By Annie Walsh
Annie Walsh of CameronTec spoke to FX users to better understand the topical issues and challenges facing the OTC Foreign Exchange market and the central role FIX can play in addressing these challenges.
Undoubtedly the capital markets in 2011 will be remembered for many history-making moments including some of the largest currency moves the market can remember. We have witnessed the global foreign exchange market — the most liquid financial market in the world with an average daily turnover in the vicinity of USD4 trillion — bear the brunt of one political crisis after another, causing widespread volatility and difficult to pick currency moves.
Currency friction in Europe and between the US Administration and China will no doubt remain a prominent feature of the global economy for at least the next 1 – 2 years. On top of this remains uncertainty of government, particularly in Europe, and the implications for continuity of fiscal and monetary policy.
Many investment banks too in their search for alpha have been left wondering ”where did the black box get it wrong?” following lack lustre P&L performance, almost industry-wide over recent months.
Without a formal open or close, the FX market presents a true ‘follow the sun’ global market, with inherent levels of opportunity and risk.
Against this uncertain backdrop, the FIX Protocol has great potential to centrally feature in what is undoubtedly the single greatest threat (opportunity, if you prefer) facing the global OTC FX market. That is of structural uncertainty compounded by impending regulatory change to be ushered in, courtesy of Dodd Frank, and MIFID II and III.
With no unified or centrally cleared market for the majority of trades, and little cross-border regulation, due to the over-thecounter (OTC) nature of currency markets, these are rather a number of interconnected marketplaces, where different currencies’ instruments are traded. Inevitably OTC FX will move, however grudgingly, away from its long-standing (self-serving) model of self-regulation, toward greater levels of transparency, regulatory oversight (either directly or indirectly) and centralised clearing.
A Two Speed FX Market
As currently drafted, spot, outrightsand swaps are to be exempt from Dodd Frank’s requirement to be traded via Swap Execution Facilities (SEFs) and be centrally cleared; FX options, Cross Currency (CCY) swaps and Non-deliverable Forwards (ND Fs), however, are not. A perhaps unintended consequence of this two speed approach is the potential for jurisdictional arbitrage, product/financial re-engineering and further fragmentation of execution venues and liquidity.
In the short term, it also means that the sell-side needs to fundamentally reconsider strategies for design, development and deployment of Single Dealer Platforms (SDPs). Multi asset class SDPs will now necessarily evolve to become simultaneously both an execution venue as a destination and a gateway to a SEF, depending on the instrument traded.
Precision and Control
In either case, FIX has a critical role to play. Greater standardisation of tags and increasingly the FIXatdl initiative are now at the core of FX volume growth from the algo and HFT community; central to this is the standard’s ability to communicate not just a ‘where’ but also a ‘how’ and a ‘when’ with the order, as well as address post-trade workflow.
To varying degrees of sophistication and complexity, the buy-side will move increasingly towards substantially automated execution via EMS/OMS; this is already well entrenched behaviour among larger asset managers and the leveraged community and will inexorably move down the FX food chain. Widespread FIX acceptance and adoption, along with the portfolio effect will drive this change, particularly as FIX evolves to address FX options and ND Fs.
“The FX market is still evolving at a fast pace and will need to adapt to the new regulatory environment with a lot of new SEFs,” says Stephane Malrait, from Société Générale Corporate & Investment Banking. “FIX will have to play a critical role to reduce the connectivity cost for new trading platforms and help with the automation of workflow for new market participants. Société Générale will continue to lead the effort to improve the eCommerce workflow using FIX-based solutions.”
Max Colas of CameronTec says an industry standard like FIX is a natural choice to approach the entire market holistically: “Currency trading, perhaps more than any other asset class, is the one truly global 24×6 market where the distribution of market centres scattered around the globe and the straight forward relationships between currency pairs create arbitrage opportunities limited only by latency constraints and computer speed. This puts pressure on FIX technology to deliver superior performance in distributed, continuous landscapes.”
Nishikant Parit at the privately held, hedge fund management firm Soros Fund Management comments that without FIX it would not have been possible to achieve STP from their trading desk to the back office. “We used FIX to efficiently integrate multiple FX EMS platforms with our OMS. This has helped us optimize our systems to support our continuously evolving business needs.”
Systemic Risk Mitigation
For those involved in FX day to day, it will have come as no surprise that the OTC FX market, unlike other asset classes, weathered the financial crisis as well as it did. This was due, in no small part, to managed systemic risk associated with entrenched, long standing market convention and dealing protocols. While FIX cannot resolve credit risk, it will most certainly play a constructive role in mitigating settlement risk, in a post Dodd Frank world.
The FX market is uniquely characterised by its ability to continue to evolve, re-shape and re-invent itself. Whether you are buy-side, sell-side, ECN or SEF, FIX has great potential to centrally feature in its next iteration.