FX liquidity fragmentation costs reduced by technology

Fragmentation of liquidity across multiple trading platforms has always been a challenge in the foreign exchange market, but the recent proliferation of new platforms creates a considerable drain on costs and resources for those market participants wanting to take advantage of every new venue.

Technology vendors that can simplify the process – whether through aggregation, co-location or simplified connectivity – have latched on to a clear business opportunity, and banks appear to welcome their contribution.

“Fragmentation has helped co-location providers because it had become very expensive for banks to connect and support many different bilateral venues, so we are happy to co-locate to where a large majority of our client base will be. It puts less pressure on us when deciding who to connect to. The cost and time to market beforehand was a hindrance when trying to connect to different market participants,” says Hugh Whelan, head of market development and connectivity at Commerzbank in London.

Prior to the advent of co-location, the process of connecting and beginning trading with clients was both timely and expensive, says Whelan. Clients would often connect directly via various points of access, but that process could take up to 90 days to complete, depending on the client’s geographical location.

“Ninety days is quite a long lead time. The cost of establishing these connections would generally be picked up by the bank. The process of onboarding a client other than over the internet has therefore become costly and time consuming – a trend that has been far too common in the past five years. Now, we’ve seen the advent of data centres provided by the likes of Savvis and Equinix – they saw an opportunity in the market to secure data centres away from the financial district and provide a single secure point of presence where banks and clients can connect to each other at a fraction of the cost,” says Whelan.

Others agree that co-location providers will continue to gain traction as long as the foreign exchange market remains fragmented and the plethora of trading venues increases the pressure to cut cost and latency. “In many ways, the success of data centres has become self-propelling, because if you have a need to connect electronically against another participant, then it makes sense to be in the same place from a latency perspective,” says Svante Hedin, managing director and head of automated trading strategies at JP Morgan in London.

As well saving on costs by co-locating, data centre providers say banks are also increasingly looking for a simplified means of trading across asset classes, and therefore having cross-asset matching engines in a single location is a valuable opportunity that attracts new business.

“Previously, if you were looking at trading venues and were trading cross-asset, you would have to build out a network infrastructure that connected to those different markets individually from your own data centre. Co-location has brought a new connectivity model where the trading venues locate themselves within the data centre, so you can now connect to all the markets at once via cross-connects. This reduces complexity and connection time from months to a day or two, and increases robustness as the solution avoids the problems associated with long networks,” says Robin Manicom, director in global financial services for Europe, the Middle East and Africa at Equinix in London.

Data centre providers are not the only vendors seeking to benefit from the increased fragmentation in the forex market. DealHub, which operates out of two of Equinix’s data centres in London and New York, launched its FX Distribution Hub last year, which provides a single interface through which market participants can price into multiple trading venues. A number of banks, including a top-three market-maker, were already using the hub at launch, and DealHub hopes to extend the product into Asia by the end of 2013.

“As the number of trading venues increases, it is incredibly challenging for banks to keep pace with all the venues they want to be connected to, and understand the nuances of each connection. FX Distribution Hub has been popular because we can not only help set up and manage those connections, but we also take care of the ongoing changes as new products and new regulations materialise,” says Chris Leaver, chief operating officer at DealHub in London.

“It’s quite a big step to take a bank’s pricing engine and connect it to a venue,” adds DealHub chief executive Peter Kriskinans. “Each venue has its own application programming interface and its own set of rules. There are many different scenarios and trading models to take into account and each venue handles them differently. We’re providing the software and expertise to handle that.”


This article was first published on Risk

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