by David Wigan
The hammer-blow fines, coming in the wake of wide-ranging recommendations from the Financial Stability Board (FSB) in September, have piled the pressure on business heads to fix order management systems (OMS), controversial pricing models and controls around the 4pm WM/Reuters fixing. And third-party vendors are poised to take advantage.
The WM fixings, which help asset managers and investors benchmark their foreign-exchange exposures, were in the eyes of many FX market insiders an accident waiting to happen, because of the way in which they were managed.
Conventional OMS, while capable of handling normal flow in the $5 trillion-a-day FX market, are ill-equipped to process the avalanche of data coming into banks in the minutes around the 4pm fix, technologists say.
“Fixes come in from a variety of sources and trading venues across a multiplicity of channels, and banks have to aggregate all that data and build a global view of risk,” says Kieran Fitzpatrick, CEO of Dublin-based Barracuda FX, which provides FX risk-management and trading software to banks.
“All this data tends to come in just before the fix and it has been the case that banks standing OMS capabilities don’t handle that kind of flow very well, and they have resorted to making do and manual processes for the fix, which clearly is sub-optimal and opaque.”
Adds another CEO of a European software company specializing in FX trade processing: “Let’s say that we have been having plenty of conversations. There is a clear opportunity for technology providers to help banks to bring more transparency to their processes.”
Challenges with banks’ existing systems were recognized by the FSB in a report published at the end of September, in which the body recommended the adoption of independent netting and execution facilities for fix orders, alongside a change in pricing protocols, better record keeping and order trails, and more transparency around pricing.
The transparency issue is a particular concern because fixing orders are traditionally executed at the mid-market rate. The problem for banks in that scenario is that it is not clear how they make a return on the transaction. Instead, the FSB recommends banks should expressly charge a spread for fixing transactions or a mid-price alongside a direct fee.
“Again, advanced order management systems are equipped to offer the functionality to implement these types of charging structures and to create audit trails,” says Barracuda’s Fitzpatrick.
Barclays in August was the first bank to have moved to charging other banks for executing benchmark orders, according to website LeapRate, and over recent weeks rival banks have started to follow, sources say. Barclays declined to comment.
A key element of the FSB recommendations is increased oversight of the fix process and companies such as Darmstadt-based Software AG and London-based Proven Legal Technologies (PLT) are among firms to offer software that can help compliance personnel monitor traders and their communications to identify manipulation and suspicious behaviour.
“Regulated banks must record all of their electronic communications, but rarely does anybody take the trouble to delve into those communications and see what is there,” says Phil Beckett, a partner at PLT.
“Often the traders are not hiding their activities with code words, but the communications must be analysed for those abuses to be found, and that requires the use of algorithms to identify key words or identify concepts being discussed.”
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Another firm leveraging demand for increased oversight is New York-based Smarsh, which offers tools for e-discovery.
“We will capture archive and monitor electronic communications including email, social media and text messages, and then have policy-management tools looking for problematic situations including compliance issues,” says Smarsh CEO Steve Marsh.
“Some banks are already doing this, but not to the extent they need to, and there is a pattern of banks discovering communications after the event that should have been discovered at the time.”
Away from compliance, some technology firms are focusing on the WM fix itself, and encouraging market participants to adopt alternatives.
“The impact of the recent episode is that the market has woken up to the existence of alternatives to the WM fix for the purposes of evaluating risk,” says James Singleton, CEO of New-York-based Cürex.
“The Cürex benchmarks, which are executable 24/5 and published by FTSE, provide an alternative through the power of the Cürex FX matching engine, which generates streaming FX fixing data that can be used as benchmarks by market participants.”
One of the most far-reaching impacts of the FX scandal is that banks must pay more attention to control and visibility of order trails, and in the longer term many in the industry predict a move away from the 4pm fix to algorithmic execution, with banks using either internal or third-party algorithms to transact orders over time and at different venues.
Meanwhile, some in the industry are advocating a wholesale move to exchange trading, an idea opposed by banks.
In any event, with most asset-manager mandates requiring them to transact at the fix, any move in that direction is likely to be incremental, suggesting the future for vendors in the OTC space looks bright.