FX investors opt for technology fix to FX benchmark probe
The regulatory probe into allegations that traders have colluded to manipulate the $5.3-trillion-a-day foreign exchange market has some way to run, but some investors are pre-empting the results with technologies they say will help them reduce their reliance on industry benchmarks.
The FX buyside community has accelerated its uptake of technologies in recent months, including execution management systems and transaction cost analysis (TCA), analysts say, in a move that will help ensure and show they are trading at the best possible price.
Rather than submitting orders to brokers ahead of the WM/Reuters 4pm fix, and relying on traders to run transactions around the one-minute fixing window, funds can either trade electronically exactly at the fix, or run strategies that ensure best execution over a period of time.
“The 4pm fix is still very useful as most funds are benchmarked against it for valuation, so it is a performance neutral way of effecting a cross-currency asset allocation,” says Lee Sanders, TSF head of execution FX/MM and UK and Asia FI at Axa Investment Managers.
"We have moved to an execution system which gives us control of the execution process, and allows us to analyze where we can make improvements. We still need the fix, however we can use the execution management system to execute at the time of the fix with hopefully enough liquidity to replace the fix if needed, given the sensitivity around it at the moment."
Around three quarters of buyside respondents to a recent Aite Group survey say they currently use an EMS, while an increasing number of FX market participants use TCA to develop execution strategies that can be monitored and modified to meet best-execution objectives.
These include pre-trade and intraday analytic tools to monitor liquidity and the market impact of FX orders, a function known as execution quality analysis (EQA). EQA collates historical data on specific currency pairs and then measures liquidity in the market to find where it’s deepest, and therefore where bid-offer spreads are tightest.
Change of strategy
“Some funds have developed EQA, but still use the WMR Fix as the benchmark for these processes and to eliminate tracking error in their funds that have unhedged FX risk,” says London-based David Woolcock, chair of the ACI committee for professionalism and vice-chair of the ACIFXC.
“However, given anecdotal evidence of a fall in recent volumes transacted at the fix, the presumption is that market participants have changed their execution strategy, especially for large orders.”
One route into the market for large orders that evades the 4pm fix is the use of algorithmically executed orders (algos), operating under names such as Sniper and Gorilla, which obtain a time-weighted average rate over a longer period, enabling investors to execute large orders without significant market impact. Axa IM accesses bank algos through its Trading Screen EMS, says Sanders.
“The EMS allows us to connect to any algo that we choose,” he says. “The EMS also gives us a lot of flexibility as to the type of order we want to send and the venue.
“We can also use the algo to execute in a way that reflects a particular investment driver,” Sanders says. “If we want to be aggressive, we can keep lifting the offers, or we can be passive and sit back and be the offer or the bid. On the other hand, if it’s one minute before an economic release, we could go all out with a big order, if we thought it was appropriate to do so”.
Axa currently executes around 75% of its tickets electronically, and the remainder by voice, which accounts for 40% of volumes. The firm is considering developing its own algos, a move that would place it outside the majority of buyside players, who rely on broker-provided solutions, according to Aite Group.
Still, TCA is no panacea, and in its survey FX transaction cost analysis providers: Brave new world, published in early May, Aite Group points that some EMS and OMS systems are not sufficiently adapted to incorporate data from TCA.
“Instructions such as a limit price or type of algorithmic strategy for a specific order are not always incorporated in certain systems and this can make TCA data less effective,” says the report. “Unfortunately, upgrading these systems is a costly affair; this means that only those large firms with a significant IT budget can undertake such upgrades.”
In any event, the continuing investigations into market rigging suggest demand for algorithmic solutions and deep analysis of trading costs is likely to continue rising.
“Through the tools available, asset managers should be able to show their investors with some certainty whether the Fix is the best choice of execution,” says the ACI’s Woolcock, “Alternatively they may find they are better off using the using the audited, ring-fenced and totally transparent alternatives that algorithmic execution offers.”