An exchange (actually the clearing house) provides a critical safety shield – stopping domino effect of credit default. An exchange uses clearing fund to cover any member’s default. No exchange has ever failed to fulfil an execution. An exchange guarantees to deliver on every single execution. In contrast, an interbank broker on either FX or bond market
– doesn’t guarantee anything, doesn’t stand behind any execution
– doesn’t take the opposite side of a trade.
– doesn’t have the same level of control over execution. An exchange controls execution and subsequently informs both market maker and market taker, who must accept the execution. In a fast market, if a limit order gets depleted quickly or is withdrawn amidst heavy trading, exchange order-matcher decides which order to reject. ECN doesn’t do this.
In an ECN context, the trade (and credit relationship) is between exactly 2 parties — market Maker vs market Taker, not the ECN.
If you see a too-good-to-be-true quote and hit it, and the dealer revises it (saw this on TMC too), you probably wish you were on a real exchange. This unfortunate scenario is known as a re-quote or slippage. To the dealer it’s known as last-look. Dealer would explain that “market has moved”, or “inventory depleted since another customer grabbed it before you”.
In practice, a dealer’s automatic execution system also needs to validate counterparty. Does an account exist? Is there credit relationship? Is this account in a blacklist with a checkered history?
In the exchange context, the trade (and credit relationship) is between an exchange member vs the exchange. Both sides have enough capital to commit to the trade. If the trade fails to settle due to either side’s default, it’s a big deal.
Every exchange always has a huge pool of clearing fund which gives it the capacity to take position as the counter-party to every trade. In contrast, an ECN doesn’t have this much capital and won’t take any position.