FX in flux
The search for best execution and best pricing leads FX customers to new systems, new platforms and new relationships.
Volatile currency prices, the imminent arrival of a new European regulatory directive for trading financial instruments and a series of market-rigging scandals are hastening a transformation of the largest of global markets: foreign exchange. Much of the current wave of change, however, revolves around the perennial focal point of pricing, as large corporations, financial institutions and institutional investors, facing imperatives to cut costs and boost returns, struggle to ensure they are obtaining best execution.
Greenwich Associates’ 2015 Foreign Exchange Services Study, conducted between September and November of last year, found that top-tier users of FX services credited execution/pricing for 45% of the value added by FX service providers. The second-most-important element, day-to-day sales coverage, was credited with only 17% of value added, while other factors – including relationship management, research and breadth of FX product offerings – were rated as being of far less importance.
The types of transactions used in the FX market have barely changed: swaps and spot and outright forward contracts still composed almost the entire universe in 2015, with a sliver (4%) left over for FX options. But where and how transactions are executed, and with whom, is changing quite a bit. No other market is so dominated by electronic trading as foreign exchange, in great part because it is widely seen as a way to reduce transaction costs. Almost three out of four (73%) users said they traded online last year; this group reported that 76% of their total FX trading volume was done electronically, up from 75% in 2014.
Another route to better execution is to expand the range of providers. While the vast majority (95%) of users work exclusively with banks, a few are now trading through non bank liquidity providers as well. Among these, 20% of total volume is now traded with non banks, up from 16% in 2014. The magnitude of users’ non bank transactions may be considerably larger, however, since much of this business is conducted anonymously.
FX users continue to move to multi-dealer platforms as well, 50% of study participants who trade electronically saying they accessed them in 2015, up slightly from the year before. Meanwhile, use of single-dealer platforms continued to decline, from 13% to 12%, as did phone- based trade placement, from 18% to 17%. Messaging systems on Bloomberg and Reuters also saw volume fall, from 10% to 9%, in part due to revelations of trader collusion in online chat rooms.
What is not changing much, however, is the average number of FX dealers that corporations and institutions use. While hedge funds and insurance companies have increased their number of relationships very slightly, fund managers and pension funds have held steady or even reduced the number of dealers they do business with. Study participants reported that their top three dealers still received 69% of their trading volume last year – unchanged from 2014. This may be partly a matter of preference – these clients still see the largest FX market players as providing them some advantages – and partly an effect of consolidation in the Financial sector.
Online, however, FX users trading electronically continue to move away from single-bank and proprietary systems. Only 37% of respondents said they used these types of systems last year, down from 40% in 2014 and 42% in 2013, while the proportion using third-party or multi-dealer systems rose slightly, from 75% to 76%, over the past year. But these numbers mask a lot of variation. The smallest-volume users – those placing less than $1 billion in trades – remain less inclined to use multi-dealer systems, 62% saying they did so in 2015, compared with 78% of those placing over $50 billion.
While FX users in most regions are moving their business to third-party and multi-dealer systems, the pace varies. In the US (74%), the UK (79%), Japan (72%), and Continental Europe (83%), the demand for multi-dealer systems is overwhelming. But in Asia, excluding Japan and Australia, 70% of users say they still place FX trades via single-bank systems, and 46% say they utilize both. This may reﬂect long-standing relationships with major banks that FX users still feel they need to operate in a complex region with multiple currencies.
However, FX users everywhere still have a long way to go to understand whether they are getting the best pricing and execution, and why. Only 17% of study participants said they used Transaction Cost Analysis (TCA) in 2015, up just a bit from 15% the prior year.
TCA is most heavily utilized in the US, but only by 27% of FX users; in Japan, a mere 4% do so. Globally, TCA only achieves widespread use among hedge funds and commodity trading advisors (42%); of corporates, only 8% practice it. Greenwich Associates will be looking more closely at FX users’ adoption of TCA, and other developments in their search for best execution, in an upcoming Greenwich Report.
About the author
Kevin McPartland leads Greenwich Associates market structure and technology research and has nearly 15 years of capital markets industry experience with a deep expertise in OTC
derivatives and financial services technology. Prior to joining the firm, McPartland was with BlackRock, where he was a director in the Electronic Trading and Market Structure group. Prior to joining BlackRock, he was a Principal at TABB Group, where he founded and led the firm’s Fixed-Income research practice. McPartland also spent time at JPMorgan, UBS and Deutsche Bank in varying capacities.
Download the full white paper: Eyes on the Price: What Next for FX Transactions Cost Analysis?