What’s Next for Foreign Exchange
What’s next for Foreign Exchange: In conversation with Matthew Reid, SimCorp and John McGrath, BidFX
Foreword by Matthew Reid, Product Manager, Director of SimCorp’s Order Manager solution.
With its far-reaching remit, MiFID II reshaped European institutional financial markets, with a series of measures that sought to address and improve Over The Counter (OTC) market transparency. Following the third anniversary of this landmark regulation, we take a look at the subsequent impact on the Foreign Exchange (FX) market, including rapid electronification, which has seen FX become one of the world’s most electronically traded asset-classes.
With an average of 80% of global transactions traded electronically, the FX market covers a number of instruments from Deliverable and Non-Deliverable FX forwards and Swaps, FX Options, and other FX derivatives, all of which come under the MiFID II instrument classification. Since 2018 and instigated by the European regulation, FX desks have made the move from a heavily manual order and execution process, to ensure an operationally effective approach that can demonstrate best execution and transaction reporting, while also accessing algorithms to enable an alternative source of liquidity to the classic RFQ approach. At the same time, the market has adopted innovation, in the form of cloud platforms, machine learning and even AI-enhanced workflows that work hand in hand with human talent.
While in the past, regulation may have been one driver for change, this year we have seen an altogether different force at play. The turbulence caused by the global pandemic had a significant impact on the FX market, creating unprecedented levels of volatility. The global uncertainty that ensued, led to a vicious cycle of dwindling appetite for risk and diminishing liquidity. While no market was left unturned, electronic trading provided some relief at least for FX, proving itself capable of delivering the scale needed, as firms found themselves both stretched by peak trading volumes and physically scattered across the world.
What is interesting is that while FX desks had the advantage of electronic trading and algos, over other asset classes, the crisis earlier in the year also saw a return to voice calls, as long-standing sell-side relationships were called upon in the scramble for liquidity. According to Greenwich Associates, two-thirds of FX market participants interviewed in their recent study said relationships became more important during the COVID-19 crisis, as the entire the FX ecosystem underwent a plunge in liquidity. While the two approaches – voice and electronic – may seem at odds with each other, Ken Monahan, Greenwich Associates summarizes that: “In reality, both can be true at the same time. The crisis demonstrated that, in extreme volatility, market participants need both relationships they can count on and effective alternative tools for sourcing liquidity and executing trades.”
Although much of the FX market has now returned to a new normal, with FX desks operating in a remote working COVID-19 environment, many firms including those lagging behind, are beginning to understand the value of electronification or digitalization, from execution and liquidity sourcing, to Transaction Cost Analysis (TCA) and more. At the same time, the rise of the OEMS, where Order Manager and Execution Management systems are consolidated to deliver firms a rich and holistic front office suite, has also demonstrated its ability to achieve improved operational efficiency, a valuable commodity under extreme market duress.
The combination of OEMS workflows has not only reduced manual processes, but more importantly delivered centralized, real-time, reliable access to data across portfolios and asset classes, empowered by an Investment Book of Record (IBOR). If the pandemic demonstrated anything to trading desks and portfolio managers, it is that this critical feature, is less a nice-to-have and more a strategic necessity, enabling firms to response rapidly to market events, and to the deluge of market data, which continues to add complexity.
The question remains, what lies ahead for the FX market as it attempts to lift itself out of the quagmire of 2020. Here, John McGrath, Chief Revenue Officer at BidFX, discusses the realities of the FX market today, and what it takes to achieve a consolidated OEMS workflow that can see firms through market volatility and deliver the operational resilience needed to ride out future events.
The growth of FX in long-only institutional investment
Matthew Reid: If we look at the growth of FX in long-only global institutions, it has mostly been used as a hedging exercise. More recently though, we’ve seen active trading grow steadily, as many investors are forced to go outside their domestic market to seek liquidity. It seems the need for scale has become considerable. What is your view on this?
John McGrath: Yes its true, the FX market has seen significant growth in recent years with Average Daily Volume (ADV) up from $4.3 trillion in 2009 to $6.7 trillion in 2019, according to the BIS surveys. Within this 10 year period long-only institutional investors have increasingly added more and more sophisticated technology to cater for the advanced needs of underlying investors, based on liquidity and regulatory/best execution concerns. For example a large buy-side firm with a centralized dealing desk and a fully integrated OEMS finds e-forex lends itself naturally to the integration of credit and trade limits, as well as capturing the best execution data required for underlying investors and TCA analysis.
One of the drivers for this growth in ADV has been the rise in FX Swaps as the preferred instrument of the long-only community. Its benefits as a hedging and currency management tool are well known and it is now well established across the market with deep liquidity and full integration from technology providers.
However this community has also seen increased adoption of a variety of other FX deal types in the past year, in particular FX algos, which saw a large growth in March this year, as the buy side look to use them more readily in times of market stress. The increase in spreads also saw algo usage grow from existing algo users, with many new users adopting it as an active strategy during the volatile market.
Matthew Reid: With this growth in mind, if we look at the rise of electronification and the automation it has created, there have been benefits realized for the buy side, such as optimized workflows. But what are some of the existing FX pain points that available solutions and services need to tackle, to turn those into opportunities too?
John McGrath: There is no doubt that COVID-19 has accelerated the roll out of new technology to respond to pain points being experienced by the buy side previously. Automation has long been an area long-only institutions have looked to achieve, in order to increase efficiency and optimize investment workflows.
The COVID-19 pandemic and the shift to remote working has seen FX follow other asset classes with an increased usage of automation across standard deal types and even to more sophisticated areas, like FX algo wheels. At the same time EMS platforms have seen high demand for automation within spreads, pricing, limits and volume, together with the need for closer integration with sophisticated OMS platforms, to ensure clients are well serviced in this area and delivered a holistic front office solution.
The market has reacted and with good resilience regarding automation and has demonstrated not only business continuity, but actually increased roll out of new technology despite remote working. With a widespread change in thinking towards remote working, as we have seen from many of the big institutions announcing future plans, this trend will continue and enterprise technology firms are well placed to respond to this demand.
That said, one pain point that that very few existing solutions and services have nailed, is the coverage of a multi-asset class EMS working in conjunction with a multi-asset class OMS. Achieving this really comes into its own, as the work being invested in one asset class can be rolled out across other asset classes. More importantly having one multi-asset view of your positions, holdings and cash across public and private markets, and strategies such as emerging markets FX, offers firms a clear advantage when it comes to investment decision making and risk management.
Other areas of growth in recent years that are being tackled by EMS/OMS providers and the buy side at large include the growth of algo usage and the increasing sophistication of TCA in FX. It seems most institutional investors now trust the leading EMS’s to deliver a total algo package, which integrates with their LP’s algo suite and allows them to manage this order flow along the lines of their standard risk and automated trades. Algo flow rose dramatically during the initial stages of lockdown this year (March/April), as the buy side looked for some form of comfort in a volatile and high-volume period. Another feature of algo development has been the implementation of more deal types, with Non-Deliverable Forward (NDF) algos seeing a large area of growth, as many of the sophisticated institutions looked to manage their more difficult non G10 liquidity requirements.
TCA has seen a similar surge in growth, with long-only institutions investing in OEMS technology, which has allowed TCA to really deliver some demonstratable results. This investment combined with an agnostic integration to 3rd party providers at an EMS level, has enabled institutions to make large strides in FX TCA. Working as a partnership, both Institutional investors and EMS, OMS providers with experience in this product, now have a real source of data in, which to monitor fiduciary responsibilities to their investors. Going forward the willingness and shared roadmap of leading multi-asset OEMS integrations, such as SimCorp and TradingScreen, have a real opportunity to drive product advancement in conjunction with their institutional clients, and this will be key to the continued growth in this area.
Matthew Reid: If we look at addressing multi-asset class coverage, rather than approaching FX in isolation, an approach many desks take, what developments are taking place in the market and at BidFX to facilitate firms with this?
In the long run, we believe those providers that can demonstrate a fully integrated OEMS, with multi-asset class coverage and a shared roadmap that also speaks to the key topics in FX; automation, TCA and algo usage, will be able to offer institutional investors the most comprehensive approach to FX.
By consolidating FX with other asset classes in the investment chain, particularly in the front office where the default has been to run it on point systems, FX desks can pool analytics and trading strategies, as well understand their exposure to risk in real-time. An example of this is the recent acquisition of BidFX by the Singapore Stock Exchange (SGX) , which has now enabled the integration of OTC and Listed FX, positively impacting many more investment processes beyond pure execution, including UMR.
The approach we have taken at BidFX to respond to the market need has really been about creating alliances and partnerships with leading providers of buy-side technology. It is our belief that the combined expertise between an enterprise and best of breed provider, together with engaged client feedback can create a strong solution enabling institutional investors to not only trust their technology but drive the maximum value out of it, to deliver returns.
As a result, we are very excited to continue to develop the alliance with SimCorp and our mutual clients by offering technology such as the support of partial fills within the OEMS framework. This allows clients the ability to gain better control of their FX flow and ultimately better returns for their investors. This is also demonstrated in our continued investment in the TCA space, which will be seamless in our integration with SimCorp. It is a very exciting time to be involved in such an alliance and working with clients to help deliver solutions that reduce pain points and deliver real benefits in their investment operations.
 *COVID-19 Shocks Will Continue to Shape Future FX Market Structure, (October 2020), Joan Weber, Greenwich Associates