Earlier this year, credit optimization specialist CobaltFX announced that BNP Paribas and NatWest had started using its technology to manage credit exposures for FX trades on interbank trading venues.
According to a report produced by the Global Financial Markets Association’s global foreign exchange division in June, broader adoption of dynamic credit solutions would enhance the FX market structure for the benefit of all institutional market participants by facilitating increased trading opportunities and meeting client demand when and where it is needed most.
By simplifying and streamlining the allocation of credit for FX transactions between banks, CobaltFX believes it can improve access to liquidity and capitalize on a trend of financial institutions optimizing the disbursement of credit for FX trades to improve market access and control.
As Joe Nash, digital COO of global macro at BNP Paribas, observes, improvements to the manual process of updating credit limits with interbank trading venues are badly needed, and aggregating IT infrastructure across multiple venues gives banks the ability to proactively manage credit exposure.
Automation
The allocation of credit for FX transactions between banks has experienced varying degrees of automation in recent years, influenced by a number of factors, including the technological capabilities of the bank, regulatory requirements, risk management strategies, and the use of advanced tools and platforms.
Banks use automated algorithms and systems to monitor exposure, credit limits and overall risk associated with FX transactions, while application programming interfaces (APIs) and electronic trading platforms have facilitated automation in various aspects of FX trading, including credit allocation.
In an almost perfectly functioning liquidity landscape such as the FX market, we tend to forget that liquidity is still credit
Fatih Atalay, Swissquote
“Some banks have ventured into artificial intelligence to optimize credit allocation by analysing historical data, market conditions and customer behaviour,” says Thomas Friesleben, managing director, StoneX Pro EMEA. “The potential of distributed-ledger technology to streamline FX transactions and credit allocation has also been explored, although implementation and usage require further improvement.”
In this context, he believes increasing the efficiency of credit payments for FX trades can lead to favourable outcomes for market liquidity.
“Credit allocation can positively influence market liquidity in several vital aspects, such as counterparty risk,” says Friesleben. “Effective credit allocation mitigates the risk associated with counterparties, incentivising market players to participate in trading.”
A liquid FX market with well-managed credit allocation becomes a more attractive destination for a broader range of participants, including institutional investors and FX market makers. It also helps prevent excessive leverage and risk build-up, reducing the likelihood of abrupt market disruptions or crashes that are counter-productive to sustained liquidity.
Reacting in a timely manner to markets and macro events through real-time surveillance is an undeniable benefit for everyone
Thomas Friesleben, StoneX Pro EMEA
Efficient credit allocation allows price discovery to be more accurate and timely, reducing transaction costs and ensuring more equitable distribution of risk among participants. It also contributes to narrower bid-ask spreads and reduced slippage.
“The relationship between credit allocation and market liquidity is multifaceted and can be influenced by various factors, including market conditions, regulatory dynamics and macroeconomic events,” acknowledges Friesleben. “Nevertheless, as a general principle, efficient credit allocation mechanisms that reduce counterparty risk and facilitate smooth trading exert a positive influence.”
Fatih Atalay, head of eFX and FX trading at Swissquote, agrees that optimal disbursement of credit for FX trades has positive implications for market liquidity.
“In an almost perfectly functioning liquidity landscape such as the FX market, we tend to forget that liquidity is still credit,” he says. “Sure, banks and non-banks can produce liquidity much easier than they could two decades ago thanks to internalization expertise and technology, but without the fluidity of liquidity the market would not absorb risk transfers in as orderly a fashion as it does today.”
Information
As to what extent market access and control can be improved through automated credit allocation, Atalay observes that credit risk is not only about the probability of a loss event – it is also about the accuracy, frequency and immediate availability of such information.
“A credit giver that has an immediate and accurate overview of its credit portfolio will operate more profitably, and that will turn into additional credit for the market,” he adds.
Automation enables rapid credit checks – including approvals – facilitating speedy trade executions. Regulatory compliance and advanced risk management also benefit from automated credit allocations as they can be incorporated into the respective systems, resulting in more accurate screening of risks and exposure limits, and better credit decisions.
“Reacting in a timely manner to markets and macro events through real-time surveillance is an undeniable benefit for everyone participating in the FX markets,” concludes Friesleben. “This will facilitate reduced credit exposures, strengthening risk management and overall controls.”
