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In search of FX liquidity

Foreign exchange (FX) is one of the world’s most liquid markets, with around USD 5 trillion exchanged across borders every day.

However, there is a perception in the market that liquidity is on the wane.

This is not necessarily true, according to David Puth, CEO of CLS. Speaking to Euromoney, he said “There is a tendency for market participants to believe that liquidity was better in the past. From what we see at CLS, liquidity appears to be very strong. It is, however, different, with liquidity widely dispersed over a number of different trading venues.”

The pessimism may in part be as a result of the increasing difficulty in defining exactly what liquidity means in the modern market, and measuring it accurately.

This was one of the questions which a recent report on liquidity in the Americas from the Bank of International Settlements (BIS) attempted to address.

Traditional liquidity metrics, such as cost metrics, quantity metrics and trade impact, have their uses, but the report finds that none are a perfect way to measure liquidity in the modern market.

This is important because one thing which is clear is that the modern FX market is becoming increasingly complex, making understanding liquidity more difficult.

The market, like many others, is fragmenting as electrification proliferates the number of trading venues and sell side participants put more emphasis on internalising trades.

Whether this fragmentation is having an impact on traders ability to trade, remains an open question.

The BIS report indicates that fragmentation does appear to be having some impact on liquidity measures, particularly when it comes to periods of market stress.

It gives examples such as the 2016 British EU referendum and flash crashes, where traditional liquidity metrics appear to have been impacted across a number of currency pairs, at least over the short term.

Dan Marcus, CEO of ParFX, points out that sometimes individual metrics don’t always give the full picture. “It may be the case that volumes are down from where they were… [However] on ParFX we do not see evidence of a problem with market depth or the ability for traders, who need to trade, fill orders.”

This is in part because, while technology is driving fragmentation, it is also creating opportunities to aggregate liquidity in more efficient ways.

“Buy-side traders have responded [to FX market fragmentation] by turning to algorithms and taking on more execution risk themselves”, says Pragma’s CEO David Mechner.

Liquidity is the lifeblood of the FX market, it is vital that the market can measure it in a way which gives an accurate representation of what it is like to trade. One solution, suggested by Mechner, is a consolidated tape, much like in equities. Until then, the market should think carefully about the metrics used to measure the market and ensure they are fit for purpose.

Global FX bounces back to over USD 5 trillion in February

February was a tumultuous time for financial markets, with high volatility influenced by the threat of a potential Brexit and ongoing turmoil in the Chinese economy. 

CLS, the global FX settlement utility has released its settlement data for February showing average daily input value was USD 5 trillion up 3.3% from USD 4.84 trillion in January 2016.

Some FX platforms reported a month-on-month decline in daily spot trading volumes. 

Average daily volumes at EBS were USD 102.6 billion in February 2016, down 1% from the January 2016 reading of USD 103.8 billion.

Read the full report in Reuters

CLS monthly settlement figures, January 2014

 

 

Total Input Volumes1 and Values in January 2014:
• The average daily volume submitted to CLS, combining the settlement and aggregation services, was 1,210,588, up 22.4% from 988,674 in December.
• The average daily value submitted to CLS was US$5.29 trillion, up 8.6% from US$4.87 trillion in December.

 

 

 

 

Input volumes are the number of instructions received by CLS on a given day for future settlement. Input instructions are not necessarily settled during the month in which they were submitted.

 

 

Note: CLS reports both sides of an FX transaction. To adjust the average daily value data to equate to the same reporting convention used by the Bank for International Settlements and the semi-annual foreign exchange committee market reports, the gross values should be divided by two.

 

 

In January 2013, CLS recalculated its monthly data, resulting in non-material changes to volume figures by an average of 0.5%. The data above reflects this calculation.