My name is Laura Lifland, and I have recently joined forces with FX Transparency after spending 15 years as an FX salesperson at large commercial banks.
After meeting with several institutional investors over the last week, there are a few topics that I find of particular interest in today’s landscape that I would encourage all of our clients to contemplate.
The first is the evolution of algorithmic trading. Most banks now offer some form of algorithmic execution in the FX markets, and often provide a suite of strategies ranging from TWAP (Time Weighted Average Price) to active price-driven strategies, and the choice to utilize internal or external liquidity. Among the many value propositions of algorithmic trading is the ability to measure market impact and gain visibility into the execution process; banks generally provide an “execution report” that states inception price, risk transfer price, actual fill as measured against those benchmarks, along with a recap of the individual trades that make up the ultimate fill. For this efficiency and transparency, banks often charge a fee (0.5 to 1bp, perhaps).
The question that comes to my mind is: are all algos created equal? Even a simple TWAP strategy can have varied performance based on the liquidity that the strategy accesses. Does a bank with negligible market share access the same liquidity as a bank with larger market share, and do their TWAP strategies cross the bid-offer more frequently than a bank with a larger pool of internal liquidity?
While execution reports provided by the banks offer a measure of market impact, they are benchmarking solely against themselves (their own price data), and not against a true representation of broader market liquidity.
We would encourage clients to identify algorithmic execution among their trade data so that we can effectively measure the market impact of these strategies, and identify where clients are getting the most value for the fee they are paying to access these platforms.
A second topic of particular relevance in the current environment of declining liquidity is the value of competitive trading as a “best execution” strategy. At FX Transparency, we know from our experience in the markets as well as from our firm’s very robust data set that competing a trade among 4-5 counterparties can have negative impact on price. Traders are not incentivized to win a trade that the rest of the market knows about, and are required to build in a spread that compensates them for the market’s knowledge of their position should they win the trade. It can be debated whether the evolution of “request for stream” vs “request for quote” pricing, and the streamlining of bank’s electronic pricing capabilities, has reduced some of the negative market impact of competitive pricing. It should also be noted, though, that in an environment where liquidity is expensive and banks are evaluating the costs of pricing, processing and settling customer transactions, a competitive model may prove quite costly on a relative basis.
A third and closely related topic is the execution costs that banks themselves are bearing. In a market operating under unprecedented legal and regulatory scrutiny, the incentive to garner maximum client volume is greatly reduced. Banks will continue to carefully evaluate the costs associated with sourcing, executing, processing and settling customer business. Brokerage fees from multi-bank platforms, credit charges, and other inherent costs of doing business will be more closely scrutinized.
In this climate, it is to the benefit of every buy-side market participant to have a clear understanding of what they are paying their FX counterparties. The market is finally coming to terms with the fact that, despite the absence of quantifiable commissions, FX execution is not – and has never been – “free”.
Whether you are handling you FX execution internally, or outsourcing it to a manager, custodian, agency trading desk or prime broker, it is important to quantify what exactly you are paying to your providers, and to know how your execution costs compare to those of your peers. Our analysis is transparent and unbiased, and can be used in discussions with providers about the underlying value of your relationship.
We look forward to helping you explore these and other topics as part of our analysis of your FX transaction costs. Our clients are our only constituents, and we hope that with our independent framework, our high quality data and our unique perspective on the FX markets, we can help you manage costs and enhance performance.