The Colt Capital Markets team has attended a number of industry events in the last couple of months, the last being FX Week Europe. The recurring themes of low trading volumes, stuttering volatility and increased regulatory scrutiny could lead to a pessimistic view of a market in a state of decline. Instead I think we are in a period of wholesale restructuring.To make sense of where the foreign exchange market is going, it is important to remind ourselves of where it has come from. The currency market is one of the biggest and most liquid in the world. Trading was founded on the practice of bilateral deals conducted over the counter (OTC) between two parties, in contrast to many other asset classes such as equities which have tended to trade on organised exchanges.The global financial crisis has however increased the regulatory interest in OTC markets, and resulting reforms mandated by the world’s leading economies, in the form of the G20, moved more and more trading of different asset classes on to exchanges in an effort to increase transparency as well as monitor and manage risk. The foreign exchange market had a reputation as being fair and efficient and remained liquid during the financial crisis itself but events since then have brought the industry’s perceived opacity into question. As a result it is expected that during 2015 all FX derivative trades such as non-deliverable forwards (NDFs) and foreign exchange options will move to be traded on swap execution facilities (SEFs). It is hoped that trading on these venues will be more transparent than OTC trading.While the electronification of the FX market creates its own disruption, adding to the over-arching sense of an industry in flux, it does appear that the latest innovations are starting to provide some much needed rejuvenation.For example, electronic trading is making the composition of the foreign exchange market more diverse as organisations such as hedge funds and smaller regional banks begin to challenge the dominant position long-held by the big investment banks.Not only are we seeing foreign exchange trading become more electronic, the adoption of algorithmic trading strategies is a key feature too. From single-digits in the early part of the new millennium research company Greenwich Associates estimates that electronic trading volume grew to 74 per cent by 2013.Together electronic and algorithmic trading enable participants to capture new opportunities in the market while achieving more accurate pricing, smaller spreads and shorter transaction times.All of which serves to make the global foreign exchange market – and it is becoming even more global with liquidity pools moving to Asia – more efficient, with competition and better technology leading to more aggressive quoting and improved services for customers.As technology – particularly that which is outsourced – becomes more widely used in foreign exchange trading, we are seeing demand for a rapid modernisation of processes and the evolution of an industry that more and more resembles equities in terms of its structure and practices. While some may think that this process should have started many years ago, it’s difficult to argue that ‘now’ is not better than ‘never’.
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