Dealer-customer and inter-dealer trading in a fragmented spot market

Trading activity in the FX markets is fragmented across a range of venues and liquidity providers (Markets Committee (2018)). Before the turn of the millennium, the FX market was a "plain vanilla" OTC market, with trading dominated by major dealers. While still retaining its OTC structure, a multitude of other venues and providers has emerged since then (see eg Chaboud et al (2022)).  For three decades, two electronic brokers, Reuters (now Refinitiv) Matching and Electronic Broking Services (EBS) Market, have been especially important for the inter-dealer spot market. Often referred to as the "primary venues", they are organised as central limit order books (CLOBs). They have been the main sources of reference prices for the entire spot market. But there are also more than 30 secondary venues in the dealer-customer market segment, which has grown strongly in recent years, especially when compared with primary market activity (Graph B1). Customers can also trade directly with more than 20 dealers via proprietary single-dealer platforms (SDPs) or obtain direct prices streams from more than a dozen PTFs.

Trading volumes on the primary venues have been declining for over a decade (Graph B2, panel A). One reason is more internalisation. Another is that dealers were weary of adverse selection by PTFs engaging in high-frequency trading strategies (HFTs) after PTFs gained access to these venues in mid-2000s. In an attempt to insulate bank dealers from what were perceived as "toxic" HFT strategies, primary venues have subsequently introduced "speed bumps" to level the playing field. A third reason is the greater use of execution algorithms that help users, including dealers, to slice orders into smaller pieces and to distribute these efficiently across different venues. In 2020, execution algorithms were estimated to account for 10–20% of global FX spot trading (Markets Committee (2020)).  Last, PTFs often hedge the risk arising from liquidity provision to customers using futures rather than going to the primary venues. In part for this reason, futures markets have emerged as another locus for price discovery in currency markets alongside the primary venues (Chaboud et al (2021)).

Despite their downward trend, volumes on primary venues have typically jumped with volatility but not so this year. Some inter-dealer trading volumes have typically gravitated back to primary venues during volatile conditions (Moore et al (2016)), so that volumes rose as volatility increased (Graph B2, panels B and C). After an initial rise of trading on primary venues in early 2022, trading volumes remained flat as volatility continued to rise. This divergence may reflect several factors, including stagnating customer volumes, some decline in PTF activity, including on primary venues, higher internalisation ratios, more risk management with related parties, and a greater share of direct electronic execution even among dealers.

The views expressed are those of the authors and do not necessarily reflect those of the Bank for International Settlements. Markets Committee, "Monitoring fast-paced electronic markets", report submitted by a Study Group, Markets Committee Papers, no 10, 2018. A Chaboud, D Rime and V Sushko, "The foreign exchange market", in R Gurkaynak and J Wright (eds), The Research Handbook of Financial Markets, available on SSRN, 2022. The time series shown in the graph overstate the turnover on primary venues because the publicly available data from EBS (CME/NEX Group) and Refinitiv include volumes traded on some of their other platforms. Markets Committee, "FX execution algorithms and market functioning", report submitted by a Study Group, Markets Committee Papers, no 13, 2022. A Chaboud, A Dao and C Vega, "What makes HFT tick? Tick size changes and information advantage in a market with fast and slow traders", available on SSRN, 2021. A Moore, A Schrimpf and V Sushko, "Downsized FX markets: causes and implications", BIS Quarterly Review, December, 2016, pp 35–51.