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Eyes on the price: What’s next for FX transaction cost analysis?

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Findings from Greenwich Associates 2015 FX survey



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Currency volatility, a new European regulatory directive for financial instruments trading, a series of market-rigging scandals and the desire to cut costs are intensifying top-tier institutions’ focus on achieving best-quality execution in foreign exchange trades.

An analysis of the results of Greenwich Associates’ 2015 Foreign Exchange Services study finds that asset managers are under more pressure to show clients they are getting best execution, while dealers, facing tougher competition, are less inclined to bundle execution, instead placing more trades on an agency basis.

Both, accordingly, are turning to transaction cost analysis (TCA) to gauge the effectiveness of their trade execution over time. Use of TCA grew modestly among FX investors last year, but sizeable numbers of institutions in the US and Europe have now adopted it, as have hedge funds and commodity trading advisers.

TCA is now easier to do as algorithmic trades generate more data that enables swift analysis of results. At the same time, TCA itself has come to embrace a wider variety of trade analytics.

The results, however, are only as good as the benchmark that is applied to them. Arrival price is the most popular, notably among hedge funds, but corporates and banks use a variety of simpler benchmarks, including the price at a specific time of day such as the WM/Reuters London 4pm fix.

Institutions are nowhere near a consensus view on what is the best benchmark for FX, however.

The Greenwich study also revealed a shift in the preferred sources of TCA analytics, from proprietary tools to third-party providers, suggesting that institutions are looking more intently for the best, most innovative analytics from firms focused on providing them.

The exception is hedge funds, which rely on proprietary tools that they develop in-house to meet their own, more sophisticated requirements.

No other market is so dominated by electronic trading as foreign exchange. Almost three out of four institutions said they traded electronically last year, accounting for 76% of their total FX trading volume.

Multi-dealer platforms (MDPs) are the e-trading channel of choice, while the use of single-dealer platforms (SDPs) continued to decline last year, as did use of phone-based trade placement. While SDPs continue to provide benefits such as custom execution algorithms and reporting, MDPs give quick access to multiple counterparties – critical to ensuring best execution.

What has not changed much is the average number of FX dealers that corporations and institutions use. The largest institutions – those with over $50 billion in assets – still maintain relationships with an average of more than 10 dealers, while the smallest – those with less than $1 billion – work with only about five.

This could be, in part, a matter of preference – these clients still see relationships with the largest FX market players as providing them advantages – and partly an effect of continuing consolidation in the financial sector. Banks and other dealers, meanwhile, feeling liquidity constraints, have become stingier about offering value-added services in return for FX execution.

In all of these developments, however, a definite trajectory is traceable: toward greater attention to execution, greater use of TCA, and greater reliance on third-party and MDPs for FX trades. Economic and regulatory pressures and new demands by the owners of assets, which have wrought these changes in the market, will likely continue.

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