Judged in isolation, Deutsche Börse's recent partnership with an embryonic, electronic trading platform for EM FX, for an undisclosed sum under £10 million, is a modest commitment.
However, viewed alongside other investments, such as Digital Vega – the independent FX options platform – the Bombay Stock Exchange, the Taiwan Futures Exchange and others, a picture emerges of an exchange with a clear resolve to establish a strategic presence in the EM FX market.
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| We want to build up liquidity gradually. And we aren't creating this liquidity out of nowhere – it will move from voice trading onto an electronic venue Brendan Bradley |
“We were interested in looking at FX, but it is quite a crowded space, [so] we felt we needed to come at it from a different angle,” says Brendan Bradley, chief innovation officer at Deutsche Börse and member of the Eurex executive board.
“This partnership allows us to grow quicker in FX than we could on our own. We were drawn to the type of currencies R5 addresses. It is a better fit for us as non-deliverable forwards (NDFs) are more standardized as well.”
It is very much an investment that must be viewed in the context of its overall strategy.
“FX options is also going to be really important for us," says Bradley. "Regulation will drive more market participants from single-dealer to multi-dealer platforms, creating liquidity in central liquidity pools like Digital Vega.”
According to the exchange, EM FX trading is worth around $80 billion to $120 billion per day – and it is not alone in the view that this segment is likely to see steeper volume growth in coming years than G10 FX.
Jon Vollemaere, CEO at R5FX, says: “China is obviously experiencing the most rapid growth, but Brazil, Russia and India are also moving up the Bank for International Settlements [FX] survey rankings. There is more interest in their underlying economies, which typically means debt and equity flows, but it also means currency hedging.”
Electronic EM FX trading specifically has seen a 300% increase in the last 12 months, according to Deutsche Börse figures, necessitating an improvement in the channels used to communicate and execute transactions between those markets and traditional money-centre cities.
Little liquidity
The need for this improvement has become clear to the banks and other market participants in EM FX. A business still dominated by voice broking, there was relatively little liquidity in electronic trading pools for EM FX, despite the high level of interest in such a service among banks.
It was two banks wrestling with these very challenges that originally approached Vollemaere and lead to the conception of R5FX and InterBank (R5IB), the bank-to-bank liquidity pool.
The banks were looking for help trading and hedging EM currencies electronically to optimize price and liquidity discovery. Vollemaere saw a gap in the market for an electronic liquidity pool that could be accessed and shared by institutions otherwise in competition with each other.
Now R5IB is within touching distance of an expected March launch, with more than 20 banks from across the world signed up. On day one, R5FX will trade 10 USD-referenced, electronically brokered NDF currencies: the renminbi, rupiah, rupee, ringgit and real, as well as the Taiwan dollar, the won and the Philippine, Colombian and Chilean peso.
| The knee-jerk reaction is to say we have followed the exchange model, but that is not the case – our platform is in the middle of the exchange and OTC models Jon Vollemaere |
It will use a central limit order book and be available via API and GUI interfaces, connecting with relevant clearing and reporting venues, with margins and clearing kept inside Europe for regulatory purposes.
Although R5 declined to disclose the names of the banks involved in the project, it said they represented a range of sizes, from large multinational banks to smaller, regionally focused players.
Vollemaere says: “The banks with the biggest issues in terms of accessing EM currencies are the mid-sized banks, the 10th to 25th biggest banks. We have calculated that around 70% of the turnover in EM FX is with institutions who have signed up with us.”
It is vital to secure the support of these local players, he says. Even the biggest banks struggle to cover all markets and even a relatively modest player in FX overall can be a top-five player in its own local currency. So R5 will work with local liquidity providers to ensure maximum coverage across markets.
“We see it in all asset classes – in FX, fixed income and cash equities – the inventory held by the tier-one banks will continue to diminish, that is going to create a shift in liquidity,” says Bradley.
Vollemaere says: “For us to have more than 20 banks on board before launch is very encouraging and obviously we expect more to join following the launch.
“We will have new products launching as well as amendments to existing products in response to suggestions from our users. We will add new crosses and currency pairs, and it will be led by what is most popular.”
He adds: “The idea is very popular among banks which are looking for liquidity in EM currencies. There are futures markets scattered in various places but many banks find it very hard to access them. It's much easier to merge it in one place.”
This demand came partly at the behest of regulations such as Dodd-Frank and EMIR, which for currencies mandate central clearing only for FX options and NDFs. However, regulation is a catalyst for changes that banks have been making anyway.
“Banks are looking to move flows onto screens and CCPs, even without regulations to improve their capital adequacy and enhance liquidity,” claims Bradley.
The hope is R5IB will generate its own momentum as increased liquidity in EM currencies generates more interest, and more interest generates yet more liquidity.
“The liquidity is there and will grow as more emerging markets make their currencies freely convertible,” says Bradley. "The only question is: how fast will this growth be? The established markets already see more liquidity through screens, but the trend has much further to go. Regulators would like to speed up this transition.
“We want to build up liquidity gradually. And we aren't creating this liquidity out of nowhere – it will move from voice trading onto an electronic venue.”
New partnerships
Over time, there might be new partnerships in the form of product cooperation, where R5 trades products after-hours in Europe when home markets in Asia are closed, he adds.
Vollemaere is keen to distance R5FX from the exchange model – though neither does his platform sit neatly within the OTC sphere, he says. “The knee-jerk reaction is to say we have followed the exchange model, but that is not the case – our platform is in the middle of the exchange and OTC models.”
He describes the business model by reference to a Venn diagram, saying: “With OTC in one circle and exchange in another, we're smack in the middle on the overlap. Think of it more like a gravitational pull towards the middle.”
Bridging these two trading worlds will benefit the industry as a whole, he says, adding: “For EM trading, both markets want an easy way to reach each other and both desire more liquidity. Often they have a different view on currency direction which is useful, and it removes the difficulty of access for all.”
R5IB is not the only project R5FX is working on. Among other things in development is OpenMarket, a similar platform that will be open to all, with most interest expected from algos and high-frequency traders.
The separate markets will allow banks to trade between themselves without having to compete with hedge funds and other aggressive traders with superior technology, Vollemaere says, adding: “You need different venues to accommodate the different trading styles.
"Bank-to-bank trading is very different to trading involving HFTs or agency brokers –they need a different service though it is supported by the same technology. Ultimately, one may overtake the other but rather than push one product or the other we want to make both available and allow the market to decide where the liquidity will be.”
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