The Foreign Exchange Joint Standing
Committee (FX JSC) was established in 1973, under the auspices of
the Bank of England, as a forum for banks and brokers to discuss
broad market issues. The membership of the Committee includes
senior staff from many of the major banks operating in the foreign
exchange market in London and representatives from brokers,
corporate users of the foreign exchange market and the Financial
Services Authority. Given the importance of developments in
e-commerce for the structure of the foreign exchange market, the FX
JSC decided to set up a subgroup of experts from this field to
advise it. This is the third of a series of annual reports produced
by this subgroup.
Developments In Electronic
FX Joint Standing Committee report on e-commerce in FX markets
We summarise the findings of the report published this month by the
Foreign Exchange Joint Standing Committee (FX JSC).
At the time of our report last year, the market's attention was
clearly on multi-bank portals following the closure of Atriax.
Multi-bank portals were able to offer STP and were advancing in
providing new functionality for customers. Proprietary bank systems
were being used to support pricing into the multi-bank portals but
were not seen as competitive in their targeted market sector.
In 2003, proprietary bank systems have been back in focus again.
Banks are focusing upon targeting flows through prime brokerage,
white labeling and liquidity-exchange models, and proprietary
systems are central to these models. Banks that have aggressively
marketed their proprietary platforms reported to the subgroup that
they saw much higher volumes across these platforms, than through
their participation in the multi-bank portals. A common trend for
all banks is that e-commerce volumes are growing.
Proprietary systems can also offer more tailored and integrated
services. Many foreign exchange trades are a bi-product of another
transaction such as a payment to a foreign supplier or foreign
currency security purchase. If a foreign exchange trade can be
integrated into this process then the convenience factor can play
in favour of the proprietary bank system.
The market leaders are still FXall, Currenex and FXConnect. FXall
and Currenex have tended to attract corporate customers whereas
FXConnect has tended to attract fund manager clients. However, all
are looking to expand their customer base into other sectors,
increasing competition between the portals.
The daily volumes through these portals are estimated to have risen
rapidly from $7bn per day in May 2002 to $14bn per day by October
2002 according to one survey1 and anecdotal evidence suggests that
volumes have continued to grow into 2003. However in the same
survey it is estimated that trading over multi-bank portals only
accounts for 7% of the wholesale foreign exchange market.2 As a
comparison, the April 2001 BIS Triennial foreign exchange survey3
estimated total daily average foreign exchange turnover at almost
$1.2 trillion. The subgroup believes there is evidence that banks
may be more willing to provide liquidity through a variety of
multi-bank portals than a year ago.
FXall reported that its average daily trading volumes were $7.5bn
in April 2003.
FXConnect reported that it averaged $10bn per day in April 20035
Currenex do not release trading figures, although third party
estimates suggest the average daily trading volume is between
$4.5bn and $6.5bn.
There are geographical differences in foreign exchange e-trading
take-up. In Europe and the Americas, 35% of larger organisations
(defined as those that trade more than $2.5 billion in a year)
trade foreign exchange electronically, while only 25% of such
organisations in Japan do.
The multi-bank portals are seen by some as pricing and connectivity
utilities with the banks picking up the vast majority of the
transaction costs, as well as a significant proportion of the
initial investment capital. All platforms face the challenge of
making the pricing model more equitable to both parties and may
seek to achieve this through product innovation and the addition of
value added services.
A new development is end-user to end-user matching systems, such as
Hotspot FXi. These enable customers to post bids and offers
anonymously, as well as to hit market prices. Banks provide
liquidity by making prices but are unable to take prices. This
model is primarily attractive to hedge funds and professional
foreign exchange trading entities. As yet no one is offering a full
market based model where customers can post bids and offers and
banks can trade both customer and bank prices. The subgroup thinks
it is inevitable that this type of model will evolve.
The multi-bank portals have strong brand names and may expand into
other Treasury related businesses. The subgroup believes that it is
likely that there will be further consolidation or withdrawal from
the multi-bank portal business at some point, and that further
consolidation is unlikely to cause any disruption in the markets.
In fact it would strengthen the position of the remaining portals
given that uncertainty still exists in the market, particularly
following the closure of Atriax.
This is an arrangement under which a client's (often an
institutional fund or a hedge fund) foreign exchange deals are
cleared through a single counterparty (the prime broker). The prime
broker is usually a large, highly rated money centre' institution
which allows the fund to initiate trades, subject to credit limits
and collateralisation, with a group of pre-determined third party
banks in the prime broker's name, not in the client's name. These
third party banks are skewed towards those of a higher credit
quality but are limited in number. An attraction for the prime
broker is that the business provides a stream of fee income in
return for use of its balance sheet and credit assessment
facilities, which it may view largely as fixed costs. The third
party may also welcome the prime brokerage arrangement because it
enables them in effect to accept the fund's business without having
to incur credit risk to it only to the prime broker. Prime
brokerage also allows for a reduction of operational risk for the
client because all its positions are with the prime broker.
The leveraged fund community makes widespread use of prime
brokerage accounts, but there are a few examples of other
institutions such as corporates and small banks doing so too. At
present, prime brokerage accounts are much more common in the US
than in Europe, but some market participants report that they
expect the practice to grow in Europe if the number of leveraged
funds based there continues to increase.
Provision of liquidity and provision of credit are becoming two
distinct services within the foreign exchange market. Competition
has already put significant downward pressure on the fees charged
for foreign exchange prime brokerage and as this trend continues
banks may feel pressured to increase their exposure to more risky
names, particularly in the hedge fund sector. Customers often have
multiple prime brokers and it is becoming more difficult for a bank
to monitor a customer's overall exposure. Banks are mitigating
these risks to some extent through margin accounts and improved
technology. This enables them to manage cross-product risk,
cross-product netting and margins more effectively.
White-Labeling and Outsourcing
White labeling is the outsourcing of liquidity provision by a bank
to a third party through an e-commerce platform. The customer deals
with their relationship bank (hereafter referred to as the white
label' bank) via an e-commerce system and a back-to-back deal is
automatically generated between the white label bank and the third
party bank (the liquidity provider') to pass the foreign exchange
risk to the latter.
For the liquidity provider, the attractions of white labeling are
the ability to attract greater
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