§ 2 The Market Structure

2.1 FX Trading Platforms' Evolution

Although foreign exchange trading could be sourced back to ancient Babylon，globalized FX trading officially started in 80's last century when Britain moved away from fixed exchange rate releasing capital control.Floating exchange rate arrangement and capital control release gave rise to current foreign exchange trading.

Trading practices have changed dramatically over recent decades as electronification advanced the fastest in FX trading.Telephone lines used to be employed in FX trading last century have now largely been replaced by electronic trading platforms and traders were gaining access to faster and more transparent transactions according to the 2019 survey of Banking of International Settlement in Figure 2-6.The relative shares of voice and electronic execution in the FX market have not changed since 2019，and around 60％ of trades continue to be executed electronically.

Since late 1980s the electronic trading platforms have transformed FX trading practices.Starting from inter-bank wholesale market，this advanced trading methods eventually reached the retail market in the 1990s.Electronic Communication Network brokers such as Reuters，EBS，FastMatch are the brokerages in FX.Reuters has been the leading force in FX trading practices evolution.It first launched a system for bilateral trades between dealers replacing telephone conversations with typed messages.Reuters then offered a computer page called FXFX which provides dealers’indicative quotes for liquid currencies in real time.Thomson Reuters Matching，introduced in 1992 pioneered the electronic limit-order market to foreign exchange.One year later，in 1993，other banks were forced to form a consortium and brought the Electronic Broking Service（EBS）to compete with Reuters.In 2002，Continuous Linked Settlement was constructed.By settling both legs of every trade simultaneously and multilateral netting，this electronic trading system has soon become an integral part of FX market.

Foreign exchange dealing has become steadily more concentrated among a handful of powerful dealers due to the network externalities.The trading volume in foreign exchange has been growing while the number of dealers doing large-scale foreign exchange trading has been shrinking.Meanwhile，trading platforms survived from competition have gained speciality in some specific currencies.For example，Reuters dominates currencies of Commonwealth of Nations and the Scandinavian currencies，while EBS provides better liquidity for the EUR，JPY，and CHF.

Although the voice brokers and direct interdealer trading through telephone gave way to electronic trading platforms in the liquid currencies，some emerging-market currencies that are relatively not liquid are traded by telephone lines.Voice brokers have not been completely mopped up yet.In fact，the electronic brokers may have encouraged more speculative trading.They were said to be liable for the 2015 market turmoil mentioned in last section when the Swiss National Bank's（SNB）eliminated the lower bound on the EUR/CHF exchange rate on 15th Jan.2015.Nowadays，voice brokers are also used for sophisticated foreign exchange derivative trading.

As the development of electronic trading has materially altered the nature of the inter-bank market，intensified competition invited an explosion of new electronic trading platforms targeting the retail market.Since middle of 1990s，more and more individual traders were able to take part in FX trading as non-bank firms began a more momentous shift in FX market.FX Connect，the electronic platform launched by the global custodian State Street in 1996，provided electronic trading for end-customers.By the end of last centenary，electronic trading platforms such as Currenex，Hotspot FX，Lava were mushroomed.Major banks responded to competition from these new entrants by offering new system and acquiring independent platforms.More multibank trading systems for end-customers were available.Even the famous inter-bank brokers，Thomson Reuters Matching and EBS，were opened for customers via prime brokerage.

2.2 Electronic Communications Networks（ECNs）for Individual Traders

Market makers usually trade either by dealing directly with each other or trading through electronic communications network brokers.Individual traders take part in the foreign exchange trading through two types of brokers：markets makers and electronic communications networks（ECNs）.One retail trader can easily collect information，charting software and news feeds，through the user-friendly trading platforms provided by market makers.

When a dealer puts a price at a foreign exchange broker or via some internet trading platforms，it is called brokered dealing.Like a silent auction，the buyers and sellers in a brokered dealing are unaware of each other's identity until the deal is done，and the trading process may not be accepted if the price offered is not satisfying.

The vast majority of interbank trades flows over Electronic Broking Service（EBS）and Thomson Reuters Forex Capital Markets（FXCM）platforms.They are main electronic communications network brokers.

ECNs pass on prices from multiple market participants，such as banks and market makers，as well as other traders，and display the best quotes on their trading platforms based on these prices.ECN-type brokers also serve as counterparties to FX transactions，but they operate on a settlement，rather than pricing basis.Unlike fixed spreads，which are offered by some market makers，spreads of currency pairs vary on ECNs，depending on the pair's trading activities.During very active trading periods，there can be no ECN spread at all，particularly in very liquid currency pairs such as the majors（EUR/USD，USD/JPY，GBP /USD and USD/CHF）and some currency crosses.

Electronic networks make money by charging customers a fixed commission for each transaction.Authentic ECNs do not play any role in making or setting prices，therefore，the risks of price manipulation are reduced for retail traders.

There are two main types of ECNs：retail and institutional.Institutional ECNs relay the best bid /ask from many institutional market makers such as banks，to other banks and institutions such as hedge funds or large corporations.Retail ECNs，on the other hand，offer quotes from a few banks and other traders on the ECN to the retail trader.

1） Electronic Broking System （ EBS ）

EBS BrokerTec is a market-leading e-trading technology and solutions web-based provider.It is part of Inter Capital（ICAP），a leading markets operator.ICAP has a long history of excellence in broking foreign exchange and is well established as one of the leading global brokers for spot foreign exchange.A daily average spot trade of 82.3 billion dollar was recorded on EBS in Apr.2016.On 1st Feb.2017，EBS BrokerTec enhanced its EBS Live Ultra data feed，providing spot foreign exchange data at 5 millisecond intervals and launching the fastest FX live streaming data feed available from a primary FX market venue.In 2008，China's state news agency，Xinhua，integrated ICAP's global market data into its financial service platform.This collaboration gave birth to CFETS-NEX.（www.cfets-nex.com.cn）

2） Thomson Reuters （ including matching and FXall ）

As the competitor to EBS，Thomson Reuters gained the champion in 2016 with daily average spot trade of 97 billion dollar recorded in Apr.2016.Founded in 1851，Thomson Reuters has been at the forefront of a thriving and dynamic FX marketplace.In foreign exchange market，Thomson Reuters created the first community（Thomson Reuters Dealing），the first video terminal for trading currencies，and the first global electronic matching service.In 2014，a foreign trade desktop was launched to deliver the value of all FX offering to the global professional community，for all stages of the trading life cycle and featuring single sign-on with FXall Treasury Center，Electronic Trading and Thomson Reuters Eikon ^TM .In addition to the FX Trading desktop，Electronic Trading was introduced to provide banks with a FX rate engine and white-labele-commerce capability.

Nowadays，there are various brokers for individual traders to choose.The following table gives some suggestions.

2.3 FX Market Structure

1） Market Makers

To simplify analysis，the participants of foreign exchange market could be classified into two tiers：the interbank or wholesale market，and the client or retail market.Those large banks in Table 2-1 form the wholesale market（interbank market），where most foreign exchange trading activities take place.Since large transactions may affect the prices，the basic prices in foreign exchange market are determined in wholesale market，where market makers in the major money center banks around the world deal in two-way prices for both buying and selling.Table 2-1 proves that the interbank market is an exclusive club of large banks，and that their expectations and actions are decisive on day-to-day exchange rate movements，thus they are called market makers.Market makers deal with each other，they keep the market liquid and help keep the prices announced from diverging greatly.Market makers“make” or set both the selling and the buying prices on their systems and display them publicly on their quote screens.They stand prepared to make transactions at these prices with their customers.Because the foreign exchange market is a continuous auction market，buy and sell orders do not match at all points in time，market makers enable the immediate execution of orders from ultimate traders by willing to take the other side of the transaction，they therefore provide liquidity to the foreign exchange market.

There are usually more than one market maker in foreign exchange market，all of whom simultaneously announce buying and selling prices，the same underlying currency trades may take place at different exchange rates.As the technology develops and as the stiff competition between numerous market makers，this exchange rate difference is narrowed down squishing out any possible arbitrage opportunity.Still，there normally exits a dispersion of buying and selling prices throughout the foreign exchange market，hence no“overall equilibrium” prevailing in foreign exchange market.

2） Participants diversified and market structure

Long characterized by a two-tier structure，electronification in FX market advanced most rapidly in dealer-to-customer trading.Financial innovations brought many trading venues and more choices in FX trade execution.With more non-bank financial institutions such as prime brokerage offering inter-mediation functions，FX market structure has become quite fragmented.Many principal trading firms were established.By employing the prime brokerage services，these principal trading firms have made their stand in the realm that previously was exclusive to inter-banks.Different FX venues are available for a diverse set of market participants with diverse trading interests.The changing composition of market participants contributed a fast growth of tier 2.

When FX trading be fragmented across many venues，the structure of FX market became multilayered as shown in Figure 2-7.Execution methods are now classified into two types：direct trading and indirect trading.Direct trading is dealt with a chatting system，via a proprietary single-bank platform，or a direct electronic price stream.Indirect trading involves a third party for matching.It could be a traditional voice broker，an electronic broker platform or a multi-bank platform.