Banks turn to analytics playbook to take on FX platforms

Dealers aim to lure clients from high-fee multi-dealer platforms with improved investment analytics

For foreign exchange dealers, high transaction fees on multi-dealer platforms (MDPs) have slashed FX spot and swap margins, and – for all but a handful of the largest players – made business unsustainable. Now, in a bid to restore eroding profit margins, banks are backing beefed-up analytics tools to coax clients back to single-dealer platforms (SDPs).

For the most frequently electronically traded FX products, buy-side firms have migrated en masse to MDPs. Between 2016 and 2019, market share of electronic dealer-to-client trading on MDPs jumped from 35% to 55%, according to the Bank for International Settlements triennial survey.

And while requests for quote (RFQs), pitting dealers against each other, fulfil buy-side best execution requirements, dealers say trading on MDPs is eating into dwindling bid/offer spreads. A dealer’s spread on a short-dated FX swap might be less than $1 per million, for example, and the platform charging the dealer $2 per million to execute – making it uneconomical in some cases for banks to trade and creating an uncertain future for second and third-tier banks.

“There are probably going to be five single dealers that continue to exist. Outside of that, [the others] cannot make enough money to justify their existence,” says an FX executive at a large US bank.

In an attempt to prevent further attrition, dealers are preparing to take on the platforms through a range of approaches. Some hope to entice clients back to the single-dealer environment with improved pricing on bilateral trades – JP Morgan has begun to provide separate pricing for single and multi-dealer venues and Barclays has said it would consider taking the same approach.

But many are hoping to lure clients to their own proprietary platforms with an enhanced suite of value-added services, such as transaction cost analysis (TCA) and pre-trade analytics. Dealers say this is particularly relevant for more complex derivatives instruments and ‘lumpier’ trades.

“People have been predicting the death of single dealers for the last decade, but they are still here and still very relevant,” says David Wilkins, head of Ficc execution services for Europe, the Middle East and Africa at Goldman Sachs. “MDPs perform a service unless you need something in size and complexity like exotic derivatives. That is where single dealers have real demand.”

People have been predicting the death of single dealers for the last decade, but they are still here and still very relevant

David Wilkins, Goldman Sachs

Dealers try to compete on price, says Wilkins, but it’s not the only factor: “It is about coverage, data, functionality, certainty, service, and how we can compete further up the value chain to be meaningful to our client.”

BNP Paribas meanwhile has enhanced functionality in its flagship digital assistant service, ALiX, in a bid to help clients with pricing, notifications and research across FX products and algos.

“This is an area of growth, where we can offer clients personalised content based on what their needs are,” says Asif Razaq, global head of FX automated client execution at the French bank. “Whether it’s looking for axes on options, axes on swaps, or information on euro/dollar research, we can now create those personal solutions and deliver [them] to the client.”

The platform, which is offered exclusively on the bank’s Cortex SDP, began life with a skillset aimed at helping clients with algorithmic execution, but has evolved to become a multi-function tool in order to assist clients with pre-trade decision making, says Razaq.

UBS has also enhanced functionalities on its flagship Neo platform with the rollout of Trade Pricer, which gives FX options traders pre- and post-trade analytics, and provides suggestions on restructuring to deliver a full service at the point of trade.

Total impact

Greater investment in SDPs comes as sophisticated investment managers look to conduct more in-depth analysis into the overall cost of trading.

Buy-side firms typically strive to have as many liquidity providers as possible competing on MDPs and aggregators. In theory, the RFQ process allows them to pick the best counterparty to trade with on the end-client’s behalf.

And while such a trading strategy works well to achieve best prices in the short term, various studies suggest buy-side clients benefit from better execution over the long term by being connected to fewer FX liquidity providers.

“We see a lot of clients doing their own analysis on LP performance,” says Ciara Quinlan, head of principal electronic trading at UBS. “They’re recognising that increasing liquidity providers often does not equal better pricing and execution. And they’re very wary that their execution style and choice of LPs impacts the quality of liquidity that providers can show them in the long run.”

There’s also a regulatory imperative for investment firms to execute orders on the “most favourable” terms to the end-client. Europe’s second Markets in Financial Instruments Directive (Mifid II) requires by law that parties take account of factors such as speed of execution and market slippage when executing trades in the market, as well as price.

If you’re trading with aggregated liquidity providers and one of those liquidity providers is causing market impact post-trade, the impact is realised by and costs all providers that the trade has been split and executed with

Ciara Quinlan, UBS

The Swiss bank has carried out research with clients on how to optimise their liquidity pools and reduce market impact to receive better pricing over the long term.

“If you’re trading with aggregated liquidity providers and one of those liquidity providers is causing market impact post-trade, the impact is realised by and costs all providers that the trade has been split and executed with. Then, over time, the client may end up with a worse-priced liquidity offering from those providers as a result of that market impact,” says Quinlan.

One of the main ways FX dealers look to accomplish this is through algos. Several FX dealers have recently enhanced their algo product suite for clients executing on their SDPs in order to improve their internalisation capabilities, whereby client flow is matched against the LP’s own flow or with other client orders.

Citi is rolling out a revamped FX algo suite which will bring its offering up to date by adding new strategies and improving its ability to match liquidity internally to reduce the amount of hedging required on external venues.

Similarly, Deutsche Bank has included its principal resting order into its FX algo suite, through which clients leave passive electronic FX orders with the bank; they can stream either individual limit orders or peg their orders relative to Deutsche’s mid-price, allowing them to execute at a price similar to the bank’s principal desk. The German bank says this allows it to minimise adverse selection on passive fills, and signalling risk is minimised due to its investment in reducing information leakage.

UBS shares the goal of achieving low market impact for clients. “We’ve spent a lot of time on ensuring that we reduce any information leakage,” says Quinlan – an objective that has been achieved through maximising the firm’s internalisation rate. “So that we minimise and are very selective in when we trade externally to the market.”

MDPs … still MVPs?

Despite dealers’ efforts, MDPs are the most dominant form of trading for buy-side firms and volumes are growing – some have even seen record trading volumes on the back of a recent volatility spike.

In March, FX Spotstream reported a record average daily volume (ADV) of $70.1 billion across all products, up 28.1% year-on-year. CboeFX reported an ADV of $44.4 billion for the month, its highest since March 2020 and up 15.9% year-on-year. EuronextFX saw its second-busiest month with a $26.1 billion ADV, up 23.1% year-on-year, while Deutsche Börse’s 360T reported ADV across all FX products at €118.4 billion ($126.4 billion), an increase of over 20% year-on-year and its second busiest month for the platform in the period since March 2020.

These platforms are heavily used by large asset managers mandated to use extensive bank panels for their trades.

Using an SDP is not an option for us – it doesn’t work for someone our size

Global head of FX trading at a large US asset manager

Some say the incentives to move back to bilateral connections are unclear.

“Using an SDP is not an option for us – it doesn’t work for someone our size,” says the global head of FX trading at a large US asset manager.

An FX executive at a second US asset management firm says executing on an MDP is the optimal way of trading for the firm’s own clients: “Best execution is usually about price but is also about the back end, which is often more robust on an MDP.”

Then there are those who believe the innovation offered by dealers in SDPs may have been overplayed. Stephen Best, head of FX product, capital markets at London Stock Exchange Group (LSEG), which owns Refinitiv, says MDPs can offer similar data and analytics services to those available via bilateral connections – and make them available to a much wider variety of buy-side firms.

“A large asset manager may have a currency exposure in the hundreds of billions and would need a process where they can manage their exposure in a repeatable way, but still trade with a number of different counterparties,” says Best. “Those types of situations lend themselves more to multi-dealer platforms – and what we’ve found over the past number of years is more demand for features such as trade performance reporting in order to better evaluate their executions.”

MDPs are also increasingly being used by the buy side to evaluate best execution across multiple parameters – not just price – says Best.

“We can drill down to the leading banks in terms of liquidity provision for certain sizes, currency pairs, tenors, forwards etc. By giving the buy side access to that information, it informs them going forward on the decisions they might want to make or who they may want to have in their panel of banks for certain trades.”

This is more difficult to do with SDPs, adds Best, because a client can only properly evaluate the dealer it has executed with. “When you have an MDP and you have a panel that you can choose from, it’s possible to evaluate and to have an awareness of their performance over time.”

Proprietary spin

The continued dominance of MDP trading is also prompting banks to imprint their own ‘look and feel’ on the platforms in cases where they can offer their own proprietary trading experience, whilst also challenging electronic flow.

Three years ago, JP Morgan made available the central hub for its algorithmic execution – Algo Central – on the Bloomberg terminal. It has since made a number of adaptations to enable predictive analytics to tailor orders, and to change the speed and execution style of already-live trades.

The bank’s head of continental eFicc sales, Alexander Nowak, says this has enabled the bank to inject a JP Morgan-specific experience onto the multi-dealer platforms themselves.

“A lot of clients are trading algos with us on these MDPs through Algo Central, and we’re able to deploy applications that allow them to have a single sign-on experience within these portals and still be able to have a JP Morgan-curated experience,” says Nowak. “I think [that], technology being the adaptable, flexible thing that it is, we’ll find new ways to incorporate with these multi-dealer portals – and extend the JP Morgan user experience more widely.”

LSEG’s Best says that more than 20 banks have signed up to give access to their algos via Refinitiv’s FXall. The firm has worked with banks to see how they can jointly facilitate more access to business over its platform, he says, and anticipates a future of mutual partnership between platforms and FX dealers by opening access to a wider range of buy-side clients.

“Liquidity providers are our customers as well,” he says. “Over the past few years, we’ve gone from resistance to multi-dealer platforms, when they were first coming out, to more willingness from the banks to work with us as partners now.”

Editing by Louise Marshall