FX Supplement 2014 | Overview

Author: Gordon Platt
Rodriguez, DailyFX: Clearly, many traders fear the next major move is just around the corner, and any especially crowded trades seem at risk, as speculators will flee at the first sign of danger.

According to a recent report by Stamford, Connecticut–based Greenwich Associates, the slump in FX trading volume has all the features of a cyclical decline, as hedge funds and central banks have slowed their FX trading. But, the report continues, in reality the slump could reflect a major shift in the FX business model. “Greenwich Associates believes there are FX-specific factors at play that signal a secular shift as well,” the report says. “Regulatory concerns and tightening budgets could lead to most FX trading being done on an agency basis and executed via exchange. Dealers who invest in their electronic platforms will benefit from this potential shift to agency-style trading.”

In general, only the biggest banks can afford the cost of building these big platforms. Financial institutions as a whole increased the share of their trading volumes executed electronically by three percentage points to 77% last year, Greenwich Associates says. Nearly three-quarters of global FX trading was electronic last year, up from 71% in 2012.

“Electronic FX volumes are also getting at least a minor boost from currency options, which are often traded through single-dealer platforms that allow for a maximum level of customization,” Greenwich says. However, its Market Structure and Technology practice recently released research showing that regulatory burdens set to take effect in the coming years could severely slow the growth in FX options trading.

Until now the FX industry has been largely unregulated. In the wake of allegations that the 4 p.m. London fix for benchmarks was being rigged, however, further regulation is likely. The UK Treasury said in June that it was working with the international Financial Stability Board to clean up the market. A task force set up by the FSB recently proposed a series of 15 reforms, including extending the time for the London fix from one minute to five minutes. It also wants banks to separate their fixing orders from the rest of their FX business and to take other steps to minimize conflicts of interest. The FSB, however, did not go so far as to recommend a global utility to match fixing orders. The London fix is used to create a benchmark to value trillions of dollars in investments.

More regulation, more compliance costs and more technology replacing human traders will continue to change the market. The new way of doing business could make it harder for most banks to make a profit from FX trading.