Platform Diversity and the Evolution of FX

Slide 1

James Sinclair CEO, MarketFactory jsinclair@marketfactory.com Platform Diversity and FX Market EvolutionSlide 2

Today’s Discussion Why is FX Different? Where Have We Been (Recently)? 3. Where are We Going? MarketFactory, Inc. (c) 2011

Slide 3
Why is FX Different?

Slide 4
Less Regulation Nasdaq BATS NYSE Nasdaq OMX PSX CHX CBSX NSX Nasdaq OMX BX NYSE Amex NYSE ARCA EDGX ISE RegNMS: Plus dark pools (<15%) FX ECNs are not constrained and have freedom to differentiate themselves. MarketFactory, Inc. (c) 2011

Slide 5
Platforms are All Different Different : Location(s) Price distribution frequencies Depth of book: and indicators of depth Info about the quotes that make up a price level Tick size Info about deals and amounts done in the market Some have Last Look Upgrades are frequent Different platforms for different currencies, purposes Understanding of each platform required MarketFactory, Inc. (c) 2011

Slide 6
Global and Fungible London $725bn per day Asia $375bn per day New York $400bn per day Chicago $100bn per day MarketFactory, Inc. (c) 2011

Slide 7
And Also… Credit instrument Substantially a principal market Natural interest arises from non-FX activities: Cross-border capital market activity, FDI, trade Doesn’t fall in value (you’re just on the wrong side) MarketFactory, Inc. (c) 2011

Slide 8
Complexities in Equities and FX are Inverted High technology needs vs. high market structure knowledge needs Equities 1million msgs per second Thousands Real-time broadcast Tick by tick – every tick! Thousands / second Centralized markets Heavy – e.g. Reg NMS Standardized NBBO Established; low difficulty Full depth of book None b/c of CCP Order routing from point of order submission Complex Easier Attribute Throughput Symbols MD Frequency Order Submission Fragmentation Regulation Market Structure Price Discovery TCA Transparency Price Filtering Order Routing OTC FX 1 million msg per day 20 pairs; 66% of FX in 6 pairs Real-time custom snapshots Max 100 orders per second Globally fragmented venues Unregulated – isolated venues All non-standard; all bespoke Venue specific Difficult – lack volume info 1-3 levels of depth common Heavy b/c of bilateral credit Complex decision process Complex Easier MarketFactory, Inc. (c) 2011

Slide 9
Where have we been?

Slide 10
Interdealer FX Market in 2011 Interdealer FX Market in 2003 Reu EBS CME DB Structure akin to US treasuries: Interdealer: Brokertec, eSpeed; Customer: Bloomberg, Tradeweb Still similar + GovEX. Prop Shop BoA JPM UBS Dres-dner Citi Prop Shop Prop Shop Prop Shop Prop Shop HS Real Money, Corporates CX FXall CX Integral Execution through ECNs, banks and some funds Not shown: Futures brokers Retail Com-merz FXall Barx MarketFactory, Inc. (c) 2011

Slide 11
Recent Platform Changes Decimals More transparency Faster feeds More ticks More visible depth Faster matching engines More venues NDFs new pairs, new futures contracts New order types MarketFactory, Inc. (c) 2011

Slide 12
So, where are we going?

Slide 13
Decimalization… A Very Well-Rehearsed Story Source: Tick Size Regulation, Intermarket Competition and Sub-Penny Trading. Sabrina Buti, Plus options: SEC Penny Pilot 2007 & Ongoing MarketFactory, Inc. (c) 2011

Slide 14
Message Rates Increase… MarketFactory, Inc. (c) 2011

Slide 15
Spreads Contract… 16ths Decimalization Source: NYSE Factbook NYSE -84%! MarketFactory, Inc. (c) 2011

Slide 16
But Unevenly So Before and after moving to 1/8ths. Source: NYSE, Eighths, Sixteenths. Michael A. Goldstein, Univeristy of Boulder MarketFactory, Inc. (c) 2011

Slide 17
Source: Aite Group Many Orders already at Major FX Platform minimum But: Order Size Falls… in FX it
Cannot MarketFactory, Inc. (c) 2011

Slide 18
Similarly in Options “It wasn’t introduced in a responsible and conservative fashion… Pennies made sense for options that were trading under a dollar. But as you went above that, pennies didn’t make sense. We said there would be a loss of liquidity and that’s exactly what we saw.” [ Not for all options: “…Pennies made sense for options that were trading under a dollar. ..We said there would be a loss of liquidity and that’s exactly what we saw.” Gary Katz, ISE Shrinking size: “With nickel and dime increments, you might have had 1,000 contracts… often [now] you’ll only see 10 or 15 contracts.” Andy Nybo, Tabb Group Volatility: “… In pennies, you move to the next trading increment much more often.” Ed Tilly, CBOE Quoted in Financial Times, November 3, 2010 MarketFactory, Inc. (c) 2011

Slide 19
Pipping in FX: Repeat of Sub-Pennies in Equities Source: Tick Size Regulation, Intermarket Competition and Sub-Penny Trading Fig 1. Sabrina Buti, University of Toronto, et. al. June 1, 2011 MarketFactory, Inc. (c) 2011

Slide 20
Rebate Trading Example: BATS Options pricing $0.50 rebate if you set a new NBBO (in size) $0.20 to $0.40 rebate as maker $0.30 to $0.40 cost as taker See batsoptions.com MarketFactory, Inc. (c) 2011

Slide 21
Rebate Trading Why not in FX today? There is high risk replicating across platforms: Major platforms don’t send tick-by-tick market data High minimum size Tick size still on the larger side If that changes… MarketFactory, Inc. (c) 2011

Slide 22
Rebate Trading

Slide 23
Execution New Venues – But they are additive Liquidity only moves to detriment of venues in smaller markets, e.g. TBAs, TIPS, when venues lack differentiation, e.g. European MTFs, or a change on scale of voice-electronic Block trading – four ways to trade: Transfer risk to a Bank Algorithmic Trading (chop it up) Dark Pools/Order Types (akin Pipeline, ITG Posit, Liquidnet) Shop through a Voice Broker And most significantly… MarketFactory, Inc. (c) 2011

Slide 24
Spot DMA New Participants, More Participants Next Phase of Market Growth Movement in that direction. For example… MarketFactory, Inc. (c) 2011

Slide 25
Enter FCMs Stage Left …

Slide 26
… and Stage Right

Slide 27
Each Model a Little Different …

Slide 28
… Most Provide Margin

Slide 29
Some Provide Access …

Slide 30
And Different Target Markets …

Slide 31
Retail Platforms CitiFX Pro FXCM Pro Gain GTX Alpari Direct Pro Saxo Others… MarketFactory, Inc. (c) 2011

Slide 32
In Summary If major platforms reduce minimum size: Tighter spreads in liquid ccys Higher message rates If market goes tick-by-tick: Rebate Trading And Waiting Like a Coiled Spring… DMA in Spot Dark Pools Algos MarketFactory, Inc. (c) 2011

Source: Forex Network