromoney rankings, the level of concentration has been consistent over the last 10 to 20 years and people go up and down the ladder,” they said. “Maybe concentration levels are too high but there’s certainly competition.”

All panellists noted increased volatility, poor and fragmented liquidity, but unchanged spreads, with risk transfer remaining high in light of these conditions.

“Most firms just want to externalise the risk and cross the spread for that in line with their execution strategies,” said one panellist.

“Spreads are widening in line with volatility and people are looking for opportunities to save on spread crossing costs and take a bit more execution risk so they can be more exposed to execution risk but get some cross spread savings be that through liquidity seeking algos but also on the principal side. There is a choice between crossing the spread and risk transfer or actually working orders in the market.”

Elsewhere it was noted that the foreign exchange markets had seen a wave of internalisation by banks amid the volatility and uncertainty.

“Previously FX was heading down the equities route where you would see the buy-side using algos to execute on exchanges. Instead of that we’ve seen the opposite with banks increasingly internalising flow allowing them to reduce market impact. It’s ironic because we went from the equitisation of FX to the FX-isation of equities,” said one panellist.

Speakers were united in their agreement that the last year had altered the way the buy-side interacts with liquidity providers, now choosing quality over quantity and relying heavily on data and analytics to evaluate both observables such as fil rate, reject rate, liquidity and non-observables such as market impact.

“A few years ago, there could be up to 10 liquidity pools but a consensus is emerging that five or six is more reasonable. Even for those buy-side traders that need to use a network of banks, they’re trying to rotate which ones they use so it’s not more than five or six at a time.”

Despite this, fragmentation of liquidity remains apparent with additional channels such as peer-to-peer pools proving both to exacerbate this and go some way to alleviating it.

The importance of relationships and changing roles of counterparties in the last year has been a poignant theme throughout TradeTech FX 2022. According to panellists, the increasingly fragmented liquidity landscape has meant that buy-side clients are relying on liquidity providers as “liquidity partners”.

“They [the buy-side] want to understand more about liquidity pools. They want to know what the difference between them are,” said one panellist. “They want to know about internalisation. It’s been spoken about for years but it’s still a big question mark. They want to know if they place an order into the market, where do I get placed top of book. They want help evaluating how pools perform vs an index.”