Few market participants would deny that most of the investment in electronic FX trading has been about winning the trade rather than settling it.
Money has been spent on improving the post-trade element of the life cycle, acknowledges Frederic Ponzo, managing partner at capital markets consultancy GreySpark Partners, but reckons that investment in front-office systems has been at least three or four times higher.
The amount allocated to the back office, he argues, has been insufficient to properly decommission obsolete or less-relevant platforms. The result is stubbornly high operating costs due to duplication and limited automation.
Back-office processes that evolved to support nascent electronic trading were designed to handle low volume, large tickets, but as ticket sizes fall, post-trade infrastructure is unable to keep up.
That is also the view of Adrian Patten, co-founder and chairman of Cobalt, who says that incumbent post-trade providers rely on cumbersome, manual processes and disconnected legacy technology.
“As much as 80% of back-office time is spent purely on reconciling systems,” he says. “Complex and opaque cost structures have become the norm, with trading institutions facing multiple licence fees, messaging charges, IT overheads and staff costs.”
Brad Bailey, research director with Celent’s capital markets division, says there is a heavy reliance on systems that need to move to much more rapid cycles.
“Regardless of one’s opinion on the future of blockchain-based systems in the capital markets, the technology has driven much thinking and process remapping in post-trade FX,” says Bailey.
Ultimately, it should be possible to eliminate all human involvement from the post-trade workflow, which would generate cost savings for both market makers and takers.
“In markets where spreads are wide and labour costs low, there is no real incentive to hollow out post-trade efficiencies,” says John Ashworth, CEO of Caplin Systems. “However, where spreads are neither wide nor labour costs low, there are huge incentives to eliminate unnecessary human steps in the chain.”
According to Henry Wilkes, CEO of Point FX, rather than undertaking a complete overhaul of their systems, market participants have tended to “patch” these systems to cope with the increasing complexity of the FX market.
However, that approach won’t work forever.
“There is a growing aspiration to move more in line with the equities market and that will require drastic changes,” he adds.
“There is also a growing willingness to embrace blockchain as part of a new post-trade infrastructure for FX. Digitization of assets and agreements could become an incentive for the FX industry to standardize processing trade data and reduce costs and risk.”
This final point is significant. Reliance on inefficient post-trade processes not only increases costs for market participants, it also poses operational risk to the FX market.
“The only way to continue to support increasingly sophisticated front-end systems is to move quickly to increase investment in back-end system capabilities,” says John Halligan, president of Global Trading Analytics.
“While the initial costs will be onerous, the efficiencies gained will lead to long-term cost savings and a degree of reliability, which will protect the integrity of the FX markets into the future.”
Brian Charlick, from CGI’s risk and regulation financial services team, looks to the regulatory reporting environment as an example of how under-investment in post-trade activities can lead to increased operational risk.
“Tight implementation schedules and restricted budgets have led to many organizations creating a series of tactical solutions or engines for reporting, with some organizations having more than three different engines to create reports,” he says.
That’s a problem. There is heightened compliance risk because of multiple engines not always using the same source information for reporting, leading to reports sent to one regulator being different to those sent to another regulator for the same transaction.
“The level of manual workarounds used to ensure that reports are created, monitored and, where necessary, remediated creates additional cost and the threat of inconsistency and incorrect reporting, which can lead to fines and reputational damage,” adds Charlick.
As speed, ticket volumes and regulatory complexity increase, so too do operational and regulatory risk.
“Clients are now focusing on end-to-end solutions, where the post-trade aspects of a project are as important as the trading features,” says Mark Briant-Evans, director of FX at IHS Markit.
“We are seeing a genuine inflection point in post-trade, with even the largest market participants looking to standardize, outsource and mutualize the cost of their post-trade processing.”