Credit is not allocated or managed correctly at trading venues in real time and the person bearing the credit risk is often the last to know.
That, at least, is the view of Adrian Patten, co-founder and chairman of Cobalt, an FX-focused fintech company, in a recent market commentary. To make things worse, Patten adds, many risk systems sit downstream and are slow, requiring manual processes.
Patten’s comments were made in the context of promoting Cobalt’s own low-latency credit-management solution, and need to be seen in that light. But others do not disagree.
Henry Wilkes, chief executive of Point FX, claims that risk technology systems cannot keep pace with real-time automated trading systems.
“Credit management is a major challenge for the foreign exchange industry,” he says, “and it is essential that the technology infrastructure that supports the credit and risk function is radically upgraded to be able to manage live credit management, creating a more efficient and transparent process for all market participants.”
Tracking and managing credit in a live environment should also give institutions and clients more flexibility and protection from large losses, allowing market participants to unwind trades in an orderly fashion without increasing risk.
Perhaps it is time for a shift in focus towards the buy side, empowering them to better control their credit limits and in turn, allowing both liquidity providers and prime brokers to fairly allocate credit across the market.
That is certainly the view of Jean-Philippe Malé, chief executive of BidFX, who also notes a reliance on the manual handling of processes within credit risk management. He suggests the market will move towards a central network for automated credit allocation, driven by distributed ledger technology.
Such comments are music to the ears of companies such as Cobalt that reckon the answer to improved credit management lies in blockchain-based solutions.
Even those who believe that methodologies for evaluating, measuring and real-time monitoring of risk have improved greatly over the last four years – both on the principal and prime broking sides of FX businesses – accept that current processes are not perfect.
“It has become more challenging to manage credit in an efficient way because clients trade across many platforms, and each platform has its own credit limit with varying methodologies,” says Audra Scharf, director of FXall.
Credit providers split their total credit appetite among various platforms, ensuring that their exposure stays within their overall client limit. The aggregate credit available on all platforms generally exceeds the actual credit appetite of the credit provider, but there would be obvious appeal in having a single location from where credit providers could track overall exposure and platform limits could be rebalanced based systematically on actual utilization.
Despite room for improvement, ParFX COO Roger Rutherford reckons FX credit and risk management processes have been transformed over the last decade and that adoption of electronic trading, growth of algorithms, proliferation of trading venues and greater number of counterparties have all had an impact on the way credit is allocated and managed.
“Larger institutions have best-in-class credit management systems that are automated and allow counterparties to track and manage their exposure in real time,” he says. “This has been complemented by the emergence of specialist vendors that help less sophisticated firms with credit management.”
In relation to manual processes, credit providers still need to manually update credit limits on a number of platforms. Automating this process and allowing for credit limits to be updated via a programme interface would enable credit providers to update limits systematically, based on inputs from their internal risk management/credit systems.
Jon Watras, head of sales for Asia-Pacific for Cboe FX, reckons his platform does a pretty good job in this respect. While it has counterparties trading in their own name, it is heavily reliant on prime brokerage connections and has taken a number of steps to assist prime brokers.
“The only manual process is that when the broker wants to update credit lines, they log into a web portal GUI [graphical user interface] and make these changes,” he says. “But if a prime broker wants to avoid the manual steps of managing limits and integrate with its credit technology, it can do so by integrating with our credit API.”
FastMatch also offers an application programme interface to credit managers to facilitate real-time management of credit for firms trading on its platform. Clients trading bilaterally via private broker credit then default to its central counterparty clearing house when credit is fully utilised, which allows trading to continue in times when it would otherwise cease.