THE FX MARKET: NOT ALL BROKERS ARE EQUAL


With typically over USD 6 trillion traded daily, Foreign Exchange is by far the largest single market in the world. Imports and exports of goods and services all have a value or cost that must be met in any one of the 180 currencies currently in existence. In short, almost everybody has an exposure to changing FX rates whether as individuals, corporates or governments.


Despite the huge size of the market, over 60% of global FX volume is dealt by the 10 largest FX dealers including JP Morgan, UBS, Deutsche, Citi and HSBC but also “non-bank” providers such as XTX Markets. In previous years, most trades were executed telephonically. More recently the rise of electronically traded FX (eFX) has gathered pace to the extent that almost all trades are now transacted electronically on purpose built dealing platforms.


These large FX dealers are the primary sources for providing market liquidity between each other and into the wider market. However, unlike securities and derivatives trades that typically execute on a centralised exchange order book, eFX is driven by the quotes made available to the market from the largest participants who act as OTC market makers. The market makers electronically stream their prices to their customers who are usually smaller banks, large corporates or large brokers. Those banks and brokers in turn deliver their own quotes to their customers based upon the quotes that they receive.


This pricing process diverges from the transparency offered by an exchange order book. If 10 brokers receive pricing from a single bank, it is possible that pricing made to each broker may be different, even if the same currency pair, amount and delivery date were requested by each broker simultaneously. If the 10 brokers were each able to receive pricing from 10 separate FX dealers, there could theoretically be 100 different quotes available in the market depending on which broker is requesting the price from which FX dealer.


To further complicate this process, banks do not necessarily view high volume trades as desirable; a notion that is mostly alien to the exchange traded world. FX banks increasingly use very sophisticated statistical analytical tools to “grade” the business flow that they receive from their customers. Ultimately, banks engage with the FX market to make profit and it is this measure that is most closely watched, specifically regarding the time window of profitability available to the bank post-trade before that trade becomes unprofitable.


Customers who buy into rising markets or sell into falling markets are less likely to provide the bank with an opportunity to make money from the trade. The analytics tools are capable of measuring these timescales in fractions of seconds and in specified timeframes. If a pattern emerges where a customer consistently causes a bank to lose money, they are able to widen their pricing to that customer to discourage receiving additional trades. The FX bank is not obliged to make an attractive quote if it has limited appetite.


THE MARKET MAKERS ELECTRONICALLY STREAM THEIR PRICES TO THEIR CUSTOMERS WHO ARE USUALLY SMALLER BANKS, LARGE CORPORATES OR LARGE BROKERS.


4 | ADMISI - The Ghost In The Machine | Q4 Edition 2021


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