More than one in three (37%) of the institutional FX traders surveyed by JPMorgan late last year reported that best-execution requirements and precision of execution were the most pressing issues they faced on a day-to-day basis, ahead of liquidity (29%).
These findings are indicative of an FX market that has matured to a point where most customers have access to all the liquidity they need, and historically low levels of volatility have enabled market makers to confidently quote larger sizes at smaller spreads than ever before.
The next challenge is to develop trading strategies to take full advantage of this liquidity, which involves creating better tools for execution and for measuring execution quality, suggests Neill Penney, co-head of trading at Thomson Reuters.
“A typical best-execution policy will require the company to prioritize between the objectives of timing the market correctly to execute at the best overall rate, minimizing bid-ask spread paid to brokers, minimizing the risk of P&L due to market movement while the order is being executed, and minimizing leakage of trading information into the market,” he says.
Having determined its execution strategy, the next step is for the customer to ensure it has access to the market data, execution tools and transaction cost analysis (TCA) tools to execute against the strategy, measure relative success and identify the next phase of improvements.
Jean-Philippe Malé, chief executive of BidFX, reckons market participants who use agnostic trading systems are better positioned to navigate this marketplace, providing access to execution tools without sacrificing robust liquidity.
“A fully functioning execution management system should provide access to actionable data and robust liquidity in addition to efficient and transparent trading tools, enabling traders to fulfil best execution while managing trade flow, avoiding market manipulation and controlling both information leakage and market impact,” he says.
There is limited value in having an execution policy document for FX that conflicts with policies for execution in other asset classes, cautions Andrew Woolmer, managing director New Change FX (NCFX).
“Beyond that, the policy needs to take account of real systems and processes – we have seen several best-execution documents that talk about systems that don’t actually exist,” he says.
Klarity FX director Amarjit Sahota suggests the main value of an execution management system lies in providing a fast, accurate and reliable platform for transacting orders. Additional analytics can be helpful, but are really just bells and whistles to the core system functionality, he adds.
Whether a trader ranks best execution over access to liquidity – or vice versa – might depend on how their trade is being executed and the agreement they have made with their liquidity provider.
If a trade is being executed with a liquidity provider on a principal basis, being able to validate best execution is likely to be the most important factor. If a trade is being executed on an agency basis, availability of liquidity via their provider will be more significant.
Both have different outcomes and will suit different trading strategies, says ParFX chief operating officer Roger Rutherford.
“It is therefore crucial that providers are transparent with their clients about the services they offer and how they intend to trade on their behalf, as well as the advantages and disadvantages of each trading methodology,” he says.
Unsurprisingly, almost two thirds (61%) of the FX traders who responded to the JPMorgan survey said Mifid II would impact their daily operations and, of those, one in three said it would alter the types of execution orders they use.
TCA/best-execution support was identified as the most important service to address Mifid II requirements.
Mifid II will drive clients to adopt more sophisticated trading strategies and to execute a higher proportion of their volume on regulated venues such as MTFs, says Penney at Thomson Reuters.
This is due to both the hard rules in the directive around best-execution reporting and also a wider drive in the industry to greater transparency from execution desks to asset owners, such as pension holders.
Clients will expect dealers to have at least the same level of transparency for spot transactions as are required in other areas of FX and other asset classes.
Curtis Pfeiffer, chief business officer at Pragma Securities, notes that electronic trading – and in particular algorithmic trading – lends itself to Mifid II transparency requirements because market prices and execution prices are databased, making it easier for clients to analyse execution quality.
The goal of Mifid II is to unbundle and clarify costs to promote a more efficient marketplace – if it didn’t bring changes to how execution is done then that would be a failure, says Woolmer at NCFX.
“This will drive product innovation – some of which we are seeing already in the algo space – but it will also drive change in settlement processes, credit relationships and so on.”
However, although he lauds Mifid II’s drive for transparency, Sahota at Klarity FX also warns that it will come at the expense of bottom-line expenses for suppliers and that these costs will be passed on to the buy side.