FX primary venues seek reversal of fortunes

EBS and Refinitiv fight to restore market share – but bilateral trading may be too entrenched, dealers say

Everyone can admire a good comeback, whether or not you like the result. Take the New England Patriots’ improbable victory from 28-3 in Superbowl LI or Ben Stokes’s Ashes-saving innings at Headingley in 2019.

Now, the two interbank trading venues for spot foreign exchange, EBS Market and Refinitiv Matching, are hoping for their own redemption story after years of dwindling volumes and questions over liquidity.

The platforms have embarked on an overhaul of their infrastructure and product range, in a bid to entice users back.

But reversing the flow of trades away from the primary venues will be a tall order. Dealers have long complained that the platforms are a high-information environment where users can see each other’s trade intentions on the central limit order book, or Clob. This leaves dealers exposed to the risk that prices will move against them as a large order is sliced up and executed over time – an effect known as market impact.

As a head of electronic FX trading at a large US bank says: “There are still major liquidity concerns on these interbank platforms, and the market impact of executing on them has steadily gotten worse over the years.”

In 2018, the average daily volume (ADV) of spot trades on EBS was $90.5 billion. By 2021, the figure had slumped to $61.4 billion, before bouncing back to $66.7 billion this year. Refinitiv has seen a similar pattern. The firm reports data on its Matching and FXall venues together. Across both platforms, spot activity stood at $99.8 billion in 2018. In 2021, the figure was $87.4 billion, and this year it’s $101 billion.

The slump in volumes is partly a consequence of dealers internalising more of their FX trades. And when they do need to go to the external market, more are opting for bilateral trading relationships or curated liquidity pools on secondary venues.

 

“As a liquidity taker, we do considerably more volumes through bilateral relationships versus how much we take on a primary venue,” says Dmitry Ilyaev, global head of spot and eFX trading at Commerzbank.

But dealers have a dilemma. If they pull too much trading from the primary venues, they will deprive themselves of a key source of pricing. Currently, volumes on EBS Market and Refinitiv Matching provide a useful benchmark for bilateral activity.

“The reality is you will find it very difficult to differentiate your liquidity without using primary markets for price discovery,” says Geoff Jones, director of FX spot trading venues at London Stock Exchange Group, which bought Refinitiv last year.

Changing platforms

Refinitiv is in the midst of a two-year project to transfer its Matching platform on to the same Millennium architecture that LSEG uses for its equity exchanges. This effort will speed up order processing and quoting on the venue, the firm says.

Refinitiv is also offering new incentive schemes, including a market-making rebate and access to a five-millisecond data feed on the venue, providing users ensure that market-making accounts for at least 25% of their overall trading activity.

The firm says around 30 bank and non-banks have signed up to the market-making scheme over the course of the year. As of last month, around 70% of those participants still qualify for the scheme based on the eligibility criteria.

LSEG’s Jones adds that increased volatility in major currencies and the incentive schemes have meant both bank and non-bank market-makers have traded more on the platform, and as a result, spreads have tightened. For example, USD/CNH spreads were 20% tighter in the first quarter of the year, compared with the same period in 2021.

The exchange group has also looked more carefully at the microstructure features of its platform such as randomisation of orders on the matching engine, and pegging and tagging.

The high-frequency data feed access scheme aims to weed out participants that just watch the data without actively contributing to the liquidity pool. Jones says the scheme has transferred value from those than consume data to those that contribute to it. Using a theoretical value of trades, the firm quantifies the benefit at around $5-a-million for the typical user.

The primary venue still is the biggest liquidity source in the market that simply cannot be ignored. You still have to trade on the primary venues otherwise clients will not be maximising their access to interbank liquidity

Asif Razaq, BNP Paribas

EBS, meanwhile, has made efforts to curb high-frequency trading activities over the years by introducing speed bumps and minimum quote life features. Most recently, EBS Market migrated its three electronic spot matching engines to one based in New York for most spot pairs. The migration simplifies the platform and improves EBS’s ability to innovate and offer new products, the firm says. Announcements on product launches are expected in 2023.

Matthew Gierke, head of EBS Market, explains that even standard order types such as fill or kill (FOK) orders were not possible on its legacy architecture. But the platform has added new features such as a minimum quantity order qualifier, which enables dealers to specify a minimum amount of an order to be filled. Users can also match larger resting orders with opposing trades at a predetermined price without signalling the full order size.

“After three or four years of slow market conditions and participants really focusing on where else they can manage risk more quietly, we are now seeing the return of some of that activity to the primary venues,” says Gierke.

Overall spot volumes on EBS Market are up 11% so far this year, compared with the same period last year. Since the platform migration in May, EBS Market has increased its share of trades on the industry-standard settlement system, CLS, by 5%.

The venue has also renovated EBS Direct, its disclosed trading platform that enables banks to create their own liquidity pools of executable streaming prices or request-for-streams. The enhancements aim to speed up trade processing and provide users with new ways of executing trades, such as client-to-client matching.

Turnaround

These recent initiatives have helped both venues to capitalise on global macro uncertainties, as dealers return to the primary markets in the search for liquidity.

This was particularly evident in September after the Bank of Japan’s intervention to support its currency market prompted ADV on EBS – the dominant venue for Japanese yen trading – to reach a two-year high of $76.3 billion and an increase of 31% year-on-year. September was also the highest month for Refinitiv since March 2020, as the volatility surrounding the UK’s mini-budget announcement hiked ADV on Matching and sister venue FXall to $112 billion, an increase of 26% year-on-year.

The spike in volumes lends weight to arguments that primary venues are a key source of liquidity and price discovery for market-makers. As Jones points out: “People need to continue trading in the primary market to make sure the primary markets are viable, such that they can use them for price discovery.”

Asif Razaq, global head of FX algo execution at BNP Paribas, says primary venues provide the official reference rate for transaction cost analysis in major currencies, making it difficult for banks and clients to trade through other platforms.

“The primary venue still is the biggest liquidity source in the market that simply cannot be ignored. You still have to trade on the primary venues otherwise clients will not be maximising their access to interbank liquidity,” he says.

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But some suggest that the recent increase in primary market volumes owes more to the macro environment, rather than any structural changes on the platforms.

“We have not grown our volumes on them from these initiatives,” says the head of electronic FX trading at the large US bank. “[Refinitiv’s] brokerage rebate doesn’t really affect us.”

In fact, Refinitiv’s fee rebate scheme may even be a deterrent for some types of traders. BNP’s Razaq says the bank wants to avoid a perception that its execution algorithms are deliberately routing flow to a specific venue in order to earn a rebate.

A senior FX trader at a second large US bank says the firm made a strategic decision four years ago to minimise the use of what they call “information-heavy” venues.

“We try to trade as little as possible on EBS or Refinitiv because of the information impact. I don’t think we’d set zero as a target explicitly, but I think if we really wanted to, we could get pretty aggressive with not trading on there and I don’t think we’d miss it at all,” says the trader.

Buy bilateral

While spot volumes have drifted away from primary markets in recent years, dealers have developed other avenues for trading. Banks have set up bilateral streams with other liquidity providers, including non-bank market-makers. Much of the new activity takes place via direct APIs, or application programming interfaces, as banks invest in their technology stacks to better equip themselves to knit together liquidity streams from a wider variety of sources.

Tie-ups between market-makers are not new, but have often been cast in simple terms with regional and mid-sized banks taking advantage of white-labelled pricing to give their local clients access to global markets. But concerns about declining liquidity on public venues are prodding some larger-sized dealers to consider these strategic alliances.

One advantage of bilateral trading is it nullifies any possibility of market impact. Transaction costs for electronically trading FX spot, such as brokerage, can also be reduced by as much as 80% for large-sized trades through bilateral streaming, dealers say. Commerzbank’s Ilyaev says trading passive orders through disclosed bilateral relationships are a more cost-effective method of execution than through the primary venues.

“If you are naively submitting bids and offers at the top of the book or inside the spread on the primaries and waiting to get filled, the cost can be higher than crossing the spread with a disclosed bilateral liquidity provider,” he says.

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An FX executive at a European-based dealer says liquidity can be as much as five times deeper from direct bilateral relationships compared with EBS or Refinitiv. Some banks now trade as much as 70% of spot via bilateral feeds.

Bespoke liquidity pools curated on secondary venues, such as Cboe FX (formerly Hotspot) and FXSpotstream, have also become an attractive way for banks to optimise large-sized trades in the interdealer market.

These platforms enable banks to cherry-pick who can see their trades and who they want to exclude from their liquidity pool, such as high-frequency trading firms. So-called “dark orders” allow users to post interest on a secondary venue and ensure that the interest is not visible on the open, or lit, market.

BNP’s Razaq says: “This allows us to trade against natural interest in the market as opposed to me showing my interest to the market and the market then reading that information, which could be detrimental to the execution.”

Since December 2021, ADV on FXSpotstream and Cboe FX have grown 61% and 44% to $69.1 billion and $42.7 billion, respectively.

But managing a network of bilateral relationships is no easy task as it requires a huge amount of resources and investment. Banks must maintain connectivity to multiple liquidity providers, and develop a method for aggregating market data. Banks also need smart order routing, potentially co-located in the centres where the liquidity is being provided. Plus, firms need to analyse metrics on each individual provider.

“However, if this is done well, then curating these liquidity pools outside of the primary venues is beneficial,” says Commerzbank’s Ilyaev.

Editing by Alex Krohn