Mike O’Hara: Hello and welcome to Financial Markets Insights
As the world’s most heavily traded market, global foreign exchange is an incredibly dynamic asset class. And one of the trends we’ve seen in recent years is a shift in liquidity towards Asia. So what is driving growth in the various financial centres in the region?
Michael Ourabah: Tokyo has been traditionally the place for FX trading. We see a lot of people talking about having something opening in Singapore for FX. We don’t see that materialising quite right now, but I’m sure we’re going to see that more and more over time, as people see that there is value in having another location, more the heart of Asia.
Rami Soliman: Australia, we’ve seen a very large growth in retail aggregator flow, retail trading has become quite large there, and that’s driven the Australian market, effectively, and pricing and connectivity that needs to get to these places has had to evolve as a result.
Hong Kong has been mainly broker and hedge fund dominated and it’s a gateway to China in volume and so that’s why a lot of people have gravitated to making and taking prices there, and I guess it’s also a consequence of the equity growth over there in terms of, there are a lot of richer people from that diaspora who are trading in other asset classes and certainly FX is a second derivative of that, so you see the trading there.
Singapore is effectively another hedge fund growth led, and probably the closest to Japan in terms of the underlying- that’s where a lot of the banks are putting their centres and so they’ll trade from these regions if they’ve got a- my days at Citi was effectively London, but there’d be a Singapore desk as well as the Japanese desk. So the banks, you’ll find, have put a lot of their tech bases there and their FX pricing is out of there as well.
Mike O’Hara: Of course, the biggest potential market in the region is China. So how is Shanghai developing as an FX trading centre?
Jon Vollemaere: Shanghai is taking a very large leap forward, and it’s in a different way to the other cities. One of the benefits of a communist economy, or a post-communist organised economy, is that when the PBoC says, “We’re doing this,” then (clicks fingers), everybody does that pretty much straight away, unlike here, where things tend to drag and dates and stuff go through, but we all eventually get there.
The difference, of course, is that the number of zeros on the end of everything in Shanghai is so vast that the rest of the world is popping up there, beyond the Citibanks, HSBC, Standard Chartereds who have been there for 100 years kind of thing, and that creates this big opportunity.
There is still a large number of restrictions for foreign firms of what they can and can’t do. I think probably the best example is there are free-trade zones, there’s the Shanghai Free-Trade Zone, Shenzhen Free-Trade Zone. When that first started, there was a list of what you could do in the free-trade zone; two years later that became what you could not do in the free-trade zone and then, all of a sudden, there a lot was more activity in those areas, so that’s government policy change. That’s the driver, that’s what will make the difference with Shanghai being a location, hands down.
Mike O’Hara: One of the unique aspects of the FX markets in Asia is how diverse and fragmented they are compared with those in Europe and the US. So how does this fragmentation impact liquidity in the region?
Eddie Tofpik: There are two assumptions you need to make; one is all FX is fragmented and illiquid, by its nature. You’re dealing with individual people in individual banks or, rather, individual desks or sections within individual banks, rather than a general mass book, there’s no order book that’s across the thing.
The second thing is each bank has its own particular flavour. In Asia, it tends to be more along the time zone limited. Okay, Japan, that deals with the local market in Japan. Hong Kong, Australia and Singapore, especially Singapore, have gradually got those markets as the time has moved across. So yes, it’s fragmented, yes, it’s illiquid, but that specific time period between the close of New York and the opening of Tokyo, that’s the most illiquid. I think I gave you an example in the past of the flash crash in Sterling as being an absolute case. The main hedge funds don’t trade that market anymore, as far as I’m concerned. You still have the high frequency traders, but there is cycling liquidity amongst each other so it gives an illusion, a mirage, of liquidity.
Tom Higgins: We’re seeing quite a lot of growth in liquidity providers and specifically, the non-bank ones, in Asia.
The market is a less developed, just because it’s a bit younger. It’s still in a growth phase, and so there are still lots of pent up demand there for brokers to exist and set up in FX and CFDs, and now actually crypto CFDs. Therefore, is demand for liquidity providers to deliver there.
Now, in the past, that might have been delivered from London or from New York liquidity providers, but the latency now becomes more of a problem. They were not so sensitive to latency before, but as markets develop, and people get more sophisticated, and you have more trading algorithms, latency becomes more of an issue.
When traders and brokers, local brokers, realise that they can get much lower latency by going with a local liquidity provider, be it non-bank or bank, then that’s the choice that they start making.
Mike O’Hara: So what does this mean for those who are providing the underlying trading infrastructure?
Stephane Malrait: The banks and the service providers, the trading platforms, they have to adapt their flow to match their client needs, and probably, that was a discovery for them when they entered the Asian markets, trying to talk to the potential clients, try to understand how they currently hedge, how they are going to hedge in the future.
What we see as well is that there was an evolution in the market in general, where there was a strong inter-dealer market with very order book driven, algorithmic trading driven, and the consumer market was very RFQ driven, based on price and direct relationship. Those two are converging in the industry as well in Europe, but they are converging in the industry in Asia as well.
The clients are going to look at that, and they are starting to adapt to those changes. For certain currencies, they prefer to go to more advanced algorithmic models. For others, who are more liquid, they still prefer to hedge themselves using a traditional RFQ model on the trading platform.
Michael Ourabah: Mainly people already had infrastructure in place for London-New York, because they were trading equities and futures, and other instruments on these routes, so they didn’t need to make any specific adjustments […] for low latency, and having the right infrastructure there.
The same for New York to Tokyo, to be perfectly honest. Some improvements are always on the table, such as building wireless capabilities on the terrestrial segments of these routes.
The one that made the difference is really London, Tokyo, that’s a market that was really under served from a telecom infrastructure perspective.
Of course, early adopters like prop trading firms, HFTs, are the first ones to jump on these, but we can see now that the tier one banks have been jumping on them as well, considering that these matching engines were actually faster than they were. They were losing a lot of business because they were not on par with these anymore. They see the need, since the last two years, of actually going towards that as well.
Even some are being a bit creative, asking for just a bit of bandwidth with wireless, to ensure that they can send the right critical signals, and then a larger amount of bandwidth for non-critical information that still needs to go through for a regulatory perspective, for example.
Mike O’Hara: There are certainly many challenges for Western firms taking the leap into the Asian FX markets, but equally, there are some very exciting opportunities. Understanding how liquidity is shifting, where the potential for growth is, and what is needed in terms of infrastructure to access that liquidity, will be essential factors for firms who want to capitalise on those opportunities.
Thanks for watching. Goodbye