Trading Timing

At the time a trade is made through a broker, the trader does not know the name of the counter party. Subsequently, credit limits are checked, and it may turn out that one dealer bank must refuse a counter party name because of credit limitations. In that event, the broker will seek to arrange a name-switch i.e., look for a mutually acceptable bank to act as intermediary between the two original counter parties.

The broker should not act as principal.

Beginning in 1992, electronic brokerage systems (or automated order-matching systems) have been introduced into the OTC spot market and have gained a large share of some parts of that market.

In these systems, trading is carried out through a network of linked computer terminals among the participating users.To use the system,a trader will key an order into his terminal, indicating the amount of a currency,the price,and an instruction to buy or sell. If the order can be filled from other orders outstanding, and it is the best price available in the system from counter parties acceptable to that trader’s institution, the deal will be made.

A large order may be matched with several small orders.

If a new order cannot be matched with outstanding orders, the new order will be entered into the system, and participants in the system from other banks will have access to it. Another player may accept the order by pressing a “buy”or “sell” button and a transmit button. There are other buttons to press for withdrawing orders and other actions.

Electronic brokering systems now handle a substantial share of trading activity. These systems are especially widely used for small transactions (less than $10 million) in the spot market for the most widely traded currency pairs—but they are used increasingly for larger transactions and in markets other than spot. The introduction of these systems has resulted in greater price transparency and increased efficiency for an important segment of the market.

Quotes on these smaller transactions are fed continuously through the electronic brokering systems and are available to all participating institutions, large and small, which tends to keep broadcast spreads of major market makers very tight. At the same time electronic brokering can reduce incentives for dealers to provide two way liquidity for other market participants. With traders using quotes from electronic brokers as the basis for prices to customers and other dealers, there may be less propensity to act as market maker. Large market makers report
that they have reduced levels of first-line liquidity.

If they need to execute a trade in a single sizable amount, there may be fewer reciprocal counterparties to call on. Thus, market liquidity may be affected in various ways by electronic broking.

Proponents of electronic broking also claim there are benefits from the certainty and clarity of trade execution.For one thing there are clear audit trails, providing back offices with information enabling them to act quickly to reconcile trades or settle differences. Secondly, the electronic systems will match orders only between counter parties that have available credit lines with each other.

This avoids the problem sometimes faced by voice brokers when a dealer cannot accept a counter party he has been matched with, in which case the voice broker will need to arrange a “credit switch,” and wash the credit risk by finding an acceptable institution to act as intermediary.