Foreign Exchange Liquidity and Providers

Forex Industry

 

 

High liquidity is crucial for all financial markets and their participants, as it reduces transaction costs and risks. Some studies link a lack of liquidity in a market to financial crises.

The Chase for Liquidity in the Decentralized Forex Market

High liquidity is very important to all the financial markets and their participants.

Liquidity is especially important in all financial markets. The Foreign Exchange market is an OTC (Over-The-Counter) financial market that operates as a vast decentralized network. In this market, many different providers offer the same exchange rate, and there is no single quote at any given time. As a result, quotes for the same currency pair can vary, making the pursuit of high liquidity even more essential.

Liquidity Aggregation

Liquidity aggregation involves gathering orders from multiple sources and routing them to a large executing entity.

A retail aggregator combines small retail trades into larger orders that can be filled by a major market participant. These larger participants have direct access to the extensive liquidity of the ECN network. Retail aggregation benefits every market participant by:

  • Providing access to the best possible spreads at any time

  • Enabling trading with minimal slippage on order execution, especially during news releases

  • Facilitating the easy execution of large order sizes

  • Continuously diversifying order execution risks by using several liquidity sources

Forex brokers can act as retail aggregators, filling their clients’ orders at the best bid-ask prices at the top of the book. Brokers use electronic aggregation services to access sufficient liquidity. The software that combines liquidity from different providers into a single venue is called a Foreign Exchange Aggregator, or FX Aggregator.

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Market Depth

Market liquidity is closely linked to market depth. Market depth measures how much liquidity is available at different price levels and shows the total volume at each level.

Generally, market depth is based on:

  • The number of buyers and sellers
  • The size of buyers and sellers
  • The existence of market makers
  • The participation of institutional traders

 

 

 

The Foreign Exchange Liquidity Providers (LPs)

A Forex liquidity provider (LP) is a participant that buys and sells currencies on behalf of others. Liquidity providers help Forex brokers fill their clients’ orders, while also trading their own accounts. These providers are typically large entities such as investment banks, major brokers, and investment firms.

Tier-1 and Tier-2 Liquidity Providers and ECN/STP Forex Brokers

There are two main types of liquidity providers in the Foreign Exchange market:

(1) Tier-1 Liquidity Providers

Tier-1 liquidity providers include very large banks and organized exchanges such as:

  • UBS, Barclays, and Deutsche Bank

  • CME Group, CBOE, and ICE exchanges

Additionally, some large brokers and investment firms that can trade directly on the ECN network are also considered Tier-1 providers:

  • Forex brokers that trade directly with Tier-1 liquidity are called ECN

  • Forex brokers that connect directly to a large Tier-1 liquidity provider are called DMA

  • Only about 10% of all financial brokers have direct access to Tier-1 liquidity

(2) Tier-2 Liquidity Providers

Tier-2 liquidity providers act as intermediaries between Tier-1 entities and brokers. Examples of Tier-2 providers in the Forex market include:

  • LMAX, FXCM Pro, Swissquote, and Currenex

Forex brokers accessing Tier-2 liquidity are called STP brokers.

Largest Liquidity Providers in the World

Below is a table of some of the largest liquidity providers globally.

  • USA
  • CME Group, Morgan Stanley, Citi Group, CBOE Global Markets
  • JPMorgan, Equinix, Currenex, Goldman Sachs, Merrill Lynch
  • Nasdaq, NYSE, ICE, Bank of America
  • EUROPE
  • Euronext, Deutsche Bank, ABN AMRO Clearing, BNP Paribas
  • Luxembourg Stock Exchange, Societe Generale, TopFx
  • UK
  • Barclays Capital, UK Clearing House, London Stock Exchange
  • LMAX, CMC Markets, FXCM Pro, XTX Markets, Tickmill Prime
  • SWITZERLAND
  • UBS, Credit Suisse, Swissquote, SIX Swiss Exchange (SIX)
  • JAPAN
  • Nomura, MUFG, Mizuho Bank, Tokyo Stock Exchange (TSE)

 

 

 

Key Takeaways

Here are some key takeaways regarding Forex market liquidity:

  • The Foreign Exchange market is an OTC (Over-The-Counter) financial market that operates as a vast decentralized network. In this market, many different providers offer the same exchange rate.
  • Liquidity aggregation involves gathering orders from multiple sources and routing them to a large executing entity.
  • A retail aggregator combines small retail trades into larger orders that can be filled by a major institution with direct access to the ECN network.
  • Liquidity aggregation provides traders with benefits such as narrow spreads and minimal slippage.
  • There are two levels of Forex liquidity providers: Tier-1 and Tier-2. Based on their access to these providers, Forex brokers are classified as ECN, DMA, or STP.
  • The key liquidity indicator is trading volume. High trading volumes reflect an active market with strong liquidity.
  • Market liquidity is linked to market depth, which measures how much liquidity is available at various prices and shows the total volume at each price level.
  • Higher liquidity in a market corresponds to lower risks. Studies have linked a lack of liquidity to financial crises.

 

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