by David Brown, Chief Commercial Officer, IPC.
In the global FX marketplace, no firm is an island unto itself. In fact, that’s the very reason that trading firms are referred to as market participants – because every trading firm is a participant in the global marketplace. Every market participant has a place in the greater market structure, which is itself an interdependent network.
In the global FX marketplace, no firm is an island unto itself. In fact, that’s the very reason that trading firms are referred to as market participants – because every trading firm is a participant in the global marketplace. Every market participant has a place in the greater market structure, which is itself an interdependent network. Asset and fund managers depend on brokers and market makers for access to liquidity. Brokers and market makers in turn depend on the existence of trading venues and platforms to source liquidity. Market activity is underpinned by data, which is consolidated and supplied by market data vendors. It’s a community, in which every member plays a unique and vital role.
It’s well understood that the phenomena of automation, globalization and fragmentation are vastly altering today’s FX markets. Over the last 10 years, we have witnessed a revolution within the FX trading community, one in which firms of all sizes are actively involved in trading a wide range of FX instruments at a variety of execution venues all around the globe. The idea of a 24 hour-a-day marketplace is no longer a fantasy, but a reality, creating unparalleled opportunities.
With these new opportunities come new challenges. How can firms expand their presence into emerging or frontier markets, or new asset classes or services, without investing massive amounts of up-front capital into communications infrastructures? For FX trading firms that have a global footprint, the complexity of global networks also requires communications resilience and redundancy. Connectivity failure kills markets.
Furthermore, the universal imperatives of transparency and fragmentation make it nearly impossible for small- and medium-sized players in the industry to sustain full-scale connectivity programs on their own. Likewise, larger players need to balance their own desire for control with the realities of rising infrastructure costs and complicated global communications networks.
Connectivity for a fragmented market
FX is a highly liquid asset class – and the one most frequently traded globally, with average daily turnover exceeding $5 trillion. A considerable proportion of this daily turnover arises from the increasingly significant high-frequency trading taking place in the deepest and most liquid parts of the FX market, such as the spot FX markets for the major currency pairs (including US Dollar, Euro, Pound Sterling, Japanese Yen and Swiss Franc). The emergence of smaller banks and retail investors trading in this market has also contributed to the high daily turnover.
The rise in electronic execution, high-frequency trading and algorithmic trading has led to more and more trading taking place on electronic broking platforms, multi-bank trading systems and single-bank trading systems. This has resulted in FX markets experiencing considerable fragmentation of liquidity in recent years, and associated connectivity challenges for market participants. As a result, FX trading firms are increasingly leveraging ready-made FX ecosystems to rapidly access liquidity venues and trade lifecycle services. The right type of network and connectivity platform enables FX trading firms to differentiate themselves from their competitors, capture alpha and gain strategic advantage in the marketplace under a range of market conditions.
Accessing innovation in a changing marketplace
Following the 2008 financial crisis, as trading patterns have evolved and non-equity trading has matured and become increasingly electronified, financial extranets have grown in importance across FX markets. As trading firms integrate frontier technologies into their trading applications, extranets are now far more than conduits to market connectivity – although this is at heart their basic and most vital function. They also act as a facilitator for new technologies, fulfilling a pent-up demand among FX trading firms for services that can navigate an increasingly interconnected and complex marketplace. These ecosystems provide a more secure ‘walled garden’ for FX trading and offer participants a depth and variety of liquidity sources that can be particularly beneficial in stressed market conditions – such as those experienced over the past year and half, as a result of the global Covid-19 pandemic. And as the capacity of financial extranets to offer a wide breadth of FX trading tools and low-latency services increases, their place in the FX trading landscape will arguably become only more significant.
The fast-moving nature of global FX markets makes it essential for FX firms pursuing sophisticated trading strategies to be able to obtain access to new market data and connect to new pools of liquidity. An increasing number of fintech providers are entering the FX marketplace, offering interesting and exciting products and services. For example, recent years have seen the emergence of very niche FX data feeds which trading participants are keen to access. These providers also offer novel and innovative solutions to the challenges posed by ever more stringent and demanding regulatory compliance requirements. A financial extranet that offers connectivity and access to a range of service providers can not only help individual trading firms achieve their goals, but also act as a medium for innovation to enter the FX market.
Extranets in the time of Covid-19
Large, networked communities – such as those created by financial extranets – enable greater resilience. Imagine, if you will, a not-unrealistic scenario in which an emergent virus is sweeping the globe. Some of your traders are at home under quarantine. Others, reluctant to use public transport, have opted for your DR site instead. Your counterparties are all experiencing the same issues. Pricing is not reliable, spreads are widening and it’s unclear where the liquidity really lies. You need to continue servicing clients, making prices, accessing liquidity and managing risk. For firms that are highly dependent on a small group of venues and counterparties for market access, this spells disaster. But for those with access to a vast, diverse community, this is an opportunity to shine, to demonstrate real differentiation from competitors.
Given their diversity, FX trading firms vary greatly in their size and in the sophistication of their infrastructure and operations. While there is certainly no one-size-fits-all approach, the resilience challenges faced by FX firms have a great deal of commonality: trading from a home-working environment, the ability to continue servicing clients in a secure and compliant manner, and the ability to continue accessing markets and liquidity.
A new approach to business resilience
It’s not an understatement to say that the FX industry has had to fundamentally rethink its definition of, and approach to, business continuity planning (BCP) and disaster recovery (DR), over the course of the last year. It has become clear that we’ve now shifted to a new paradigm in business continuity and disaster recovery, one in which merely having a business continuity plan and a DR site in itself is insufficient. Firms must now think more generally about resilience and consider the new technologies and services that they may need in order to support different forms of organizational resilience.
Today’s business resilience paradigm is, in our view, a more holistic one. It considers not only the technological and infrastructural aspects of disaster recovery and business resilience, but also the wider questions of market resilience and access to liquidity. Historically, business continuity was all about being able to failover successfully to back-up systems, shift operations to secondary DR sites, and continue accessing the market as normal (albeit with other market participants in the same situation). Now, it’s about ensuring that the contingency measures in place provide robustness and flexibility to cope with whatever type of event is next thrown our way.
What does this mean for FX trading firms? We’re seeing activity that indicates firms are starting to reassess their trading strategies and how to source liquidity. Our clients are beginning to consider how they can increase their resilience when it comes to liquidity, by bringing on new exchanges from different jurisdictions, and expanding their liquidity footprints. It’s not just about exchanges and venues, but also single-dealer platforms, and direct access to brokers and market makers where possible – diversification is key to building that liquidity footprint and the resilience that it brings.
It can take weeks or even months to complete legal and technology on-boarding to a venue or liquidity provider, so having that connectivity in place upfront is important. Access to market data is also vital – in periods of great uncertainty, when markets are volatile and liquidity is drying up, it’s absolutely essential for FX trading firms to understand where the liquidity is and then to have the means to access it,.
For firms that are highly dependent on a small group of venues and counterparties for market access, this spells disaster. But for those with access to a large, diverse community through a robust and resilient extranet provider, this is an opportunity to demonstrate real differentiation from competitors. It’s a very different way of thinking about business continuity planning – but one which we firmly believe will enable firms to go beyond mere survival and to thrive in whatever conditions they find themselves in.
Choosing the ideal extranet partner
So, then, what are the factors that might influence an FX trading firm’s choice of suitable extranet provider with which to partner? The ideal financial extranet provider’s role is primarily that of a facilitator, providing the necessary infrastructure, hosting and connectivity for FX trading firms to pursue strategies across global FX markets.
The best providers try to make their service as accessible, simple and cost-effective as possible, with low lead times to make new and additional services available as quickly as possible. They also provide a high standard of support for client on-boarding, and throughout the client experience. This may entail additional support at times of exceptional market activity or change.
Service level agreements must be high-quality and transparent. At a minimum, FX trading firms should look for guaranteed 100% uptime with no single point of failure and scrutinize the small print around levels of availability, failover capacity and latency buffers. As we’ve mentioned, it’s also incredibly important to have a diverse network, and a provider who understands their market participants and looks ahead to the future, ensuring that they are growing the ecosystem to support future business models, technology paradigms and trading patterns.
In our view, access to a successful ecosystem in the form of a financial extranet– one that offers its participants connectivity to an already built, diverse and global financial ecosystem – is key, not only for gaining and maintaining a competitive advantage and growing as a business, but also to building greater market resilience. This community should include a wide variety of counterparties for FX price discovery, liquidity and execution, such as broker/dealers, inter-dealer brokers, exchanges, other trading venues, dark pools, hedge funds, pension and mutual funds, institutional investors, trade lifecycle services and market data providers. In other words, the information that firms need to find liquidity, and the ability to access it.