World Without Currency Borders
By Steve Davis, General Manager, Business Development, M-DAQ
OTC FX and Exchange-traded products have traditionally been treated very separately. How do you see it going forward?
The various asset classes have traditionally had their own distinct alpha goals, regulation, trading/matching, risk management, settlement with distinct underlying technologies. With increased regulation arising out of the Global Financial Crisis and with the technological leaps made in trading capability over the last 10 years, there has been a significant and ongoing narrowing in this difference across the spectrum.
As an example, objectives such as achieving best execution and being able to source real liquidity (which are common place in the exchange- traded space) are becoming increasingly more relevant for OTC FX execution; as investors attempt to better understand the cost of execution right through the investment process.
Those who transact across both asset classes (e.g. cross border exchange traded product investors) and who are increasingly viewing their costs on a holistic level are looking for a more cost effective and transparent method. We are looking to address this issue as we bring together the prices of both assets to create a holistic price, whilst applying the same level of rigor to FX execution that is expected for exchange market execution.
Can you explain more about this “Holistic price”?
The objective is to make cross border trading easier, simpler and more certain by enabling users to price, trade and settle security transactions in the currency of their choice regardless of the base currency of the underlying security.
As increased focus is placed upon FX pricing, it’s become apparent that institutional investors are looking for more transparency and price competition. Retail investors are looking for an easier and more affordable opportunity to enter international equity markets.
From a pricing perspective we collate and aggregate live FX prices from the top 10 Global FX Liquidity Providers in numerous currency pairs, to produce our ‘M-DAQ’ FX price. We then apply these prices over the underlying security order book to create live virtual order books. These prices are live and executable, not indicative, and at the same time do not fragment existing equity liquidity pools.
To date exchanges that have wrestled with facilitating multi-currency trading and settlement have had to sacrifice trading liquidity by splitting that liquidity by currency. This fragmentation in turn has simply increased the costs of transacting in the underlying security.
You have talked about the positive impact on security trading but how does this approach add value on the FX side for cross border transactions?
There are a number of ways, the simplest of which is to improve the FX rate at point of execution. The best way to achieve this is not to relying on a single pricing method, i.e. having a single bank price the FX. By having competition for the FX price by the way of aggregation, the client will be assured of quality execution and essentially ‘Best Ex’ for FX.
Reducing the potential for FX volatility is another key aspect. Currently the majority of FX transactions related to exchange listed securities are done at a specific fixed points in time post security execution (often hours after). If the FX is transacted as the security is executed, analysis shows there is a significant reduction in FX volatility, which minimises the potential for loss of alpha.
You mention that FX providers are willing to facilitate M-DAQ pricing on a firm basis and without minimal size restrictions, is that characteristic of the OTC FX market?
No it is not. From single financial institutions through to established FX multi-dealer portals the provider/market-maker generally has the final decision (last look) on whether a quote rate is still valid for execution. In addition, participation is usually on minimum deal size basis (typically quarter-million or more) with the larger the size the more competitive the price.
The rise of HFT and electronic trading that is common place in the exchange traded world is becoming increasingly prevalent in FX and this has increased demand amongst FX Banks for non toxic flow to avoid being picked off. By providing our FX banks a venue that is underpinned by security transactions and hence non toxic, we have been able to align their pricing models to be more akin with what is in place in the exchange traded market today.