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David Woolcock 15-Jul-2019 14:15:30 12 min read

Is there a case for a shared/utility platform approach in today’s FX market?


I have always been a fan of the concept of a shared platform across banks. Looking at some of the big examples such as SWIFT and CLS, and the shared ownership/consortium concept such as EBS and FXall, you can see how the utility aspect can be put to good use. As the increased automation of FX trading evolves, customers now have a wide range of choices when it comes to execution of trades. Central Limit Order Books (CLOBs) such as Reuters Matching and EBS have spawned single dealer platforms (SDP) and multi-bank platforms (MBPs) alongside anonymous ECN’s, so a wide choice of platforms have become available, suiting all types of market participant’s preferred execution choices. Technology has allowed for aggregation in what remains a fragmented market place and algorithmic techniques are a growing component across a wide spectrum of the market.

Consequently, this has led to the main liquidity provision being concentrated in the hands of a small number of large banks and, latterly, a small number of significant Non-Bank Liquidity Providers have appeared adding to the mix. Some traditional participants in the FX market have already withdrawn and with new regulation and the FX Global Code impacting the market others are looking at their value proposition going forward. All of this has also led to an explosion in data allowing LP’s to access more input data from which to build their pricing with the attendant technology costs this implies. On the flip side, liquidity consumers can utilise new data to benchmark and improve the quality of their trade execution. The use of artificial intelligence and machine learning in trading algorithms has the potential to introduce new market dynamics and increased complexity.   

Against this backdrop, some smaller and medium sized banks are under increased pressure when it comes to liquidity provision to their client base. Many have relied upon recycling liquidity with a “deal and cover” model in which they capture the hard mark up on a trade and offset the risk electronically with a larger liquidity provider through either a platform or aggregator. However, with the speed of trading dramatically increasing coupled with pressure on margins, many have resorted to using “last look” to deploy a “cover and deal” model in which no principal market risk is assumed though settlement and credit risk is present. This phenomenon was noted in a BIS report last year as having moved “primarily to an agency-based model of market-making, and serve mainly as conduits of liquidity between clients and the large FX liquidity providers”. With the FX Global Code calling for better and more transparent disclosure of execution policies, this leaves smaller players using this technique in a difficult position with regards to their client proposition and the disclosure of the capacity in which they act.  

Could all this lead to banks returning to the idea of a shared or utility platform approach that goes beyond just ownership of a common platform such as FXSpotStream, which is a bank owned consortium operating as a market utility. FXSpotStream are reporting volumes up 33% in H1 2019 when compared to the same period during 2018, and claiming to be the fastest growing eFX Service in 2019. This shows, perhaps the efficacy of the consortium model and other examples included FXall before its sale to Thomson Reuters and originally EBS. This consortium approach, however, does not solve the problem for the banks using cover and deal as it requires a consortium of banks who are liquidity providers taking risk on to their own books and with the attendant cost of such activity in today's high-speed fragmented marketplace.  

We have seen the emergence, in very recent times, of a number of shared/utility platforms but these tend to be concentrated in the payments and regulatory reporting spheres with anecdotal evidence pointing to them being highly successful at reducing the per bank costs as a result. Recent announcements from the Nordic bank sector also serve to show the benefits of a common standard and shared cost of a cooperative platform for handling Know Your Customer (KYC) data. From the same region, the savings bank sector has set up a shared platform in the payments sphere. I have not noted any similar developments in the eFX space when it comes to dealing with customers. In the Retail FX Market, we have seen a decided shift in recent decades to a utility platform approach with the development of the MetaQuotes trading platform.   

My own direct experiences include having been involved in two shared/utility-like platforms in the eFX space. The first was involving co-operative banks in Europe over 30 years ago where each bank would contribute their national currency liquidity to a shared pricing platform. As each national co-operative would have tighter spreads in their own currency, the advantage was to be pooled to the benefit of all, resulting in better customer pricing and increasing flows in your own currency. Sorting out cross currency liquidity would have been an interesting technology challenge (given the voice nature of execution) in the late 1980’s if the idea had gone beyond the drawing board!    

The second, almost two decades later, was for a small consortium of banks who pooled liquidity that was then aggregated. Therefore the customer always dealt on the best-aggregated price. However the deal was booked with their main bank and as such the market risk was covered by a back-to-back transaction when needed. Banks discretely posted their hard mark up into the platform, which was added to the aggregated price but not shared between participants. Both these projects offered efficiencies in cost savings to the participating banks (especially if replacing a SDP) and better pricing for customers, and serve as a good illustration as to how a utility approach could lead to a win-win situation for all stakeholders. These days, it would have been a useful tool to show you are treating customers transparently and executing at fair prices. In addition, you would now be able to offer better reporting tools and TCA with the attendant costs shared.  

When I joined Eurobase, we had supplied a savings bank platform that was deployed by a German Landesbank to service their underlying Sparkassen. It included an innovative sales desk hybrid electronic solution and allowed for both “on behalf of” and “in the name of” trading styles, alongside other bespoke features required by the Sparkassen. In the shared platform model, this deployment would be reversed. The savings banks themselves would own the platform and invite Landesbank to supply liquidity directly that would be aggregated where feasible from a credit perspective. The shared platform would allow cover and deal to be deployed in a transparent manner to the benefit of all participants. It would allow customers to benefit from aggregated liquidity while clients dealt with their main account bank/banks. For those preferring voice execution sales desk functionality, it would allow for this in an auditable and compliant manner using the shared platform as a utility or SDP via a white label.  

Such a deployment by a like-minded group of banks in a “utility-as-a-service” model would see the technology deployed in the Cloud as a shared platform mutually operated for the benefit of the bank group themselves, with the utility stakeholders seeing the cost savings/revenue earnings directly accrued to them. Additional services including a payment, regulatory reporting and shared KYC/KYB and AML functionality would further yield savings across the participants. In the payments arena the revised Payment Services Directive (PSD2), which comes into effect in September, could easily and cost effectively be complied with innovative add-on’s from the FinTech world. This efficiency, allowing better margins to be achieved, could be critical in this era of low interest rates.   

Another platform approach was featured in a McKinsey Digital report recently, which posited an era of the platform-based company. In this model, IT is described in the report as “organised around a set of modular “platforms”, run by accountable platform (or product) teams. Each platform consists of a logical cluster of activities and associated technology that delivers on a specific and can therefore be run as a business or “as-a-serviceas technologists say.”  In the report, they cite a leading global bank that created multiple platforms one of which was a payments platform. This platform acted as an internal “payments-as-a-service” business for the rest of the bank. What I found interesting about this concept is that Eurobase has already adapted our own e-Payments platform (covering FX & domestic payments) so it is both outward facing for customers to use and inward facing for other areas of the bank to use. Deployed, this would drastically engender efficiencies across a bank and replace multiple legacy payment architectures by a modern “fit for purpose” single comprehensive payments platform. An inward-looking shared platform approach!!  

In conclusion, structural changes mainly regulatory led are creating opportunities in execution, compliance and data sharing. With cost control high on the agenda, we can see a bright future for shared co-operative platforms. This will likely see an increasing number of grouped participants looking at how they can deploy a utility platform approach going forward which is fully compliant with both regulations and the FX Global Code. The upside being that execution choices will be available to the customer in a robust, fair, liquid, open, and appropriately transparent market utility trading platform.    



David Woolcock

David Woolcock is an independent consultant and Director, Business Consulting at Eurobase. In addition, David is Chair of the Committee for Professionalism at ACI – The Financial Markets Association as well as Vice-Chairing the ACI FX Committee. He is also a member of the Market Practitioners Group for the Bank of International Settlement's FXWG that wrote the FX Global Code.