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Forex Trading

TCA and FX best execution: Why now and how?

Jill Sigelbaum

10 Sep 2018

FX best execution and the TCA approach. Photography: Carlos Barria
To sculpt an effective, enduring FX TCA program, market participants need to be mindful of the challenges, such as sourcing market data and securing accurate time stamps. Photography: Carlos Barria

The growing focus on FX best execution is leading to greater adoption of transaction cost analysis (TCA) tools. How can market participants establish a successful FX TCA program?


  1. MiFID II requirements and cost pressures are driving the buy side to focus more on FX best execution, driving industry adoption of sophisticated TCA solutions.
  2. Rather than just relying on FX TCA reports generated by liquidity providers, the industry is adopting independent TCA solutions that enable like-for-like comparisons of provider performance.
  3. Among other challenges, market participants should carefully consider whether their trade execution lends itself to effective TCA, and whether they have accurate time stamps across their end-to-end trading workflow.

A lot has happened in the foreign exchange (FX) market in the decade since the financial crisis.

First and foremost, regulation and heightened conduct standards have placed increased demands on market participants to implement fair and transparent FX trading practices.

European investment firms, in particular, are facing new and onerous requirements under MiFID II to take “all sufficient steps” to obtain the best possible results for their clients when executing orders, rather than just “all reasonable steps”.

In addition, competition and cost pressures have driven market participants on the buy-side to focus a lot more on lowering transaction costs in order to improve overall returns.

This all adds up to greater industry-wide focus on sophisticated tools for best execution using FX transaction cost analysis (TCA).

What is the current state of FX best execution?

Historically, the pursuit of FX best execution has been fairly limited outside equity markets, with FX and other over-the-counter (OTC) markets lagging in TCA adoption.

Several factors explain this lag.

As FX exposures often arise off the back of international bond or equity investments, they are sometimes an afterthought for fund managers, with less consideration given to the quality of their FX execution as a potential drag on performance.

Furthermore, one major obstacle to conducting TCA in OTC markets is that market data is less readily available than in exchange-traded markets.

The fragmented and OTC nature of the FX market creates significant challenges sourcing market data that is comprehensive enough to calculate the appropriate price benchmarks necessary for TCA.

However, due to the aforementioned industry dynamics, buy-side traders today are compelled to pay closer attention to their FX execution, and as a result the industry’s TCA capabilities are evolving rapidly and growing in sophistication.

In parallel, the buy-side is becoming more informed, increasingly using analytics on a post-trade basis to assess the quality of their historical execution and to identify opportunities for improvement.

On a pre-trade basis, it can also drive trading decisions, such as which venue to trade on, at what time of day, or with which algo.

FXall trade performance analytics
By comparing client trading activity with market volumes and spreads, clients can pinpoint the most opportunistic time windows to execute their orders.

FX TCA: The key considerations

When market participants commit to establishing an FX TCA program, they should consider a few key questions:

  1. What are your objectives?

The first step should be outlining the objectives of your TCA program.

Do you need to demonstrate compliance with your best execution policy? Are you looking to gain a competitive edge by lowering transaction costs?

While MiFID II is raising the bar for proving FX best execution, the adoption of TCA is also driven by buy-side traders seeking to execute orders in the most cost-efficient way possible.

The execution of large block trades remains a pain point for the industry, especially in a world of heightened capital requirements restricting banks’ appetite to take execution risk.

With the advanced algo and TCA solutions now being developed for FX, the buy-side is now better equipped than ever to execute such orders with minimized market impact.

Clearly defining what you aim to achieve with TCA will help guide your approach and find a TCA solution that fits your needs, whether that is to meet FX best execution reporting requirements, or to drive trading decisions, embedded within your trading workflow.

  1. What is your benchmark?

Benchmark selection is a key aspect of TCA and should be given significant attention.

The most appropriate benchmark to use will differ from one market participant to another, depending on factors such as their fund mandates or the objectives of their execution desk.

Commonly used benchmarks include an average rate over the relevant trading window (e.g. a TWAP for example); a benchmark fixing (e.g. the WMR rates); or the prevailing mid, bid, or offer price at a given point in time on the primary markets, which offer a representative view of the overall FX market.

Once you have identified the appropriate benchmarks against which to measure your execution performance, carefully consider the data sources and methodologies used to compile them.

A seemingly simple TWAP benchmark could be calculated differently by different liquidity providers, resulting in inconsistent comparisons.

Furthermore, a discrepancy in the market data sources used to calculate a given benchmark could yield material differences.

  1. Does your current trade execution lend itself to demonstrating FX best execution?

Market participants can greatly improve the effectiveness of their TCA program by ensuring a few simple principles are followed.

The first is leveraging electronic execution.

FX best execution requirements are driving further adoption of electronic trading, since electronic execution provides increased transparency through an audit trail of quotes, prices and time stamps — all essential elements for effective transaction cost analysis.

The industry is still experiencing some growing pains with time stamps.

These are necessary to assess potential execution slippage across the life-cycle of the trade, from the time of origination by the portfolio manager, to the time the execution desk submits the order into the market and it gets filled (potentially over a period of time if it’s an algo trade).

Participants should carefully evaluate their end-to-end trading workflow, including their order and execution management systems, as this will ensure these time stamps are accurately captured and stored, and made available for TCA.

The second is receiving competitive pricing. As regulators and asset owners increasingly pressure the buy-side to achieve and prove best execution, trading volumes continue to shift to electronic trading platforms where trades are executed on a competitive basis.

Multi-bank platforms allow market participants to receive quotes and streaming prices from multiple providers simultaneously, and to deal on the best price.

The winning quote, losing quotes, and trade details are all recorded and available to demonstrate that the trader acted on the best price received from a panel of liquidity providers.

  1. How will you compare your trade execution consistently across liquidity providers?

TCA can provide concrete data that market participants can use to have more meaningful conversations with their liquidity providers about pricing.

However, it is crucial to assess providers through a consistent TCA framework in order to ensure like-for-like comparisons.

Information such as average spreads paid to each provider, or the percentage of winning quotes submitted by each provider, allows participants to compare the performance of their providers.

This information can inform traders’ provider selection process, and encourage providers to adjust their pricing in order to win more deals.

FXall trade performance analytics
Analyzing provider performance across numerous factors allows clients to have more meaningful conversations with their banks about the pricing they receive.

This kind of analysis is best conducted by independent TCA solutions.

Rather than solely relying on TCA reports generated by the providers themselves, the industry is adopting TCA solutions that are independent of the liquidity providers and assess provider performance in a uniform manner, enabling like-for-like comparisons.

While TCA is viewed by some as more art than science, rigorously addressing the aspects outlined above will provide a sound basis for the implementation of a comprehensive FX TCA program.

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