Introduction Consolidation and Fragmentation of Markets
2006 continues to provide dramatic evidence of the rapid transformation that is sweeping the vast and growing FX asset class that now exceeds $2 trillion in daily volume. Significant investments are being made on the part of banks, brokerages, exchanges and vendors -- individually and in joint ventures -- to automate, systematize and consolidate what has historically been a manual, fragmented and decentralized collection of trading venues. Combine this with the shifting ownership of the major FX trading exchanges, and one needs a scorecard to keep track of the players, their strategies and target markets.

While at first glance, outside observers of the FX marketplace may be surprised at the pace of this change, we believe that what we have been seeing over the past several months is the natural progression and evolution of the FX markets. In particular, this inevitable nature of markets to consolidate and fragment is a constant and has a real impact on trading and the success or failure of trading relationships.

Fragmentation in markets results from competition based on business and technology innovations. As markets centralize or consolidate to gain scale, certain segments become underserved and are open to alternative trading venues that more specifically meet their trading needs.

Additionally, new participants that enter existing markets change the trading dynamic with their different approaches and motives to trade, co-opting the venue to their style as they grow in size and volume. There are many recent examples of this phenomenon, such as the advent of EBS Prime, which many industry experts point to as one of the reasons for the founding member banks to sell the entire platform because it was no longer meeting their original inter-dealer needs.

As these alternative venues grow and gain critical mass through consolidation, there will be new cycles of innovation and competition to carve out certain segments that have specific needs better served elsewhere. This dynamic of consolidation and fragmentation is a constant that can be seen in virtually all industries, markets and trading venues. In addition to the repeating cycles of markets to consolidate and fragment, the nature of trading amongst institutions and their traders varies dramatically as well. These differences are fundamentally due to the heterogeneity of the participants and the trading systems that they use.

There are many dimensions contributing to the participants heterogeneity, with the most important being their "motives to trade" (market makers, hedgers, speculators, asset exchangers, etc.) which can be substantially different, and therefore necessitate different trading venues, styles and approaches. Other dimensions include information asymmetries among participants (informed or uninformed traders), active or passive, patient or impatient, risk-return expectations, investment time horizons and corresponding reaction speeds to market conditions, investment styles, as well as many others.

As a result, FX market participants should recognize that their heterogeneity will continue to bring more cycles of change, and therefore realize that one size fits all will no longer apply.

Heterogeneity ImplicationsUltimately, such a large degree of heterogeneity among the participants and the various trading venues they use for providing and consuming liquidity implies certain outcomes that can be predicted and planned for. Such as:

The concept and the process for liquidity discovery (searching, sourcing and matching liquidity from multiple venues) will be emphasized as much, if not more than the process of price discovery. This will be even more relevant for FX vs. other asset classes due to the decentralized and opaque nature of the FX markets.

Trading venues will continue to evolve as participants differentiate themselves and re-determine on an ongoing basis, what exactly attracts them to, or repels them from a trading venue or type of counterparty

Information transparency regimes will change as venues innovate to attract new and incremental business, including price and counterparty transparency both pre- and post-trade.

Trading costs, whether they are embodied in spreads, commissions, fees, etc will change as liquidity takers realize the value of liquidity depth, resiliency and immediacy; while liquidity providers will realize their true opportunity costs and seek to avoid customers who are incompatible for their services.

Trading protocols and workflows will digitize and become more electronic as participants enter the market at low costs with new electronic business services for trading with others, such as Quote, Order and Credit Providers as well as Facilitators. Price and execution latency will therefore become an even more critical issue, due to its impacts on operational and execution risks.

These predictable outcomes raise an important opportunity for FX market participants. In order to succeed, participants need to acquire technology and "on demand" services at low or no entry costs to adapt as fast as these changes occur.

Flexibility in an On-demand World
Flexibility in systems is an absolute in order to respond to the market and the constantly changing nature of trading relationships and new liquidity venues. Innovative use of technology will allow for the unbundling and re-packaging of core services, therefore the optimal solution leverages technology to its fullest through the right set of network and trading services that are on-demand and easily provision-able based on trading dimensions.

Just as the ubiquity of the telecom grid enables you to easily dial someone and engage in a conversation without having to invest and deploy infrastructure, the existence of a similar grid for FX trading allows FX market participants to quickly and easily initiate and evolve specific trading relationships.

Integrals FX Grid was built to facilitate such an on-demand world. FX Grid is connected to 13 of the worlds largest market makers and over 200 institutions, providing direct market access and the fastest connection among trading parties. Market participants connect to FX Grid through a single Integral API from which they can negotiate, execute and settle trades with counterparties. System integration becomes an ondemand service by eliminating the need to integrate and manage multiple systems and services as well as insulating participants from changes in technology made by other participants in the network, such as modifications to their systems' APIs.

This end-to-end automated system allows for precise provisioning of liquidity, giving sponsoring institutions unprecedented flexibility to provide, target and deliver customized liquidity solutions to their individual customers.

Through this complete solution, FX market participants are freed up to innovate on their FX business models, giving them a highly scalable platform. FX market participants owe it to themselves, their customers and stake-holders to examine their current systems and determine how they can best leverage this new technology to access new markets, grow their businesses and achieve real business efficiencies.

About the author
Harpal S. Sandhu is CEO of Integral Development Corp, the leading provider of innovative, end-to-end solutions to automate FX trading. Integrals FX Grid and FX Inside platforms provide a complete, end-to-end liquidity sourcing and distribution system that is delivered under a sponsoring institutions branding. Founded in 1993, Integral employs more than 170 professionals and maintains development, support and sale