With trading volumes reaching $7.5 trillion daily, the forex market is one of the most liquid financial markets in the world. Its accessibility is growing significantly too in the age of digital transformation, with broker-dealers opening the door to markets by providing fresh avenues for trading. But is a lack of transparency from market makers mitigating the impact of the FX revolution?
Broker-dealers offer invaluable services in providing traders with the ability to execute trades, market insights, fundamental analysis, and even educational content to help shape market strategies.
However, the quality of services offered can be negated by a wider lack of industry transparency which can undermine the value offered by broker-dealers and their bottom line as a result.
According to a recent survey of European fund managers, 82% of respondents claim that they’re experiencing a lack of transparency in forex markets. The issue, which stems from difficulties in comparing market quotes, has formed a correlation with higher forex hedging costs, which impact 84% of European, 75% of UK, and 71% of North American fund managers respectively.
To further add to this correlation, some 73% of UK fund managers reported the same transparency issues–a figure that falls in line with their respective hedging costs.
Navigating a Complex FX Ecosystem
This lack of transparency stems from the level of complexity surrounding the industry as the volume of execution methods and trading platforms have grown and the wider FX ecosystem has become more digital.
In the 21st Century, the rise of electronic multi-dealer platforms created a dealer-to-customer market that allowed clients to submit a request for quote (RFQ) to different counterparties. Since then the trading ecosystem has grown further with the vast majority of trades taking place online.
The digitization of FX markets has resulted in many challenges that can impact the performance of broker-dealers, including:
- Market Segregation: Modern FX trading doesn’t take place on a single exchange, and instead trades are supported by broker-dealers on an over-the-counter basis.
- The Rise of Opacity: Because of this segregation, a lack of available information prevents competitive quotes from helping clients discover the best options for executing trades online.
- Lack of Liquidity: Because segregated exchanges use dominant currencies to leverage trades, markets can become more illiquid in other currencies that could offer more value to traders. This pushes more institutions into extracting more costs for thinly traded currencies.
For broker-dealers, this lack of transparency can push more power into the hands of market makers who can offer market quotes at their own discretion and can make the pursuit of true value throughout the forex landscape more difficult.
The Challenge of Transparency
In a recent European Commission draft proposal to counter issues with transparency by using central bank rates as a benchmark for calculating FX mark-ups, we can see that regulatory intervention could soon help to deliver a fairer ecosystem for broker-dealers.
While the proposal has been dismissed by the European Fintech Association (EFA) over fears that central bank rates don’t offer a practical benchmark for forex rates due to their static nature, it’s fair to look to regulators as prospective problem solvers.
The EFA has advised that payment service providers (PSPs) should disclose currency conversion charges and FX mark-ups as a total cost over an aggregated live mid-market exchange rate that’s delivered in a neutral manner. This aggregated mid-market exchange can stop PSPs from using independent sources for their mark-ups and instead implement a more unified approach to leveraging payments.
Shifting a similarly transparent process for the forex trading landscape could deliver a fair and unified solution for the ecosystem. It could also help to leverage more client trust and stamp out fraudulent activity within the FX landscape.
In a move that holds more direct links to the world of FX trading, a growing number of prime services have committed to delivering their own levels of transparency in areas that suffer from inefficiencies.
Backed by emerging technologies, prime brokers are capable of supplying intuitive TCA and market impact tools, helping to deliver greater alignment and transparency for broker-dealers and their decision-making processes surrounding trade execution workflows.
The Battle to Protect Market Participants
To achieve more market transparency, emerging technologies and refined regulation must unite to protect broker-dealers and other institutions against rogue market quotes.
True protection can empower investors to have full access to fair, transparent, and efficient forex markets that don’t inhibit the actions of its users through opaque quotes and hidden costs.
This will fundamentally rely on ensuring that investors always have access to the necessary information in a timely manner to better anticipate market conditions and emerging trends before they can adversely impact their performance.
In leveling the playing field for quotes, we’ll see an FX ecosystem that’s built on competition and innovation, and filled with firms that are obliged to adopt the best industry standards to support the fair functionality of the market and services offered to institutions and investors alike.
Outlook for a Transparent Future
Now that the forex landscape has become a major digitized industry with many trillions of dollars in trading volume changing hands each day, transparency has never been more essential in supporting its long-term sustainability.
In generating greater levels of trust and compliance, the landscape can support broker-dealers in achieving their respective goals with as little friction as possible.
Trust and transparency are crucial for efficiency across all financial markets, and their support in the FX landscape can help to continue growing the ecosystem as it welcomes more traders and trading volumes alike in the future.
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