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FX debate, part 2 of 2: How to keep the buy side on side

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In the second part of our debate on FX, we examine the buy side as it develops its interest in new instruments such as exotic options, and examine key areas of innovation such as prime brokerage and e-commerce.

FX debate: Executive summary

• What innovations are there in foreign exchange? Banks need to work with the buy side to find useful additional services for the investment process

• The use of exotic options is growing among investors, although few are trading volatility yet

• Prime brokerage is also making a difference by helping market players get access to more markets

• Standardized reporting is a point of debate and electronic trading also presents banks and investors with additional concerns


FX Debate: Making the most of a benign environment (PART 1 OF 2)
FX debate participants

AE, Millennium We accept that foreign exchange returns will be helped by innovation. For example, if you can take credit risk as well as the currency risk in emerging markets, you can increase your returns dramatically. What are the innovations you are seeing at the moment?

KMc, Westpac Banks need to continue to come up with something useful to the investment process but, more importantly, something that can be taken by a client and integrated into the investment process without relying on the bank. Some of our modelling work is proprietary information. You can’t incorporate that into your investment process, whereas something like the Westpac dollar surprise index you can. We’re willing to disclose the investment process to top-end clients.

JA, State Street What excites us in research is the idea that markets go through regimes; different things work in different environments. Although it’s not a new idea, it’s presented in a new way. Markets work in synchronicity. Such things as the carry trade have analogues in the equity and fixed-income markets, and these become synchronous. That’s more of an investor behaviour issue, more of a risk appetite issue, than a fundamental issue. We’re not trying to come up with a better way of valuing something. We’re asking what investors are paying attention to, and what’s different about the regime now. If it’s a random walk, if we flip regimes randomly, that doesn’t help with forecasting. So the key part of our regime model is assessing the probability that we stay in the same regime or, if we change regime, anticipating where we are most likely to go.

MT, RBS In terms of innovative execution products, we have created new technologies that facilitate benchmark execution. We see a lot of clients tied to benchmarks, and with the uncertainties around the application of Mifid and FX we are seeing that client base grow. They love the way it facilitates both pre-trade and post-trade analysis and it is a concept that fits neatly into a broader portfolio of assets. Not only have we created our own benchmark, but also we have done research on beating benchmarks and trying to understand what our clients are seeking to achieve, and then we reverse-engineer solutions that may improve returns. Feedback suggests that many clients are not interested in taking any risk in trying to beat a benchmark. It’s just a line in the sand. That surprises me. Why wouldn’t you try to beat a benchmark if we could possibly help you do it?

AE, Millennium But most benchmarks in foreign exchange are just marked against WM rates?



CKG, SGCIB
The old spot FX market, pre the IT/e-commerce revolution, was fantastic for banks, because the equity you needed to run a spot business was relatively low versus the returns you could make. That’s why the market was so much more broadly spread across a variety of liquidity providers because everyone wanted a piece of the good returns available. The IT revolution has changed this dramatically in two broad ways and this has affected the way that banks have expressed innovation. First, the flow part of the business has used IT in new ways to handle risk aggregation of large volumes of flows on much narrower bid-offer spreads. Secondly, the marketplace has used IT to model more complex products, giving rise to structuring and exotics opportunities. The key thing is that IT is the differentiator and it is not surprising that those banks that have led the IT revolution have created substantial first-mover advantages and have helped shape the innovation we have seen.

AE, Millennium What innovations are there in the exotic options market?



XP, FX Concepts
The market has evolved over recent years. Five years ago the banks were the market makers and managers such as ourselves were the takers, but this relationship has been to some extent reversed. There has been a rush into strategies that sell options. As hedge funds have piled into that strategy, some of the mispricing opportunities have been arbitraged away, and this is a piece of the larger picture that explains why vols are low. As the spread between implied versus realized has diminished it is only natural that managers look for opportunities in other areas of the volatility triangle such as correlation trading (realized versus realized).

At FX Concepts, we have looked at options to improve risk efficiency, particularly in capturing carry. The basic premise of options is that mispricing exists because people are willing to pay a premium to give away risk. This strategy has become crowded of late. We have moved on to model the way volatilities move, both up and down.

AE, Millennium Are those on the buy side becoming more efficient in the way they put on their risk through options, or is it still basic?



RL, Barcap
Some are using products with a lot of moving parts, particularly when you look at knock-outs and knock-ins in different currency pairs, and it’s certainly true that more people are now using second- and third-generation exotics. In the main, however, the business is still substantially vanilla and the volume of that business that goes through platforms is flabbergasting. These are clearly directional trades, executed on a streaming price basis rather than volatility trades executed with delta. That suggests that the end users are finding the use of options efficient.

CKG, SGCIB A different way of asking your question about innovation is by taking a look from the individual bank’s perspective. They are asking themselves: "Where can we enhance our overall returns on investment?" With the spot market driven by e-commerce platforms, banks are investing their resources in more complex products, which is why we are all headed down that route. What is also helping this approach is that Basle II is driving us to use IT more extensively to monitor and measure our operational risks. Also, look at the corporate side. A lot of dislocations have been introduced by things like IAS39. Balance sheet valuation or equity got shifted in one big change in January 2005, and that brought in structuring issues. But the revenue split is what is driving innovation. Volume is dominated by e-platforms, but it’s not generating money in the same way.

AE, Millennium To the buy side: are you innovating your products or innovating your process? Or both?



AB, GSAM
There are different levels of innovation. One element is the way that you deliver the final product to investors. There’s a lot of innovation in the standard funds running around 6% to 10% volatility. We’ve developed funds that run at much higher levels, 40% for example, because clients tend to be cash-constrained rather than risk-constrained. They don’t want an investment with 40% volatility. They want something with 10%, but they only need to use a quarter of the cash. Capital-guaranteed products, certificates with annual coupon payments – those things are important. That’s one side of innovation. Reducing transactions costs, that’s a significant focus. We’ve all grown a lot over the past few years but transactions costs have come down as well. We are trying to incorporate options as best we can into our investment process too.

DT, FFTW It’s easy to underestimate the difficulty of incorporating options into a traditional currency overlay programme because even plain vanilla calls and puts place a significant burden on an investment process geared toward trading cash. When trading cash, a manager would be happy if he could predict the direction of future moves 55% of the time. Assuming the exposure isn’t significantly negative carry, timing is open. A strategy can play out in one week or three months with basically the same result. With options you add two more levels of complexity. You have to predict the extent of a move to set the strike price as well as the timing of the move to set the expiration date of the option. That is where we are innovating by trying to add that skill set. It’s not something that, because the sell side delivers a product, we can use from day one. It’s something you have to evolve into, because it’s not straightforward to translate a view into an option position.

JA, State Street I wonder whether it’s the wrong product for the buy side. As soon as you get into an option, you’re not just getting the implied volatility but also other stuff you might not want as well – such as gamma and time decay.


BT, JPMorgan
Volatility-related products are becoming more popular with clients who have traditionally focused exclusively on vanilla spot and forward FX. The reason being that FX volatility is at historically low levels. Most people believe that at some point in time the carry trade will unwind and as a result G-10 FX volatility should increase. In this case buying volatility could be an attractive hedge.

JA, State Street There is this fundamental indexing term, value versus growth. I wonder if those linear products, through derivatives, are closer to an asset manager’s requirement to express a view on volatility?


DT, FFTW
Don’t get me wrong, options are a great tool to leverage an idea when a manager has a particular view about the timing and/or magnitude of a move. For instance, using options to express a view around economic data releases can be very profitable, with limited downside risk. One thing we have to be careful of is the assumption that volatility is uncorrelated to spot movements. While this may be true in general, volatility is highly correlated in certain high-carry currency pairs such as dollar/yen and thus a portfolio with exposures in both the spot and volatility markets may have much more risk than meets the eye.

AE, Millennium Another area of innovation is foreign exchange prime brokerage. This has increased dramatically and had a very positive impact in helping the buy side to attract new mandates. What are your thoughts?


MT, RBS
I agree – we see the line between margin-based business and fee-based business blurring more and more. If prime brokerage is an opportunity for our clients, we facilitate it. Certainly cross-product PB is becoming increasingly more essential to linking multiple processes. The fees are being driven so low that facilitation takes priority over direct income. It will therefore become an increasing barrier to sell-side entry as it is difficult to request a $40 million investment for something that may not show a direct return and is in a cut-throat market. Best execution is subjective – whether clients are seeking anonymity, slippage control, or just risk transfer, prime brokers allow clients to choose their venues and enable a bit of freedom.

JA, State Street It has allowed different people to provide liquidity as well, which is transformational. The BIS numbers are not coming from bank growth. That’s driven by what used to be called the buy side, providing liquidity over the electronic platforms, facilitated via credit intermediaries, such as prime brokers.

XP, FX Concepts Our business really grew once we got a prime brokerage relationship.



KMc, Westpac
It has made life easier for banks as well. As easy as it is for you to transact and increase your scope of counterparties in order to access more liquidity. It has also enabled us to have customer bases that historically or traditionally we wouldn’t have had access to.


AE, Millennium
How important is standardized reporting of currency returns?



PL, ABN Amro AM
Reporting is going to become even more important as the industry grows and investors will require more transparency in regard of the vehicle they invest in. In the past we have been more used in managing tactical overlays, which generally speaking are a more bespoke mandate adjusted to the underlying asset allocation of the investor. Here standardization of reporting is difficult since level of risk, currency universe and symmetry of mandate may differ widely from one mandate to another. Now that you have a greater distinction between the beta and alpha management, you see more pension funds or insurance companies investing in currency hedge fund rather than using overlay managers in order to generate FX alpha. Those funds are more directly comparable than overlay mandates, therefore standardization becomes easier in regard of reporting performance.

AB, GSAM It’s easy to convert them between the different levels of volatility. It’s just a question of scaling position size.



AE, Millennium
Standard reporting is easy but there are mandate constraints. How are you going to report a mandate that’s 4% vol with options, without options, with emerging currencies, without emerging currencies, with credit risk, without credit risk and then compare it against the competition fairly?

PL, ABN Amro AM Using value at risk is not a bad starting point. I was shocked to find that many managers in the currency peer group still report in terms of assets under management. That is meaningless. If you have assets under management of $20 billion with 100 basis points of target risk, this is in fact smaller than if you have $2 billion with 15% targeted volatility. Why don’t we report assets under management in terms of value at risk? Then there’s an equal footing for everyone, you can compare managers in terms of performance relative to size of asset.

BT, JPMorgan People want to know what their worst case exposure is. Perhaps a stress test number combined with value at risk is the right measure to report.


JA, State Street
On the pure currency fund side it is easy, because you can come up with a risk-adjusted return measure. We could come to a consensus on that. There remains a challenge on the overlay type of business, where there are hard constraints, particularly if you have an unhedged benchmark. You can lose half your information coefficient as a result of that benchmark, regardless of how good a strategy you have.

PL, ABN Amro AM The effect of portfolio constraints can significantly shape the portfolio returns. Investment consultants look less at currency composite series which are attached to tactical overlay as they do not necessarily represent what was the true skill set of the managers. They tend to look more for currency as asset class composites that express what the manager has delivered within a flexible environment.

AE, Millennium You said VaR is a good starting point, but would you agree that you need other measures as well?



PL, ABN Amro AM
Yes, surely some of us currency managers are primarily directional in their investment process, others are more option-driven. Clearly the portfolio risk for the latter may not be as apparent if you look purely at the ex-ante value at risk. You may miss some non-linear relationship that could come back – and as an undesirable surprise.

KMc, Westpac If we want to be taken as a separate asset class, standardization is critical, because we have to be transparent. The only way we can do that is if the industry sets a standard and reports in that way.


AE, Millennium
What are the impediments to moving forward?



KMc, Westpac
Coming to that consensus view, and the implementation of it in an unregulated environment.



AE, Millennium
E-commerce is continually evolving. How dominant will it become?



MT, RBS
It’s growing and will continue to do so. But what I find interesting is that the face of eFX seems to evolve as fast as the volumes grow. Everything from single and multibank-platforms to electronic communications networks, even "dark rooms", are changing the way we view the business. There are a lot of new venues sparked by the introduction of prime brokers. We’ve had to adjust the way we price some of this risk. You can’t tell a black box that the most efficient way to execute something is not the most professional. We’ve also been astounded by the information we have been able to glean off these new markets and this has helped us pass better liquidity on to our clients as we take a more quantitative approach to all our pricing. So although e-commerce has evolved, we’re at an early stage.

RL, Barcap I don’t think we’re early in the game. It’s already very developed and arguably it’s too late to come to the game now. If you’ve not had a market-beating platform in place for two or three years, the likelihood is that you’re simply not going to be able to create the liquidity pool necessary.

AE, Millennium Who are the prime movers when it comes to e-platforms?



RL, Barcap
Ourselves and two other banks. We do approximately 70% of our total volume on the tool now.



MT, RBS
Our volume percentages are similar but we have room to grow. In some sectors it is higher than others and we have always sought to give our clients a choice in dealing with RBS over a range of platforms.


AE, Millennium
Who here uses electronic trading platforms and why?



XP, FX Concepts
A significant percentage of our business is done through ECNs. There are two reasons for using e-trading. It allows us to be discreet and we can get best price quickly. We have one ECN that we really like, and we have connectivity from the banks that we have the give-ups with through our prime broker. We’ve been amazed how good it’s been. Even in times of perceived stress, we’ve managed to get liquidity.

KMc, Westpac Why do you still execute using voice as well?



XP, FX Concepts
We remain committed to it. It comes down to systemic risk. We had an experience years ago, during the Tequila crisis, I believe. We had a big position on a particular account and in those days we didn’t have a prime brokerage account so we were obliged to close the trade with the bank we’d initiated the trade with. They were having an office party while all hell was breaking loose and they had left a junior on the desk. It took half an hour to persuade him to give us a price, and it was a terrible price and we knew it, but we had to get out. So the problem comes if you don’t have a relationship with someone who is willing to make you a price even in a crisis.

AE, Millennium What percentage of business is still executed using the phone – and is it just to keep a personal relationship going?



MT, RBS
It’s more than just keeping a relationship. It truly depends on what the client wants to achieve and how complicated their solution needs to be.


RL, Barcap With the single-bank platform you can analyse how the client is transacting, which can be revealing. If a bank quotes a spread, by definition it starts in court and the evolution of that trade depends on how the market behaves. But if, at the very inception of the trade, you are losing money, it’s clear that the client is dealing in a way that is potentially harmful. Hard data allow evidence-based decision-making. We have ceased relationships with customers where we feel that they are inappropriately taking advantage of the system liquidity.

AE, Millennium What volumes are appropriate? Is there a size element whereby you’re too big to execute on a platform?



XP, FX Concepts
We haven’t come across that, which has surprised us.



RL, Barcap
It depends on how you want to engage with the market and execute. Our system allows us to choose to execute in blocks of five or 10 or however much you want, and you will get quoted an initial price based on the spread for what you were asking in, so a clip of 2. Clearly that liquidity is not going to touch the sides in euro/dollar. But say you’re asking in clips of 50 or 25. You’ll hit for 25, whereupon you’ll get thrown a price for 25, and you then have a meter that shows how you’re clearing liquidity. Anything between a second and four minutes, depending on what currency pair it is and the time of day. You can see how that liquidity comes back to the system. If you see the market moving away from you, you can choose to accelerate that, and the spread will be affected according to the amount that you do. If you’re prepared to execute it in clips of 25 and sit there, you will get charged the spread for 25, even if you’re doing 200. This puts power into the hands of the clients, depending on the way they want to execute it.

PL, ABN Amro AM But if I have a billion dollars to do, that’s quite a few clips to put through and at some point the market’s going to move and this may prove expensive.


RL, Barcap
It depends whether you want to transfer risk or risk manage yourself.



PL, ABN Amro AM
We do part of our volume on a platform, although a relatively small part. The majority is on the phone. But I remember a study comparing the DTB on the bonds market versus the Liffe. One being at the time an electronic trading market while the other was open outcry, both trading in contracts with the same characteristics. The research found that electronic and outcry had exactly the same features most of the time, but when things were not going so well, it was better to go to the open outcry rather than the electronic platform.

AE, Millennium What about straight-through processing? I can see why a big hedge fund with one account would want to use electronic trading, but if you’re breaking down 20 tickets with several accounts every time you trade 25 million, would the phone not be easier?


RL, Barcap
You turn on the aggregation function at the beginning, then at the end of your trade you go ‘end of trade, split’, and bang! It goes straight through.


AB, GSAM
We’ve only been using electronic platforms for the past few months but we’ve been very impressed with what we’ve seen in the major currencies. The emerging markets haven’t really found their way on yet. You get your ticket done, you press a button and the system splits it all out for you straight through to the prime brokers, or to the back office.

KMc, Westpac We’ve seen a lot more appetite for multi-bank platforms when people want to do straight-through processing to make life easy. Over 50% of the market is transacted in this way.


AE, Millennium
Please explain the difference between aggregators and multi-bank platforms?



RL, Barcap
There is no substantive difference. Typically a multi-bank platform might be limited to say four quotes, but in essence there is no real difference, as they impact the liquidity pool in the same way.

Although we have the ability to trade with aggregators, we have chosen not to supply liquidity to them as we are unclear that it’s an equitable relationship when engaging with clients.

MT, RBS As a bank you have to know how you are participating in an aggregator and account for that in your prices. The choice of using an aggregator is a client’s, and although we would like clients to use our proprietary systems we will work with them over a number of platforms.


RL, Barcap
They work by taking a rate from multiple suppliers to create a pool of liquidity, which we are unclear actually exists. All of that information is being streamed to them based on normal market conditions, on an assumption that you can touch the market in an efficient way. All of the good platforms, the good e-commerce houses, have intelligent pricing. The machine does it all. It prices and gets out of the risk, interacts with the market at large. It makes a price based on what it’s seeing on the other platforms and its own positions. Human hands do not get involved. That means that if liquidity is being streamed to an aggregator and multiple systems are then hit, the assumptions are false.

AE, Millennium How does it calibrate for size?



RL, Barcap
It knows what size. It’s pre-set. Intelligent pricing will make assumptions about what it can and can’t do without disturbing the market. With aggregators that’s not true. As a result a lot of banks are ambivalent about aggregators.


KMc, Westpac
You can fight the aggregators, and there’s just cause to do so. But the fact is there’s demand. Some large clients are choosing the aggregator route.


RL, Barcap
That’s true but we remain unclear whether it’s sensible business to support them. Aggregators claim you’ll get a better price. Not necessarily, because if you go the aggregation route, you’re heading down the route whereby you are no longer a client. The analogy is that I walk into a shop once a year in the sale to buy a shirt. It may or may not suit the shop to sell at the price but I’m not exactly a customer. It goes back to the point that Xavier made about maintenance of a relationship.

KMc, Westpac You are going to lose a portion of your client base if you refuse to deal with that section of the market.



RL, Barcap
It’s possible but whether it is sensible to supply liquidity to aggregators where liquidity is sold at what is arguably below its real price is something that we question.


MT, RBS
There are benefits if you can participate in a way that suits your market-making model. Some participants look for things that don’t look right and take advantage of that. That does not necessarily help anyone. But there is value in knowing who you are dealing with. Some clients go in on platforms for anonymity, so I’d rather at least have my pipe in there so I know what’s going on.

RL, Barcap The answer is to supply what is required. Within a few weeks we’ll be providing an order book service with complete anonymity, so a customer can rest assured that there is no danger of providing unnecessary information to the market at large.


AE, Millennium
Where’s the evolution? Are the three big players going to start buying up all the others or will niche players survive?



RL, Barcap
A lot of FX suppliers will end up being niche players. They’ll provide services in the same way that Westpac or State Street does extremely well, with regards to customer flow. People will go where the speciality is, in currency pairs or particular services. It’s a Darwinian process. The e-tools will speed up a long-term process, which has hit a hiatus. This will be the next great leap.

KMc, Westpac Banks are going to have tough decisions where historically valuable relationships go down the e-platform route, which require a lot of servicing time and resources. They may see no positive-sum gain to the relationship.


MT, RBS
But you have to be able to monetize the flow or at least analyse what it is worth to you – however it comes in.



KMc, Westpac
But what if you can’t do that internally?



RL, Barcap
We may have to change our assumptions about value, and lack of value. You may find that customers you once considered no value suddenly suit your model. It works in both ways.


AE, Millennium
Are customers also putting in bids and offers?



RL, Barcap
We have created a system where you are able to leave bids and orders. It’s PowerFill Orders and it allows customers to work orders and capture spread if they are so inclined. You can work orders based on price, volume or time. If you’re working a mid-market bid it’s a very attractive proposition, particularly without a brokerage fee.

MT, RBS The direct market access element or access to a bank’s internal exchange is a hot topic. Speed, transparency, and choice are key.



JA, State Street
There’s a bigger issue, and that’s the fragmentation of liquidity. We’ve seen that in equity markets and it’s a problem there. We’re now seeing it in the fixed-income market and I’d be interested to hear what Chico has to say about that.


CKG, SGCIB
Liquidity is arguably a combination of a number of factors: the numbers of players in the marketplace at any given time, the amount of capital they have to be able to support a specific price, and their desire to utilize their capital at a specific point in time. Fragmentation comes when these factors are challenged. This can be by an exogenous factor, eg, market data, geopolitical issue etc, or, occasionally, by abuse. When liquidity has been abused, the authorities have stepped in quickly to rectify the process. MTS, for instance, has very tight controls about the minimum levels of liquidity it requires its members to provide to help cover the majority of eventualities. The fixed-income market shares that individual market players have are spread over a larger number of players than in, for instance the FX market. The thing about FX that we always ask ourselves is: has the capital of many banks been taken away from the FX marketplace as a result of the dominance of a handful of banks in the spot market due to their use of e-platforms, and has this capital been replaced and been exceeded by the aggregated capital of all the underlying clients attached via these networks? If it has, then FX liquidity will continue to grow due to end client users on e-platforms.

JA, State Street The banks traditionally have played a different role than their clients, and the central banks appreciate that. If there is a market dislocation – as we saw recently in the European government fixed income market – on e-platforms, what happens then? Central banks have a keen interest in ensuring that they are able to efficiently undertake their unique role of ensuring orderly markets.

RL, Barcap You need relationships. A pure model hedge fund told me it does at least 30% of its business over the phone because otherwise it wouldn’t get anything done in times of crisis, particularly with less-liquid currencies such as the New Zealand dollar.


BT, JPMorgan
I haven’t seen a bank’s e-commerce portal that can do everything so that it could replace voice-dealing. E-commerce portals can be an attractive marketing tool for sales people. In the long run, finding the right balance between voice execution and electronic will vary from customer to customer and bank to bank. What is useful for a corporate may not be interesting to an asset manager or a hedge fund.

AE, Millennium What is the impact of algorithmic trading, and what does it involve?



XP, FX Concepts
It’s simply model-driven trading.



DT, FFTW
High-frequency model trading.



MT, RBS
It is liquidity optimization and high-frequency price-making, not necessarily market-making. Most algorithmic models do not have an obligation to make prices. But as the volumes grow, the line between customer and bank is blurred. At RBS we have been running high-frequency trading models for some time now and they have been at the core of some of our newer market-making capabilities.

CKG, SGCIB It can be very profitable, as we have found out. In systems that focus on adjusting to shorter-term mean-reversion strategies, there is no doubt it’s helping to keep the market less volatile. It also means that there are additional new players brought into the marketplace with capital they want to employ, which has positive implications for market liquidity. Sure, it can be turned off, but it would only be turned off in situations when normal voice pricing would also itself be limited due to one of the factors I elaborated upon earlier. For us it also has the added benefit of making us the largest single provider of liquidity globally on the EBS platform. The next stage of model development is whether or not algorithmic trading can be linked into the provision of trading prices for clients. That’s all of our next challenge. But again, the differentiator is the quality and volume of IT resources.

AE, Millennium These high-frequency trading models assume a level of volatility and are therefore at risk if this changes quickly. Is that a fair assumption?


MT, RBS
There is a risk of volatility no longer suiting their current models. Many of them are trying to make money off small positions with low risk, so I would not say there would be big losses if that happened, but they would be forced to push the stop button and try to recalibrate.


KMc, Westpac
It’s also a bit hyped up. However, it is making banks look at the risk process and their pricing processes. It’s human versus machine. You have a lot of flow executed automatically, and there’s no human interaction. The market’s shifting in a direction where you have machines talking to each other and executing, and a couple of risk-takers or technologists as well as risk managers sitting on the side lines managing specific flows and looking at a proprietary risk scenario.

JA, State Street There’s increased liquidity. Small transactions. That’s a positive for the buy side. The negative is that if the regime changes you don’t know what will happen.


Implosion

DT, FFTW Ten or 15 years ago you had Citi Paris trading against Citi London. If you wanted to work harder, and you had a larger execution desk, you could’ve got better spreads 15 years ago versus today, because there was more inefficiency. Now we’ve had consolidation among the banks, the platforms and the secondary players, and the non-bank liquidity providers are starting up. In the long run, the platforms and non-bank should add to the resilience of the market, but right now there is a lot of liquidity concentration among the top banks. I’m concerned that we may see a massive liquidity implosion during an event where the models step back from the market.

AE, Millennium Is the next evolution going to be trading vanilla options in a similar way?



RL, Barcap
It’s already happening. There’s been an explosion over the past three months in what we do in the number of options that we transact over the system. We stream live prices, so you are trading something in the same way that you would do with spot. You put in the parameters and you see a streaming price, and once the spot comes down or vol changes, you deal and click, and that will execute the delta for you.

AE, Millennium Are there any multi-platforms offering this?



MT, RBS
We are seeing some of the brokers getting into the API game. We are watching that closely.



RL, Barcap
Will the banks support it in the way in which they do FXall? I’m unclear on that.



KMc, Westpac
Not everybody’s offering APIs and streaming prices. You’d be surprised by the banks that don’t have API technology yet – Westpac has been on top of this for a while.


AE, Millennium
If you get a situation where five or six banks offer it then that could be interesting?



RL, Barcap
It’s unlikely, simply because of the mechanics of making money out of foreign exchange. The margins are so fine that six is too many counterparties.


AE, Millennium
What does the ultimate platform look like?



RL, Barcap
We believe that Barx offers traders everything they need, so in our view that is what the ultimate platform would look like.



MT, RBS
For the institutional space I think it looks a lot like a direct execution product with a joined-up PB offering that helps clients do what they want. It’s similar to what’s already happened in equities.


BT, JPMorgan
Where you can do emerging markets as well.



RL, Barcap
Yes. That is coming.



DT, FFTW
Work has to be done on the buy side to understand what is best to do, to understand the risk-return trade-off for every type of trade. I’d like to see a study that examines the conditions under which it is better to deal on the phone versus the machine.


JA, State Street
Choice is key. FXConnect is electronic but it preserves the relationship aspect, and it’s more of a request-for-quote platform. As the bank you know who it’s come from, so it’s the same work flow as the phone. We’re heading for an increasing number of choices for how you execute your trade that reflects your preferences vis à vis liquidity, relationship, time, market depth.

MT, RBS The key is having smart sales people that understand the modular nature of the products you are distributing to clients. This allows them to be able put the right plug-and-play solution together for their clients. You could build the most intensely quantitative product with the most bells and whistles, but if your sales people are not engaged it’s not going to work.

KMc, Westpac What you see is an upskilling in your sales forces to become more mini-strategists.



AE, Millennium
One of the problems on the sell side is that a lot of firms have 10 or 15 risk-takers that want coverage. Every firm suddenly becomes a multi-customer. Do you foresee that changing as IT becomes more evolved, where you’ll have less sales and the client will use the e-tool more and have a central coverage? Will that ease stress in the system?

RL, Barcap Provided the maxim holds good that you need to preserve relationships with banks to ensure liquidity provision, then IT becomes an execution method that allows for greater efficiency of coverage.


AE, Millennium
Are there any other comments on future trends?



JA, State Street
Where is the growth in foreign exchange going to come from? We have emerging central banks with more assets than those in the developed world, many of them establishing sovereign wealth funds. Annual GDP growth of 8% to 10% rapidly builds middle classes in these same countries who demand effective private-sector savings vehicles. Coupled with the changing demographic profile in Europe, America and Japan, I see this being an industry that only has growth written into it, and that’s especially true for the asset managers. Currency is an alternative asset class – it’s well defined, the consultants are on board, and there’s money coming in over the transom from institutional investors.

AE, Millennium There’s no question that we are in a positive environment for growth. As more people invest globally, especially in emerging markets, they have currency risks in their portfolios that they have to manage. Where the currency market has huge advantages is that it can tailor-make products to manage every customer’s risks efficiently.