Principal trading firms PTFs are some of the heaviest users of prime brokerage services. PTFs employ algorithmic trading strategies and have been active in FX for quite some time. What is new in recent years is that some have built a business model around making markets and thus have deeply penetrated the realm that previously was exclusive to dealers see Schrimpf and Sushko in this issue.

Prime brokered trading now accounts for a large fraction of volumes on platforms that historically catered to interbank trading, such as electronic brokers. The proliferation of alternative ways to conduct trades has been spurred by customers "shopping around" for best execution and by technology providers facing lower costs to set up such platforms. Another trend has been the use of liquidity aggregators that bundle access to different trading venues or liquidity providers Oomen Countering this tendency, FX dealer banks, in turn, have sought to build stronger relationships with their customers.

They have invested heavily in improving the technology and functionality of their proprietary trading platform offerings, known as single-bank platforms. The resulting fragmentation of the FX market has made it harder to assess market conditions at any given point in time. Market participants wishing to trade FX have more than 75 different FX venues at their disposal Sinclair Thus, while the market as a whole grew bigger, the share of trading activity that is "visible" to the broader market declined.

Against this background, the execution methods data collected in the Triennial Survey provide a unique and rare perspective on how the structure of this crucial, yet inherently opaque, market has evolved. The taxonomy used in the Triennial Survey to capture data on execution methods is aligned with the main features of the market structure sketched above.

At the broadest level, it distinguishes between "voice" and "electronic" execution. Within each, it further differentiates between "direct" bilateral and "indirect" brokered trading. This can, for instance, be a traditional voice broker, an electronic broking platform or a multi-bank platform.

The Triennial Survey data on execution methods corroborate the picture of great diversity in trade execution choices. Electronic trading dominates, although voice remains significant in some market segments Graph 2 , left-hand panel and Annex Table A. Electronic trading was roughly equally split between "direct" and "indirect" trading in , whereas "direct" electronic trading had a significantly higher market share three years earlier.

Drilling down further into various forms of electronic trading, direct forms of electronic execution were about equally split between single-bank platforms and other direct forms of electronic trading, such as price streams Graph 2 , right-hand panel. When it comes to indirect electronic trading, "anonymous" venues, where counterparty identities are only revealed post-trade, attracted a slightly higher market share than "disclosed" venues, where counterparties know each other's identity before they decide to trade.

The main trend in FX trade execution has been increased "electronification"- deeper penetration of the market by electronic and automated trading. Electronification comes in a variety of forms, catering to the needs of a diverse set of players fast and slow traders, banks and non-banks etc. It enables automated and continuous trading, bringing together participants with diverse trading interests so that they can more seamlessly adjust and redistribute financial exposures.

Yet the market-wide average masks notable differences across key instruments and market segments. The segment where electronification progressed the fastest was dealer-to-customer transactions Graph 3 , centre panel. This rise also reflects the changing composition of market participants, with financial customers, such as hedge funds and PTFs, and lower-tier banks playing a more active role see Schrimpf and Sushko in this issue.

The dealer-customer segment has arguably also been the place where technological innovation has been the fastest, as witnessed by a greater range of trading venues featuring a diversity of execution protocols. That said, electronic trading in forwards has been catching up at an accelerating pace. Platform trading and prime-brokered access, in turn, have attracted hedge funds and PTFs to trade NDFs electronically.

As a result, inter-dealer trading accounted for less than a third of the total electronic spot market in , 10 percentage points lower than in Graph 4 , left-hand panel. This decline in electronic inter-dealer trading was driven principally by internalisation, whereby dealers temporarily warehouse risk arising from client transactions until it is offset against opposing client flow. This practice, in turn, reduces the need to offload any imbalances in inter-dealer markets.

Data showed dealers reporting in the United Kingdom and the United States had some of the largest declines in electronic trading on anonymous inter-dealer venues Graph 4 , left-hand panel and also posted some of the highest internalisation ratios for spot trades Graph 4 , centre panel. As a consequence, electronic inter-dealer brokerage systems, which have long constituted the main locus of electronic inter-dealer trading, now only account for a small fraction of the entire market.

As Evans and Rime highlight, order book depth on these platforms also declined in tandem. A likely factor has been greater algorithmic trading Graph 4 , right-hand panel , especially by PTFs on a prime brokered basis , which tends to involve greater activity at the top of the order book.

Despite this, these so-called primary venues eg EBS Market and Reuters Refinitiv Matching are still vital for FX market functioning.

Primary venues still serve as an important point of price discovery Markets Committee , and when volatility rises, internalisation becomes more challenging and dealers need these venues to manage inventory imbalances Moore et al More internalisation also means that fewer trades are visible in the broader marketplace, resulting in less information leakage Butz and Oomen It likely led to an increase in "on-us" settlement across the books of the dealers.

It may contribute to a market structure in which concentration begets more concentration: given that dealers with large flows from a diverse set of clients find it easier to internalise and can price more competitively, letting them attract ever greater customer flows. Indeed, the falling share of inter-dealer trading has gone hand-in-hand with a handful of banks coming to dominate FX volumes. The ability of dealers to internalise benefits greatly from electronification and the ability to attract customers to trading via single-bank platforms or direct price streams.

Subdued FX volatility in recent years was also conducive to internalisation. This is because there have been fewer instances of large imbalances in order flow that are difficult to match internally, thus requiring hedging on inter-dealer venues. The Triennial Survey confirms that, despite the overall trend, electronic trading is not progressing uniformly across all instruments and market segments. Most prominently, inter-dealer trading of FX swaps has remained heavily voice-reliant, while dealer-to-customer trading has moved towards greater use of electronic execution methods.

There are several interrelated reasons for voice retaining a higher share in FX swaps. First, swap trades vary greatly in size, with inter-dealer transactions at times involving particularly large notional amounts. Second, FX swaps are more difficult to price, with internal and balance sheet considerations playing a relatively larger role. The largest dealers use internal models to set their prices eg relying on their money market desk and taking funding rates in different currencies as inputs as opposed to sourcing price signals from wholesale venues.

This means that inter-dealer FX swap trading still often relies on intermediation via voice brokers. Third, FX swap trading entails management of credit risk because it involves exchanging principal in two different currencies, at the spot rate at contract inception and at the forward rate at contract maturity.

This risk needs to be managed and allocated across counterparties which, at least so far, still requires some manual processes. By contrast, electronic trading continues to make inroads into dealer-to-customer FX swap trading. When quoting bid or ask prices to customers, dealers can rely on inter-dealer mid-prices as input. Such trading with customers is more amenable to electronification, eg by streaming prices on a single-bank platform or responding to a request-for-quote on a multi-dealer-platform.

The Triennial Survey shows that trading on multi-bank platforms sometimes referred to as "secondary venues" to contrast them with electronic brokers, which are referred to as "primary venues" constitutes the fastest growing execution method over the past three years. Some of these secondary venues operate anonymous limit order books, akin to those on primary venues. Others cater to disclosed forms of electronic trading, where identities are known to the counterparties before they decide to engage in a trade.

This allows some aspects of relationship trading to be retained, while also matching with a broader pool of potential counterparties. The trend towards greater reliance on methods where end users can choose from a range of liquidity providers and various ways to implement the trade is reinforced by increased attention to best execution.

Sophisticated clients increasingly rely on execution algorithms to spread large orders over time and across multiple electronic venues. FX trading has evolved rapidly over recent years.

It has seen further electronification and increasing variety in trading venues and protocols. In spot, FX intermediation has tilted towards non-bank electronic market-makers, who substitute speed for balance sheet. Activity has also gravitated more to dealers' proprietary liquidity pools and away from primary inter-dealer venues.

Clients can use algorithms to enhance execution and navigate a fragmented market, albeit in exchange for taking on more market risk themselves. All these developments have led to more choice for tech-savvy clients, but also to some important risk-shifting and greater market fragmentation. Yet there are signs that fragmentation may be reaching its peak. Some customers are reportedly questioning the cost of connecting to so many venues.

Dealers, too, have been re-assessing whether it is beneficial to quote prices on a large number of third-party systems. For example, a top-tier bank recently announced plans to slash the number of systems it uses, from 45 to Similarly, some PTFs focused on market-making have reportedly also cut down on the number of electronic communication networks where they post prices. Furthermore, the current market configuration has emerged largely during a prolonged period of low volatility, and its resilience might be tested if the volatility regime were to change.

For example, during periods of stress, FX dealers might ration liquidity and favour clients with whom they have a strong relationship, such as those using their single-bank platform. Thus, customers who spread execution across venues could face a sharp evaporation of liquidity. The question of whose risk-bearing capacity to rely on under such circumstances could become a pertinent one. In the event of stress, the resilience of FX markets could be further challenged by the declining use of payment-versus-payment systems to reduce FX settlement risk see box.

The settlement of FX trades can lead to significant risk exposures when one counterparty to a trade sends a currency payment to the other and needs to wait before receiving the currency it is buying. Over the past two decades, market participants have made significant progress in reducing FX settlement risk. The bankruptcy of Bankhaus Herstatt in demonstrated how FX settlement risk can undermine financial stability.

Herstatt was a medium-sized German bank active in FX markets. At CET on 26 June , the German authorities closed the bank down. While Herstatt had already received Deutsche marks from its counterparties, it had not yet made the corresponding US dollar payments in New York.

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We also greatly appreciate the feedback and insightful discussions with numerous market participants at major FX dealer banks, buy-side institutions, electronic market-makers and trading platforms. Basel Committee on Banking Supervision, "Basel Committee discusses policy and supervisory initiatives and approves implementation reports", press release, October The BIS uses, whenever possible, the published USD exchange rates and consumer prices as input to the EER estimates. What's next? In this section:.

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