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When it comes to the electronification of foreign exchange swaps market, you’d forgive traders for having a fair amount of scepticism about the various venue initiatives springing up.
Many have been down this road before. Dealers recognise a problem and work with new trading venue to address it, but sell-side firms are slow to connect, leading to a lack of liquidity, and dealers ultimately switch off. All the while, the same voice-brokering processes continue to govern dealer-to-dealer trading.
A lack of interdealer trading on electronic venues has meant there has been no unified mid that can enable banks to construct a price that can be used consistently. That’s not easy, given swaps include extra pricing parameters compared with spot, such as interest rate differentials.
This explosion of new data sources and interdealer venues could mean less reliance on the voice brokers
In April, however, a whitepaper from 360t highlighted a profitability squeeze in trading operations at a time when higher operational costs, regulatory demands and capital requirements are already key economic headwinds for swaps dealers.
It said banks “are now arriving at an inflection point” and are “increasingly recognising that the status quo is no longer tenable”.
Dealers agree and are hopeful that the recent crop of new initiatives, coupled with these pressures on banks, will finally help the market turn a corner.
One such initiative is London Stock Exchange Group’s Forwards Matching going live with hard credit matching – a function that will enable banks to automate the credit-checking process, which is a key component in the electronification of FX swaps and forwards trading. It is has also cut brokerage fees for price-takers to zero for swaps of all tenors. Currently, price-makers on Matching do not pay brokerage.
By overcoming the credit hurdle – and to some extent the fees challenge – the hope is that increased dealer-to-dealer trading on the platform will then foster more sustainable market pricing data.
Other dark pool venues like Siege FX and the upcoming FXSwapX may also give traders a new way to electronically hedge client flow. For the latter, banks can effectively mask their FX swaps streaming data through encryption, which is then aggregated to create a midpoint benchmark rate for voice traders to also match to. The data they can get depends on the amount of activity they put through the platform.
There is also significant progress being made with third-party vendors. New Change FX, for instance, came out with a full one-year swaps curve data product in April, while dealers say they are increasingly plugging 360t’s Swaps Data Feed into their mid pricing engines.
This explosion of new data sources and interdealer venues could mean less reliance on the voice brokers for price construction of swaps beyond the most common tenors.
The hope is that this will help banks significantly enhance how they distribute electronic swaps pricing to clients. So far, only a handful of dealers have been able to successfully stream pricing for tenors out to one or two years. But this remains on a read-only basis, requiring buy-side firms to still execute on a multi-dealer platform.
Some help is being provided by fintech firms like Digitec. In April, the firm released a new tool that enables traders to automate the generation and distribution of multiple swaps streams from single core price, depending on a client’s tier, trading volumes and market conditions. The tool is built on top of its D3 pricing technology, a platform for pricing, curve and yield curve construction.
The electronification effort does, finally, seem to be shifting out of first gear. The first movers will dictate how quickly it gets into third.
Editing by Lukas Becker
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