Reuters: Analyzing the impact of the ‘technology arms race’ to FX liquidity

The following is a piece written in the Financial & Risk | Intelligent Trading section of Thomson Reuters.

Over the last decade the ever-growing investment in trading technology has pitched banks aggressively against one another in a race to offer the best access to FX liquidity. The finish line is far from close by. HSBC’s Global Head of FX electronic risk, Richard Anthony, explains.

“Anyone who participates in this market has to participate in the technology arms race to some degree, and there is clearly a cost associated with that,” says Richard Anthony, global head of FX electronic risk at HSBC.

According to Anthony, if spreads continue to become more compressed and volume continues to decline, as volatility lowers, this could result in a reduction in the number of market makers.

While this reduction could be good news for some, all banks continue to face challenges in navigating the increasing complexity of the market structure. Lack of liquidity is at the heart of the challenge. “One of the biggest risks for a market maker is not having access to liquidity, so as liquidity becomes more fragmented and more and more trading venues appear, we need to connect to those venues. Connectivity is an expensive process to set up and maintain,” says Anthony.

But given the number of new trading venues that have in recent years sought to enter the FX market, banks have had to be discerning about whether there is sufficient unique liquidity to justify connectivity costs.

Anthony explains that if a new venue has exactly the same participants and architecture as an existing platform, the chances of success can be fairly low. “What attracts us to support a venue is if the rules of engagement or policing are slightly different or the proposed participants of that venue are different, thereby giving access to genuine liquidity that doesn’t exist elsewhere”, he says.

An area of concern amongst FX traders remains the rising costs of trading due to lower liquidity and that FX market participants plan to continue to invest in technology resources to ensure they are ready for changes in market infrastructure that stem from regulatory requirements.

The Pulse survey, from Euromoney magazine and sponsored by Thomson Reuters, gathered feedback from FX market participants about the effect of low volatility on their attitudes and spending. The survey found that the largest FX players are hoping a rising economy will give business a boost in light of near-record low levels of volatility.

However, 53% of the 15 largest buyside firms said they were not as confident about trading FX as they were two years ago.

Source: Euromoney Pulse Survey

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