For years, the concept of “best execution” in the currency market has been a low priority among many investors. The primary reason is that OTC FX was not considered a “security,” so technically the best execution language in Reg NMS did not apply.

Today, the winds of change are upon OTC currency trading, and many investors are scrambling to put a best-execution framework in place to cover their foreign exchange transactions. Currently, some firms’ best-execution strategy for FX mirrors what they do in U.S. equities. It is a good starting point, but it’s not a perfect solution. There are many interpretations of what exactly “best execution” means, but the most common attribute of the different definitions is a focus on best price. For most firms, price is and will always be the most critical piece of the best-execution process.

Of course, there are substantial structural differences between currency and equity markets. And there are other considerations in the best-execution framework as well, such as speed, likelihood of execution, probability of settlement and other issues relevant to the investment process.

Today, all of these factors combine to demand a detailed approach to best execution in currency trading.

The FX Knowledge Blog will, over the course of four additional blog posts, focus on competitive pricing. This is the most relevant factor, where investors have the most to gain or lose, if they choose not to understand and better manage their FX costs.

As mentioned before, there are many and varied distinctions between currency and equity markets. The most important difference (when considering the best-execution framework) is that FX is a principal market. This means that executing brokers are buying when you are selling; therefore, they have economic incentive to give you the worst price you will accept. Because of this, there are strategies that may appear unnecessary to someone coming from an agency or exchange-traded market background but should be part of the best execution process.

After examining the best execution framework in equities and applying FX domain knowledge, there are four practices that should be established, which we will cover in the future FX Transparency posts:

FX TCA (Transaction Cost Analysis)
Price Discovery Process
Multiple Bank Relationships
Education (Sell-Side FX Knowledge)

Transaction Cost Analysis (TCA) has been the least common denominator across the best execution framework in equities for decades. Do you know how much are you paying to execute, and are you executing at competitive prices relative to your peers? These questions can now be answered in FX, even though there are still market participants that would prefer these not to be measured or analyzed.

Price Discovery Process

This may sound a little funny to those coming from the exchange-traded world, but most of the bids and offers you see on the Reuters and Bloomberg screens are typically indications—not prices you can actually trade on at that moment in time, although they are usually in the ballpark.

But being in the ballpark just isn’t good enough anymore.

For instance, when trading Brazilian Real (BRL) are you using “BRL=” on Reuters or BRL Curncy on Bloomberg? Are those the best tickers and what exactly do they represent? Is “BRL BMF2 Curncy” the best source of pricing information right now? (it is, by the way…) The prices on FXall are tradable, but are they competitive?

In addition, firms need to understand that all these prices and indications are for spot value only, and often may not be the value date you require. Where do you look for price discovery on FX Forwards and what are the proper day counts to interpolate? All of these variables shape the price-discovery process.

Simply put: The more information you have, the better your execution process.

Multiple Bank Relationships

The ability to compete trades is crucial to best execution. Having access to multiple banks will also improve liquidity and diversify credit risk.

Education: How to Battle the Hidden Markup

Due to the lack of regulation in OTC currency trading, hidden markups to FX trades are the norm, rather than the exception. To envision the scope of this challenge, think about every instance you execute for a value date other than spot, which instantly moves the trade into the world of interest rate derivatives.

So, for example, did you know the spot value date for NZD changes in the middle of the New York trading day? How about setting the spot rate on an FX Swap: If you are buying AUD vs. USD for spot value and selling AUD six months forward, if the spot rate is set below the market then is that to your advantage, disadvantage or does it not matter? (it is to your advantage by the way…) And if you are going to trade FX options, should you always exchange delta? These are just the tip of the iceberg for hidden markups in OTC FX Trading.


There will be four more postings in the FX Knowledge Blog on the subject of FX best execution. Each one will go into detail on the subjects mentioned above: FX TCA, Price Discovery Process, Multiple Bank Relationships and Education. Be sure to subscribe to our RSS feed so that you will not to miss the next post.