What’s so great about internalising FX flows?

In a recent article called separating the men from the boys in global FX I touched on internalisation of FX flow. I’ve had a lot of feedback on this, and I think it’s worth looking in more detail at why this is so important to banks that are building an eFX business.

By internalising flows, banks seek to internally match (uncorrelated) flows originating from clients, branches, internal prop desks, and market making hedge positions. Previously such positions would either have been auto hedged through an external venue, left as residual market maker risk positions, or dealt on another platform (lost business).

For banks with large international branch networks, it’s not uncommon to find high volumes of low value commercial transactions ‘leaking’ out to competitor bank platforms. But, by funnelling such trades through to the internal matching engine, banks can plug the leaks, and provide better services to internal branches or external clients.

At the other end of the spectrum, for banks servicing clients seeking to execute high value trades, such internalisation enables these trades to be executed with very little if any market impact, meaning that clients get ‘their amount’ done, with minimal market impact and information leakage, and less residual market making risk to the bank.

Recent comments from Barclays Capital in Euromoney support this view by stating that up to 80% of their FX spot business is now transacted on their own BARX platform, and that they manage to internalise a huge proportion of that flow.

As I see it, the benefits to the bank of internalising FX flows are:

• Higher profits through capturing a greater proportion of the bid-ask spread on FX flows
• Lower brokerage costs, and reduced reliance on external liquidity pools
• Deeper more consistent liquidity available to clients even in volatile conditions

Seems like internalising flows is a win-win, and can quickly become a virtuous circle, where order flow and liquidity begat more liquidity, creating a reliable and deeper pool of internal liquidity, which the bank can offer out to clients.

As always, the catch is in execution. It’s not easy to set up the infrastructure to support such internalisation, which takes me back to my previous blog title, separating the men from the boys!