Author: Anita Hawser

SPOTLIGHT: TRADING UP

Technology is revolutionizing foreign exchange trading and providing ever-increasing opportunities in the world’s biggest financial market.


By Anita Hawser

tu1 Electronic trading has revolutionized markets. In the equities markets, algorithmic trading platforms, high-frequency trading and smart order routing are just some of the technologies transforming the way stocks are traded. But as the largest market in the world in terms of liquidity, with approximately $3.2 trillion being traded daily, the foreign exchange market is evolving at a rapid pace. Electronic trading platforms cater to a myriad of different market participants and provide rapidly growing levels of functionality.


The FX market has come a long way since the days when it was largely a voice-traded market. The emergence of the first online trading platforms back in 2000 enabled corporate and institutional traders of FX to receive prices from multiple liquidity providers at a click of a mouse. A number of technology enhancements have since emerged, including executable streaming prices, anonymous trading via an ECN (electronic communications network), algorithmic trading, direct market access (a term borrowed from the equities markets) and the "no dealing desk," which fully automates FX trades without any intervention from brokers.


One of the biggest benefits of electronic trading is that it has opened up the FX markets to a wider range of participants, whether it is market makers, hedge funds, institutional investors, corporate treasurers, high-net-worth individuals or retail traders. "The small to mid-sized institution or the sophisticated individual trader can now participate in margin FX trading with a set of tools that were previously available primarily to large institutions," says Sanjay Madgavkar, global head of CitiFX Pro, which offers margin FX trading services to individuals and small institutions. While all FX trading platforms continue to invest in new functionality, that most likely to appeal to customers typically involves transparency, liquidity, straight-through processing, reduced latency and enhanced risk management.


Madgavkar says the most frequently used functionality on its platform is stop loss and limit order accompanied by round-the-clock streaming liquidity. "This allows traders to manage their risk more effectively with the help of easy-to-use platform tools."


While the rise of electronic trading platforms has enabled more participants to enter the FX market, margin trading carries a substantial degree of risk, which Madgavkar says needs to be managed properly. "Capital preservation rules, which ensure that a limited amount of equity is at stake in individual positions, are an important source of discipline," he explains. "Furthermore, creating maximum drawdown limits, which, if triggered, create a review of the trading strategy, helps to ensure preservation of capital during difficult phases."


Albert Maasland, CEO of Saxo Bank in London, says online trading platforms have enabled its customers, largely private investors, to trade short term to generate financial returns from spot FX, FX options, equities and contracts for difference. What matters to these customers, he says, is the ability to trade 24 hours a day in a highly automated manner with real-time evaluation of positions across multiple asset classes.


Wolfgang Koester, CEO of FX exposure management technology provider Fireapps, says the trading platforms on the market today were originally designed for institutional asset managers. But in the past 18 months or so, he notes, certain vendors refocused their efforts, as the institutional market shrank. Yet, he says, there is a fundamental lack of functionality on some of these platforms, as there is no liquidity beyond G-10 currencies, no longer-term forwards and little to no options functionality, which is of interest to companies that manage cash flow (addressing FAS 133).


Alfred Schorno, managing director of sales for multi-bank, multi-asset portal 360T, which is used by corporate and institutional FX traders, says the value being added by electronic trading platforms depends on the clients being targeted. He says institutional traders of FX are looking for speed of execution, API-based algo trading functionalities and well-integrated STP solutions. Corporate treasurers, on the other hand, are more interested in functionality that helps them optimize their internal transaction flows, and that provides price transparency and a full electronic audit trail.


For multi-bank FX trading platform FXall, it is about giving traders more choice as to how they wish to interact with the market. Having started as a provider of request-for-quote trading, which appealed to "real money" clients such as corporate treasurers and institutional traders, FXall has since added functionality including combined executable streaming prices and liquidity from its ECN, Accelor, to enable traders to execute multiple strategies on a single platform. "If a real-money client wants to trade in a particular fashion, there is a diversity of ways they can participate," says Mark Warms, general manager, EMEA, at FXall.


Electronic trading has made it a lot easier, says Warms, for clients to demonstrate best execution to internal compliance and external regulators by providing an electronic audit trail for everything a client does. However, he says, it is not just about the trade any more, as FXall is looking to develop execution quality analysis tools that will enable clients to ensure they are trading at the best time of day and in a style that is best suited to what they want to achieve. FXall is investing across the board in terms of functionality, but its biggest investment was its acquisition earlier this year of Citi's LavaFX platform. FXall already had an ECN—Accelor—which provides professional market participants with the anonymity of ECN trading as well as an advanced technical architecture. However, Warms says by integrating the best of LavaFX with Accelor, it will enjoy wider appeal to alpha traders of FX.

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Madgavkar: Sophisticated tools help
traders manage risks more effectively

While most of the bells and whistles being added to FX platforms are trading related, in the wake of the Lehman collapse there is also an increased focus on the post-trade side. "Post-trade is where further steps will need to be taken," says Schorno of 360T, pointing out that also counterparty and settlement risk is top of mind. However, unlike some other markets, Lehman's collapse had little or relatively no impact on the FX markets thanks to the CLS Settlement Bank, which was designed to reduce FX settlement risk by settling both legs of an FX trade simultaneously. In January FXall announced that it had joined CLS in order to provide its clients with an integrated solution for processing CLS-settled trades.


Yet, despite the efficiencies CLS has wrought in terms of reducing Herstatt risk, FX market participants fear that FX will be lumped in with all other OTC instruments when it comes to the sweeping regulatory changes that are forecast for the OTC markets in general in the wake of the financial crisis. FX market players fear that regulators are mistakenly incorporating FX derivatives alongside more complex derivatives like CDOs. "Anything that is not a spot FX trade is put under derivatives," says Schorno. "FX market participants are doing their best to convince the regulators that FX is a different animal to a CDO."


Ernie Humphrey, senior director of membership and treasury programs for Proformative, an online community for corporate finance, accounting and related professionals, says that when it comes to regulation, the FX market needs to educate the government concerning the importance of FX exposure management as a risk mitigation tool and not let its associated derivatives, which are often just simple swaps and forwards, get lumped in with complex derivatives such as CDOs and CDS.


As FX is now traded as an asset class in its own right, some segments of the market are pondering whether trades should be moved on-exchange. However, Humphrey says, driving everything through an exchange could cause major issues, as firms conduct trades to match exact exposures and need to do so to qualify for certain accounting treatments.


Madgavkar believes the OTC FX market may change in the future as new legislation is likely to favor centrally cleared trading, especially in derivative products. However, he says, there needs to be greater movement toward cross-border regulation so that providers do not benefit from regulatory arbitrage.