Q&A: The Rise of FX and the Tech Demands Created

This week, the Bank for International Settlements released its triennial survey of foreign exchange (FX) and over-the-counter (OTC) derivatives market activity. The survey found that total currency-trading volumes have surged to $4 trillion, which is a 22 percent increase from its 2007 survey. The FX market has risen 234 percent since 2001.

SST reached out to Jon Vollemaere, managing partner, Europe, for London-headquartered FX connectivity provider FXecosystem; Sang Lee, co-founder and managing partner of Boston-based industry analyst firm Aite Group, and Justyn Trenner, CEO of London-based research firm ClientKnowledge, to see what the technological ramifications are due to this explosion.

How are firms addressing this rise in currency trading, from a technological point of view?
Jon Vollemaere, FXecosystem: The report confirms some theories and it's certainly reinforced the review of the current infrastructure. We've seen a big increase in demand on our side of the business. Naturally that creates a review of the middleware, credit and price engines to support the increase in speed and traffic. Some banks and ECNs can produce large amounts of FX price updates, but the clients can't access all of them. Once the tech is updated, those clients trade more with the bank; in some cases a lot more. So the demand is there alright, and the smart banks are taking the initiative.

Sang Lee, Aite Group: Well, the banks have realized—at least the large FX banks—a while ago that there was huge growth potential in FX. Most of these firms have committed tons of resources to build out their FX ecommerce infrastructure and are well positioned to benefit from continued growth in FX.

Justyn Trenner, ClientKnowledge: In the period 2000 to 2005, and even through the credit crisis, a lot of the focus was on efficient means of capturing trades from commerce systems. But really in the past two years the focus is much more significantly on efficient means of capturing and managing risk. Not only are we seeing a rise in volume, but we are seeing a reduction in average ticket size, so that's a dramatic rise in the number of tickets that need to be priced and processed. You can't watch each ticket that goes through, you have to have systems that capture and manage that risk into your risk books, then process everything from the risk side through to the confirmation side. We're seeing a lot of investments in systems that allow you to manage the flow from the point were the trade hits the bank onward.

What are the most vital technology upgrades banks should think about making?
Lee: Most of the banks have focused on enhancing their overall FX ecommerce infrastructure, with low latency, robust pricing engine and growing internalization capabilities.

Trenner: Standardizing messaging and connectivity; clean, unparsed messaging and connectivity. Banks will also have to invest in better technology to process trades and information. If they've got to start by normalizing that data, well that's normally a bigger problem than installing new software. Also, standardizing benchmarks on the value of trades, the mark-to-market processes, is important as well.

Vollemaere: It's a shameless plug, but they need to look at the risk, speed and cost. With all the new activity they need to make sure the price they have out there right now is correct and can be updated faster than it can be picked off. At the same time, in its more traditional business, if Bank ‘A' is giving a better price faster than Bank ‘B,' it wins more of that client's business. Speeding up decreases client slippage costs, which makes both sides happier. It also means the bank heavily decreases its price risk to the market as well as from the market. Only the very clever have worked out the latter.

Why are so many firms getting into the currency trading game? Will this continue?
Trenner: Yes, the market will continue to grow. There have been ebbs and flows, but the general direction has been consistent over the past 20 years where the FX market has been growing, and there's no reason to think it won't continue to grow.
One of the factors that show it will continue to be hot is that as international trade grows, FX has to happen. And as markets around the world liberalize, more trading in and out of those liberalizing markets is going to happen. China is a growing economy doing more international trade and the yuan is liberalizing, so there will be more active trading in it—it's a double benefit. Also, FX doesn't require a great deal of application of credit. From a banking point of view, you don't see many banks losing money from FX.

Vollemaere: There's a lot of macro-economic activity lately and the FX rate is the easiest way to speculate on that. There are some further undertow elements going on as well. You can see in the report that the biggest growth area was ‘other financial institutions.' There's a good argument to say the threat of regulation on high-frequency trading in the equities markets have many shops looking to point their high-tech guns at bigger, self-regulated markets such as FX, which can absorb the flow. Again, in the report, trade between bank and customer for the first time surpassed bank-to-bank trading. That means more customers trading more often than before and banks internalizing flow, which they may have in the past offset to another bank.

Lee: Most market participants view FX now as a legitimate asset class and an asset class that is uncorrelated to the more unpredictable equities market. The growing importance of FX as an asset class has not occurred overnight. In fact, the growing prominence of FX can be traced back to at least five years ago.