FX: Jury out on agency desk execution
Agency desk execution has been described as the way forward for banks looking to reduce costs and retain clients, but it is far from clear as to whether most institutions will go down this road.
It is easy to see why agency desk execution might appeal to a bank. It is a method of executing FX transactions on behalf of clients without the inherent risks of running a market making capability, which means the bank does not need to warehouse and manage risk.
Any fixing order – an area that has been the subject of considerable contention and regulatory scrutiny – can be handled on an agency basis.
It is just as effective in
the spot market as
it is for more complex
“With the 11am fixing scandal and the marking up of at best orders, many banks have thought it best to offer agency desk execution,” says John Miesner, managing director and head of global sales for GTX, Gain Capital’s institutional FX ECN.
Banks are embracing agency desk execution in response to client demand, according to the head of FX at a European bank.
“Additionally, the remediation exercise undertaken by most banks as a result of the recommendations of the FSB has seen banks turn to algos to execute benchmark orders,” he says.
Miesner says the transparency of doing business in an agency model should help with compliance issues and reckons that agency desk execution could eventually account for as much as 70% of FX market activity.
“It is suitable for both large deals and smaller trades, and is just as effective in the spot market as it is for more complex FX instruments,” he adds.
The European bank head of FX is more circumspect when asked to assess the percentage of market activity that could eventually be executed this way.
“Current volumes are relatively small and whilst we see demand for agency desk execution, it is not growing exponentially – although those that have a fiduciary responsibility and like to be able to show that they have achieved optimal execution may favour the additional analysis,” he says.
In addition to asset managers, other sources of demand include hedge funds that are using agency desk execution to execute larger risks.
Paul Chappell, founder and chief investment officer of UK currency management firm C-View, reckons a large volume of FX market activity could eventually be executed via agency desks, although he accepts that a wholesale move to this type of approach would have profound implications for pricing and liquidity.
“We are already witnessing the repercussions of this move in terms of changes to liquidity and price availability – with fewer price-makers in the banks and less capacity to warehouse risk, it is inevitable that market volatility and price spikes will increase,” he says.
“The less onerous regime under which the agency approach can operate will inevitably mean that those price-making entities come under greater scrutiny.”
For more complex FX instruments, the relationships between agency banks and true market-makers become more critical
Paul Chappell, C-View
According to Chappell, this combination of events allows for a greater number of non-bank market makers – “who are often better resourced, have larger risk appetite and currently less regulatory oversight”, he says – to increase their inroads into an area that has traditionally been the preserve of the banks.
The European bank head of FX admits to a degree of uncertainty around the implications for market liquidity.
“We have definitely seen an impact on the WMR benchmark window where there are fewer participants,” he says.
“Unless you are executing a benchmark order, there is a reluctance to be active in the market during the window, but whether this proves to be a negative development only time will tell.”
He also believes that agency desk execution generally works best for large deals and in the spot market.
“When you get into less-liquid currencies and some non-spot products, such as NDFs, I would not recommend it because you would still be heavily reliant on the bank liquidity to augment the observable liquidity in the market,” he says.
With the expansion of more automated facilities to slice and execute large orders, even in an agency environment there is no reason why large orders cannot be undertaken, concludes Chappell.
“For more complex FX instruments, the relationships between agency banks and the true market-makers become even more critical,” he says.