FX Best Execution PracticesImproving Price Discovery in Foreign Exchange

Getting the most accurate price information in the FX market is about one thing: currency pair specifics. In other words, the best source for price discovery in a USDJPY spot trade is not the same as a USDZAR spot trade.

That’s not to say using one source like Reuters, for example, is not valuable – it is. However, as the responsibilities of fiduciaries move toward the application of best execution standards in FX, buy-side traders are expected to know more about the nuances of each currency pair they deal. After all, this pair-specific knowledge can meaningfully improve execution quality and lower FX transaction costs.

Let us examine a USDJPY spot trade. On Reuters, the ticker “USDJPY=” might give a bid/ask indication of 83.40 – 83.42. This is good information, but knowing exactly where the ask price is in the interbank market means the buy-side trader needs to know that USDJPY trades predominately on EBS. The ticker “USDJPY=EBS” on Reuters is showing 83.40 – 83.41. Armed with that information, the buy-side FX trader has additional leverage to demand the 83.41 ask price. Had the trader only looked at the “USDJPY=” ticker, he likely would have agreed to a deal at 83.42, resulting in inferior execution based on less than all the available price discovery information.

It is important to note that most buy-side FX traders are typically tasked with best execution responsibilities for many more currencies than their sell-side counterparts are. Additionally, many buy-side traders are asked to trade FX in addition to their primary asset class – equities or fixed income.

On the other hand, the market-making bank on the other side of the spot USDJPY trade probably has one trader that specializes only in USDJPY spot and JPY spot crosses. Furthermore, the buy-side trader is responsible for getting best execution on the FX swap points if the trade is to be settled on a value date other than spot (which is very common). The sell-side typically has an entirely separate group of traders responsible for making markets in FX swap points. The potential mismatch of information can be overwhelming if steps are not taken to keep current with all the nuances surrounding each currency pair.

The USDJPY spot example is just of one of many. For example, USDNOK does trade actively in the interbank spot market (EURNOK is the interbank liquidity source for spot NOK and should be crossed with EURUSD to get the interbank price).

FX Transparency’s execution consulting service can provide a customized solution to fit the needs of your desk and bolster your best execution strategies in currency space.