How Can Retail Flow Add Value in the Institutional Efx Market?
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How can retail flow add value in the institutional eFX market? WBR Insights & CMC Markets Institutional How can retail flow add value in the institutional eFX market? 2 Contents Purpose & Methodology 03 Key Findings 04 Executive Summary by CMC Markets Institutional 05 Chapter One 06 Challenging Perceptions Chapter Two 11 Retail Disruption Chapter Three 15 Technology Chapter Four 18 The Current Trading Environment Conclusion 21 About CMC Markets Institutional & WBR Insights 22 Contributors Simon Campbell Richard Elston David Fineberg Group Head of Trading Group Head of Institutional Deputy CEO CMC Markets CMC Markets CMC Markets How can retail flow add value in the institutional eFX market? 3 PurposeKey Findings & Methodology In Q3 of 2020, WBR Insights surveyed 100 Heads of Trading, CTO’s and similar from sell side brokers across APAC, EMEA and the USA regions, to understand the alternative views on whether retail flow can add value in the institutional eFX market. In this paper we attempt to question the traditional perceptions of the FX trading environment, assess the impact of recent retail disruptors and analyse the importance of technology, all against the backdrop of a global pandemic and a looming financial crisis. The survey was conducted by appointment over the telephone. The results were compiled and anonymised by WBR Insights and are presented here with analysis and commentary from CMC Markets contributors. 23% Mid-sized FX Brokerages 39% Tier 2 investment bank What type of organisation do you work for? Which country are you based in? 38% Hedge Fund EMEA 46% APAC 46% USA 8% What is your job title? Head of Trading 33% CTO 25% Liquidity Manager 23% Other similar job titles 19% How can retail flow add value in the institutional eFX market? 4 Key Findings Trading FX during a pandemic Covid-19 hit the APAC region first in late December 2019 There was a slight majority of respondents (55%) who before it rippled through the global economy two months said that their firms have not been using more alternative later. This caused widespread chaos and high volatility for liquidity providers during the economic ups and downs of the financial services industry, including forex markets. the pandemic this year. Value in retail trade flow Need for Our research has shown that forex trading firms are conflicted in how they regard retail traders and the diversification importance of the retail market on the industry. The growth of fintechs such as Robinhood catering to In recent years, there has been an increase in the individual traders has been widely publicised in recent barriers to entry for forex brokers looking to access years making their impact hard to ignore. On the one liquidity from traditional counterparties. Many traders hand, our survey data has revealed that the majority of still strongly believe that tier one liquidity providers respondents (52%) would be concerned by their trading can offer them a superior service however this is not counterparty having a retail background. However, on always true. Many forex trading firms are unable to the other hand, 53% of our respondents cited that access tier one liquidity pools because of their size they see value in trade flow relating to retail clients, meaning they are forced to look at alternatives. Research with 32% that said it was very valuable. A further 52% showed that the priorities for traders are: minimisation of our respondents also agreed that the integration of of market impact, ability to source prices from more retail client flow can add value with regards to price than one provider and ability to access a wide range of construction and liquidity provision. instruments. Non-bank market makers have emerged to bridge the gap in service for many institutions of various sizes. By looking to alternative providers that can offer unique pricing across multiple asset classes, forex firms can access a more complete solution tailored to their bespoke requirements. Demands on technology As the effects of the Covid-19 pandemic were felt within technology infrastructure to maintain the consistency of the foreign exchange markets, some forex firms sourced their services; whether it is robust enough to withstand their liquidity from alternative providers to ensure they increased demand during volatile periods and if it can were able to provide a high level of service to their support their workforce working from home during clients. Both retail forex traders and forex firms are lockdown restrictions. reliant on their third-party liquidity provider’s in-house How can retail flow add value in the institutional eFX market? 5 Executive Summary by CMC Markets Institutional It is widely accepted that the foreign exchange when they were unable to make a market industry exists in a constant state of evolution, and the threat of dislocation loomed large. something that is especially true in the fields By utilising alternative sources such as CMC of liquidity provision and price construction. Markets Institutional who are able to leverage The survey we have undertaken in conjunction their internal flow to generate a new wave with WBR highlights that, if anything, the pace of liquidity, market participants could have of change is now more rapid than ever, and achieved higher consistency of pricing. the extremes of volatility seen in 2020 made for an ideal proving ground to understand just Whilst it may be a step too far to claim that how far this market has come. financial-technology-based liquidity providers alone saved the day, their commitment to The field was once dominated by a small using technology to improve market quality number of the key players, but structural needs to be understood by all. The examples change for them - combined with the seen in 2020 illustrate very clearly that the innovative use of technology by an emerging world has changed prompting businesses and band of fintech’s - has nothing short of individuals to challenging their traditional ways revolutionised the functioning of the of thinking. underlying market. However, polling of sell- side brokerages revealed widely differing understandings of what the new wave of market participants had brought to the table in recent years, suggesting there’s still the potential for many to make significant efficiency (and commercial) gains. With many respondents holding onto the belief that non-bank liquidity providers are simply unable to price consistently, especially when markets aren’t functioning normally, this displays a now dated reality – and a point which was tested in the depths of the pandemic-induced volatility crisis. There has been instances with certain tier one banks How can retail flow add value in the institutional eFX market? 6 Chapter One Challenging Perceptions As a new wave of non-bank liquidity providers According to our research, 27% of respondents cited have entered the forex market, buy-side firms are that it was very important for their liquidity providers considering all the alternative options available to to have a minimal market impact and a further 42% of them when sourcing liquidity and are challenging respondents cited that it was somewhat important. their perceptions towards these new market entrants. These results highlight the need to understand the goals Non-banks generate their own liquidity in a number of of a liquidity provider before agreeing to partner with ways but will often require a critical mass from a large them as well as maintaining an open dialogue so that client base to be able to offer sufficient depth. the goals of the provider and the client are continuously aligned. The primary venues and tier one banks have traditionally been perceived as the best option for Our data revealed that the majority of respondents forex traders when sourcing liquidity. Our research are looking for multiple avenues to source liquidity has shown that 66% of respondents think that tier to increase the transaction flow and keep prices one investment banks can provide a tier one service competitive. When selecting a trading counterparty, for their clients, where, in comparison, some of these 42% of respondents said an aggregator STP was newer market entrants could fall short. However, their preference, which was closely followed by 30% this view has been challenged in recent years, many citing they preferred a bi-lateral trading counterparty. forex trading institutions are not able to access these Interestingly the respondents who suggested their liquidity pools and are therefore dependent upon preference was aggregator STP contradict the 69% who market makers and alternative liquidity providers. said that minimisation of market impact was important to them. Our data has revealed that many respondents fully understand and respect the position of market makers There could be the argument that takers of liquidity however there are still some forex traders who maintain feel they have better choice by working with a provider a more negative perception. For those that held a who has an appealing aggregation stack of tier one positive view they stated the important part played in banks and native ECN feeds and therefore a greater the functioning of financial markets and saw them as a chance of being able to get the trade away. However, if supplement to automation technology. aggregation is not managed well, liquidity takers could run the risk of information leakage. Clients making larger Non-bank market makers can play a significant role in trades looking for meaningful depth and consistent the current climate when forex brokers are struggling to delivery could benefit from having their traditional access liquidity. By having a strategy which focuses on perceptions challenged. reducing market impact, internalisers are able to offer more competitive costs of trading over the longer term. How can retail flow add value in the institutional eFX market? 7 We asked our respondents to comment on whether they felt the negative perceptions of market makers were deserved, here’s what they told us: “No as a “The market “They do traditionalist is a place of tend to have and yes as opportunities.