Presentation to the Presentation to the ECB FX Contact Group ECB FX Contact Group Trends in FX Market Structure Trends in FX Market Structure and Liquidity and Liquidity Adrian Boehler, 20 June 2018
FOR PROFESSIONAL CLIENTS ONLY - NOT FOR FURTHER DISTRIBUTION THE EVOLUTION THE EVOLUTION OF FX SPOT MARKET OF FX SPOT MARKET STRUCTURE – STRUCTURE – AT A GLANCE AT A GLANCE Pre- Late- Early 2000s Mid-2000s 2014 ? 1990s 1990s Voice based Electronification Electronification of Non-bank market Regulatory and market begins. First signs dealer-to-client makers compete in conduct agenda of multi-dealer relationships eg “interbank” FX market dominate, including interbank CLOB single-bank MIFID2 and FX Global platforms; dealer-to- platforms, ECNs Code. Appetite for “Race to zero”; client remained auditable and spreads compress; voice-based transparent workflows. volumes up Platform proliferation drives “liquidity Client algo execution mirage”; aggregation Algo execution tools grows; “best beginning to be used and execution tools execution” in focus. used by banks to by clients Traditional boundaries adapt; ‘last look’ further blurred. added as feature Traditional boundaries TCA in demand of interbank and dealer-to-client Automation? markets begin to blur 2
FOR PROFESSIONAL CLIENTS ONLY - NOT FOR FURTHER DISTRIBUTION THE FX MARKET IS IN A STATE OF THE FX MARKET IS IN A STATE OF TRANSITION TRANSITION MIFID II has increased the focus on “ best execution ” and transparency in FX markets; The FX Global Code has set the “industry standard” for good practice and is driving increasing levels of disclosure across the industry There is a trend towards auditable and measurable automated FX workflows Participants increasingly want robust, comprehensive TCA metrics, including from third-party providers Increasing numbers of buy side participants are willing to hold market risk , for example through algorithmic execution Some participants want their flow segregated from traditional market making activities through algo desks What does this mean for the microstructure of the FX market? 3
FOR PROFESSIONAL CLIENTS ONLY - NOT FOR FURTHER DISTRIBUTION ELECTRONIFICATION AND THE TREND ELECTRONIFICATION AND THE TREND TOWARDS AUTOMATION TOWARDS AUTOMATION UK OTC FX Spot turnover by execution method 70% 60% Proportion of FX spot turnover 50% 40% Voice Electronic 30% 20% Voice = Direct and via voice broker 10% Electronic = Primary CLOB venues, single dealer platforms and other ECN venues 0% Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 Source: FXJSC 6-monthly FX turnover survey Over recent years there has been a tectonic shift in the trend towards electronic execution 4
FOR PROFESSIONAL CLIENTS ONLY - NOT FOR FURTHER DISTRIBUTION ELECTRONIFICATION AND THE TREND ELECTRONIFICATION AND THE TREND TOWARDS AUTOMATION TOWARDS AUTOMATION UK OTC FX Spot turnover by electronic execution type 300,000 Electronic Broking Platforms Single Dealer Trading Platforms Multi-Dealer Trading Platforms 250,000 Average Daily Turnover, $mns Electronic Broking 200,000 Platforms = Primary CLOB venues Multi-Dealer Trading 150,000 Platforms = All other ECN venues (dealer-to-client and wholesale) 100,000 Single Dealer Trading Platforms = dealer-to-client proprietary platforms 50,000 0 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 Source: FXJSC 6-monthly FX turnover survey Strong growth amongst “secondary” ECNs Trend suggests that the electronic FX market is becoming more fragmented 5
FOR PROFESSIONAL CLIENTS ONLY - NOT FOR FURTHER DISTRIBUTION ELECTRONIFICATION AND THE TREND ELECTRONIFICATION AND THE TREND TOWARDS AUTOMATION TOWARDS AUTOMATION Algorithmic order volume as a proportion of electronic FX spot volume 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% Source: Expand Research. Data is based on a subset of the largest algo dealers in the market. Data supports anecdotal evidence that clients are increasingly automating their FX spot execution through the use of algorithms As a proportion of overall e-volumes, execution algo volumes remain relatively low Feedback suggests flow automation is top of the buy side agenda for 2018 6
FOR PROFESSIONAL CLIENTS ONLY - NOT FOR FURTHER DISTRIBUTION ELECTRONIFICATION AND THE TREND ELECTRONIFICATION AND THE TREND TOWARDS AUTOMATION TOWARDS AUTOMATION BNP algorithmic order volumes, 2017 vs 2018 Source: BNP Paribas calculations Over the past few months, we’ve seen marked growth in the algorithmic trading space 7
FOR PROFESSIONAL CLIENTS ONLY - NOT FOR FURTHER DISTRIBUTION THE EVOLUTION OF TRANSACTION COST THE EVOLUTION OF TRANSACTION COST ANALYSIS ANALYSIS With the demand for auditable, transparent and automated execution solutions growing, and MIFID2 [indirectly] sharpening the focus on “best execution” in FX, we’re seeing the demand for TCA proliferate and become ever-more sophisticated Estimates suggest around 60%+ of buy side firms are now using TCA (vs 80% in equities and 30% in Fixed Income) Post-trade TCA has evolved and end-users are using different, complementary analyses : Broker-provided: provides execution and trading analysis leveraging the large amounts of data embedded in electronic market making and algorithmic execution Internal interpretations: quantitative analysis that provides internal control and detailed analysis of calculations and conclusions Third-party TCA providers: provide an independent assessment to help demonstrate “best execution” 8
FOR PROFESSIONAL CLIENTS ONLY - NOT FOR FURTHER DISTRIBUTION THE EVOLUTION OF TRANSACTION COST THE EVOLUTION OF TRANSACTION COST ANALYSIS ANALYSIS And the timeline for TCA analysis is broadening Pre-trade: Estimate market impact and slippage before the trade Real-time: Receive performance updates, and estimate future performance of a live trade However, challenges with market data remain: 85%+ of FX spot volume is still largely invisible to most participants The TCA timeline Pre-Trade: Real -Time: Post-Trade: Long term: Fine-tune the Long Term: Decide on the execution process process while Monitor the execution process execution is live Short term: Short Term: Discretion around execution Measure individual execution start end 9
FX LIQUIDITY: TRENDS IN G7 FX LIQUIDITY: TRENDS IN G7 PLATFORM VOLUMES PLATFORM VOLUMES • Up until early 2017, we • Up until early 2017, we observed fairly consistent generally observed fairly trends in volumes transacted consistent trends in volume on major OTC venues vs transacted on Primary OTC futures markets venues vs futures markets • Since early 2017, there has • Since early 2017, there has been a dislocation between been a dislocation between the two the two • Potentially consistent with • Potentially consistent with further diversification in FX further diversification in FX wholesale market trading wholesale market trading volume towards regulated volume towards regulated exchanges, adding to exchanges, adding to Source: Reuters, EBS, Hotspot, Currenex, ParFX, LMAX, CME, BNP Paribas calculations Source: CME, Reuters, EBS, BNP Paribas calculations broader market broader market fragmentation fragmentation 10
FX LIQUIDITY: TRENDS IN G7 FX LIQUIDITY: TRENDS IN G7 PLATFORM SPREADS PLATFORM SPREADS Source: Reuters, EBS, BNP Paribas calculations Source: Reuters, EBS, BNP Paribas calculations • The relationship between volatility and spreads has remained reasonably constant • The widening of spreads triggered by the SNB event in 2015 has now largely • As the market latency is driven lower, however, its likely that liquidity adjustments unwound to higher volatility will become quicker too – so-called “flash crashes” • The relationship between volatility and spreads has remained reasonably constant 11
FX LIQUIDITY: TRENDS IN G7 FX LIQUIDITY: TRENDS IN G7 PLATFORM SPREADS PLATFORM SPREADS • Interestingly, the spread for 25mn has tightened by approximately 17% from its wides, while the inner bid/offer (top of book) has tightened by more than 42% since the peaks • Potentially consistent with growing algorithmic trading • May also be influenced by PTF activity on major venues who typically trade at TOB Source: Reuters, EBS, BNP Paribas calculations Source: Reuters, EBS, BNP Paribas calculations 12
FX LIQUIDITY: RECENT FX LIQUIDITY: RECENT TRENDS IN G7 TRENDS IN G7 PLATFORM VOLUMES PLATFORM VOLUMES • In general there was the • The widening of spreads seasonal rise in volumes to start triggered by the SNB event 2018 in 2015 has now largely unwound • But even with this rise, JPY, CAD, and GBP volumes across Q1 2018 were considerably • Interestingly, the spread for below those in Q1 2017 25mn has tightened by approximately 17% from its • Volumes for EUR, CHF, AUD, wides, while the inner and NZD during Jan and Feb bid/offer (top of book) has 2018 were very strong compared tightened by more than 42% to 2017 since the peaks • Volumes in Mar and Apr 2018 have fallen sharply across all G7 • Potentially consistent with pairs and now trade well below growing algorithmic trading, their 2017 levels Source: Reuters, EBS, BNP Paribas calculations slicing larger trades into Source: Reuters, EBS, Hotspot, Currenex, Fastmatch, LMAX, ParFX, BNP Paribas calculations smaller pieces 13
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