Winds of change blow through FX risk management

By:
Paul Golden
Published on:

Market volatility has impacted FX risk-management processes, although differing approaches to technology investment means the effect on market participants has been uneven.

Earlier this month, Thomson Reuters announced a number of changes to its bank-to-customer e-commerce platform, including the integration of its multi-bank platform FXall.

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  Changes in technology and access to credit have fuelled a huge increase in the number of participants in the FX market

Peter Plester,
Saxo Bank

Jim Kwiatkowski, global head of transactional sales at Thomson Reuters, refers to reduced liquidity limiting some participants’ ability to access the market to react to risk.

"Greater use of electronic trading and, in particular, electronic options trading suggests that FX participants are taking risk very seriously and looking to take advantage of the reporting mechanisms that electronic trading brings," he says.

The upheaval that followed the removal of the Swiss franc cap forced a rethink of volatility parameters, while the decrease in bank participation as a consequence of Basel III requirements has made FX risk management more challenging.

That is the view of Aite Group senior consultant Javier Paz, who says vendors and venues have responded by providing solutions that tie into corporate back-ends and reduce the need to use and maintain spreadsheet-based models.

Saxo Bank’s FX prime brokerage offering is a good example of a different approach to risk management. FX prime brokerage risk was traditionally managed on a post-trade basis – introducing pre-trade credit risk control applications made it possible to reduce the risk of over-allocation of credit, explains Peter Plester, the bank’s head of FX prime brokerage.

"Changes in technology and access to credit have fuelled a huge increase in the number of participants in the FX market," he says. "Clients could be trading in up to 30 venues, so the use of pre-trade risk controls acts as a risk detector.

"If a customer loses a lot of money very quickly, the risk needs to be reduced as quickly as possible and this is much harder in a post-trade risk-management environment."

According to Kieran Fitzpatrick, CEO at Barracuda FX, there is group of lead banks where automation and risk-handing is already integrated into their core business. He suggests there is a lag between these banks and those who are still getting to grips with technology that can provide real-time visibility of their consolidated risk before an event.

"For resting orders or more sophisticated products such as NDFs, a lot of the technology currently in place doesn’t have the functionality to track these orders, which are still collected on spreadsheets," says Fitzpatrick.

Many FX market participants cannot afford 
the latest risk-management tools

Henry Wilkes,  FX consultant

Tod Van Name, global head of FX and commodities electronic trading at Bloomberg, reckons the dramatic increase in reporting requirements, starting with Dodd-Frank and now EMIR, will force many firms to upgrade systems or rely on execution platforms or third-party providers.

Firms are further constrained by data silos that make compliance expensive and difficult, according to Gary Wright, CEO at BISS Research, who believes that only regulatory pressure will prompt them to upgrade their infrastructure and warns that investment in better reporting mechanisms will only mask the difficulties created by non-integrated data.

Sean De Souza, principal consultant at Capco, agrees there is a need for a move away from siloed practices, which fail to capture the true nature of an exposure across multiple asset classes.

"Banks are facing a difficult choice when prioritizing technology spend, given the competition from mandatory, regulatory-driven change from EMIR and Mifid II," he says.

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Jim Kwiatkowski,
Thomson Reuters

"Flexible tools enable front-office teams to respond to market-risk requests in a more timely fashion than specifying and delivering a more permanent reporting solution, but this ability to satisfy ad hoc requests means that there sometimes appears to be less urgency to develop a proper system."

FX consultant Henry Wilkes refers to a need for real-time data and information for more timely mark-to-market techniques.

"However, many FX market participants cannot afford the latest risk-management tools or struggle to implement adequate systems and processes, which are often only updated retrospectively in reaction to a crisis," he says.

"There probably is a tendency to accept non-state-of-the-art methods and systems as a result of lack of resources."

Wilkes advocates a targeted and cohesive approach to improving reporting mechanisms, rather than forcing all participants to adopt the same reporting standards. "Reporting is only useful if there is an ability to analyse the data efficiently and for a constructive purpose," he says.

However, this does not mean the end of FX data collection on spreadsheets, with the forwards and options markets still less electronically based.

"Spreadsheets are widely used in these markets and I cannot see that changing in the near future," concludes Saxo’s Plester.