LEADER


Fragmentation


There is already significant fragmentation of liquidity in Wholesale FX which has facilitated the evolution of a competitive marketplace creating venues that have developed features appropriate to different user types. Justyn Trenner and David Poole, Co- Principals at ClientKnowledge examine the risks of creating stagnant pools of liquidity within FX if the current delicate balance of fragmentation is upset.


leading inter-dealer brokers and some marketplaces have come and gone, there are still several growing and increasingly significant venues. So far, natural market dynamics have allowed venues offering sufficient liquidity and necessary services to flourish, while new venues who do not offer it, or whose model has not suited their target clients have failed.


A


When we consider how participants trade, important distinctions are to be made between three clearly different modes: voice-to-voice, manual-to-screen and a computer trades with another computer. Nonetheless, the fundamentals of the market are the same with each, even if the workflow is different. Using any of these methods to trade, in the overwhelming majority of cases banks acquire risk from clients; clients only limitedly trade risk between themselves; banks need to hold and lay off risk and clients will pay banks to take large risk positions and work those to the market.


With ongoing long-term increases in volume, there is more risk to manage and, responding to demand, the places that can receive and lay off risk have correspondingly multiplied, while the penalty


24 | october 2011 e-FOREX


fter much fluctuation, FX is in a period of reasonable stability of liquidity pools. While EBS and Reuters are still recognised as the


and liquidity in FX - is it worth upsetting the balance?


for pricing latency has grown and margins have contracted. As more methods of trading have emerged, the differences between voice, GUI-manual and e-trading are now much more nuanced than they were. One key effect of electronification is that it has dramatically improved transparency – prices can be seen at the click of a button and consequently it is far easier to know whether the price you are being offered is reasonable.


Te penalty for latency can be felt across the spectrum of price delivery, as we have discovered through intelligent benchmarking work that compares KPIs against best practice. At the top end, a slow/bad price can be hit when it is less than a second (possibly substantially less than a second) old by an algorithm, before the price-maker has had a chance to remove it; bad pricing will always be punished. Over longer timeframes, the process is different, but the outcome the same: if a bank updates prices in its retail network every hour and it takes another hour or two to bring


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