Traditionally, FX has been viewed by asset managers as a by-product of their other investment businesses – an administrative task outsourced to a custodian bank to complete at the benchmark fix.
However, industry experts say one of the biggest changes in the industry is the rising popularity of transaction cost analysis (TCA) tools, as managers drill down into the cost of their currency trades.
The buy side also appears to be getting smarter about how it executes trades, and no longer relies on trading at the benchmark fix. Asset managers are embracing multiple options, such as adopting algorithms for tighter pricing and even peer-to-peer trading to cut out costly middle-man fees.
Paul Aston, global head of quant solutions at TD Securities, said it is the biggest structural change he has seen in the industry. Firms are even more willing to view FX opportunistically, and take advantage of the big moves seen this year in FX market to generate extra revenues.
“Now [the buy side] is much more willing to look at FX as an asset class independently … to really take control over FX execution and make sure they are indeed getting the best execution,” he said.
“[We see] a lot more in-house TCA – what does it mean to get best execution, how do I seek liquidity, which counterparties do I use?”
Darren Johnson, chief operating officer at Impax Asset Management, was ahead of the curve when he suspected a few years ago his firm was being over-charged on FX.
He did some analysis on Impax’s GBP/USD trades and found that the custodian bank was charging 30 basis points for execution. After a heated phone call, it dropped to 7bp.
Another of the firm’s custodian banks argued its cash-management services were justification for its high fees, but ultimately Impax decided to take its business elsewhere.
“[It was a] no-brainer to change our model, to pull FX away from some of our custodians and go to third-party providers who could give us TCA and [other services such as] netting,” said Johnson.
Industry experts agreed at the conference that the buy side is turning to third-party provider solutions, as well as conducting its own in-house analysis on its trades.
The spotlight is firmly on FX now, said Klaus Paesler, head of currency overlay and strategy for EMEA at Russell Investments.
“FX before was an operational issue – now suddenly there is attention on it,” he said. “It’s partially a headline risk. [People] don’t want to be seen to be taken advantage of. Now clients ask for TCA so they don’t constantly have to be checking what kind of pricing they have.”
No safe harbour
In light of the currency rigging scandal, the popular WM/Reuters 4pm fix was reformed by widening the one-minute fixing window to five minutes, and adding more data sources to calculate the benchmark rate.
Nevertheless, benchmarks should no longer be viewed as a safe harbour, said Chip Lowry, head of agency FX services at State Street Global Markets.
“[You] can’t take the easy way out,” he said. “I think we will see more scrutiny [from the] buy side.”
The buy side is embracing a range of available options to get the best deal, agreed conference panellists. Joseph Hoffman, director in equity derivatives and FX at Russell Investments, identified the top five trading routes for asset managers.
These comprise: manage the risk themselves and trade around the benchmark; pay their bank to trade at the benchmark for a standard bid-offer spread; pay their bank to trade at a mid-market price for a fixed fee; use an algorithm to trade; or even trade with their buy-side peers using mid-point matching technology such as FastMatch to get a clearer final cost.
Despite the reform to clean up the benchmark, it still needs to be reviewed periodically and undergo stress testing to keep up with changing markets, recommended Virginie Queval, head of FX trading at Legal and General.
“Maybe in four years’ time … [when we see] new behaviours,” she says.
Now that the buy side is becoming smarter about trading FX, will the benchmark one day become extinct? It might become less relevant, predicted Queval.
“I think the educational process has started at asset manager level, [and therefore] reliance will be less,” she said.