Co-existing in the FX Ecosystem
Fri, 19 Oct 2012 09:44:32 GMT
FX is a complex ecosystem where all the tiers and specializations exist to play specific roles and provide specific value to the market . At first glance, it can appear that the lower tiers are competing with the top 10, and in a few cases with the largest super-regionals, that is probably true. At the Profit & Loss conference in Chicago last month, a panel of experts from mid-tier banks discussed their roles in the market. It gave me new insights into the vital interdependency that is present in this market.
The recurring theme of the conference was that below the top 10 global institutions, banks focus on their strengths. Rather than trying to compete with the biggest institutions, they target specific segments like a geographic region, specific client bases like corporates with specialized workflow needs, or specific offerings like a niche currency focus. Their relative value is perceived differently by different customer groups. For example, a treasurer might have limitations in how they trade. Banks can win their business by providing specialized productivity tools to match their workflow needs. Asset managers might need real-time pricing in the spot markets, but want to be backed with a voice trader they can call to get colour on the market. Specialization and expertise attract liquidity.
Super-regionals, regionals and local banks can focus on particular sets of needs and work on becoming the world leaders in that niche. In the process, they become valued customers of the tier one banks. There is a natural tension in this relationship, but they need each other, and both know it. The smaller banks need liquidity with tight spreads, and the larger banks need profitable flow. But relationships have to be considered in every routing decision. The better the mid-tier partners with their liquidity providers to make sure the flow is economically helpful to both sides, the more they’ll be able to consistently serve their own clients.
The right technology can help facilitate those relationships, and the wrong technology can damage them. For example, aggregation models can obfuscate the impact that routing decisions have on liquidity providers. Routers that indiscriminately sweep the market at the lowest price tier potentially move the market under the liquidity provider. If the bank perceives the flow to be highly correlated to the markets, it may widen spreads, negatively impacting the smaller bank’s execution quality.
To avoid this, mid-sized banks should choose transparent technology that allows users to control the order routing methods in order to carefully protect relationships. Some Tier 1 banks are beginning to offer specialized products to help their down-stream banks do this. In some cases, it might be technology to enable mid-tiers to run their own single dealer platforms, aggregating liquidity from preferred sources. In other cases, such as FX SpotStream, banks have elected to aggregate their liquidity with the other liquidity providers on the system, providing an aggregated stream while still facilitating bilateral trading relationships between banks and their liquidity providers.
Every major producer of liquidity, whether a Tier-I bank, an ECN, or a SEF could benefit by offering to mid-tier institutions tools that facilitate the process of sourcing liquidity and transforming their business with technology that allows them to profitably offer improved services their clients.
No matter what the focus, technology is the great facilitator. Banks of any size and any specialization can benefit greatly from technical solutions that allow them to rapidly and securely build an automated dealing platform. They need to be able to aggregate liquidity from both single banks where they have bilateral trading relationships and from ECNs. They need to be able to price competitively in order to make markets for their clients and distribute these prices in a low-latency environment. They need the ability to execute orders and risk manage positions. If they don’t have a big IT team, they’ll need a packaged system. Choosing the right technology provider is critical, because they’ll need one that will partner with them, understand the direction they want to go, and help them get there.