Foreign Exchange. The world s largest market, turning over USD 5.4 trillion a day.

Transcription

1 Fixing FX

2 Foreign Exchange The world s largest market, turning over USD 5.4 trillion a day. Volume derives mainly from commercial drivers but with significant recent growth in speculative activity. For traditional asset managers FX is not usually a tool for speculation. FX activity driven by non-base currency denominated asset acquisition, disposal and hedging of FX risk whilst holding the asset. Execution is done within the asset management group, or by the custodian. Credit relationships are generally driven by the underlying investors and remain direct (and hence limited). 20/04/2015 New Change FX 2

3 The FX Market Today OTC market and likely to stay that way. Market-making has become an HFT business, much as in the equity markets. Banks are in decline as the main providers of FX prices we estimate that the HFT market is almost 50% of all pricing in spot. Banks that are market makers are effectively HFT shops. Forward (non-spot) trades remain a credit product requiring banks provision. Liquidity remains very good, and the cost of execution is under significant pressure for the reasons noted above. Unlikely that banks can continue to defend highly profitable, non-transparent business models in the current climate. 20/04/2015 New Change FX 3

4 Foreign Exchange Issues For Banks Regulatory fines point to significant conduct issues amongst banks. MiFID II, Best Execution, Treating Customers Fairly, Solvency rules all putting pressure on banks. Pressure on internalisation of deals. Why are spreads being charged? Pressure also from technology HFT is now how FX prices are made and many banks are behind the curve. Many banks are already non-participants in the market-making process - they simply recycle liquidity. We estimate that only a handful of banks are genuinely HFT market-makers. Many banks therefore represent a cost layer between market-makers and clients how will banks reflect this? Pure agency? Explicit fees for FX? 20/04/2015 New Change FX 4

5 Foreign Exchange Issues for Asset Managers Regulatory obligation to provide due diligence on FX execution process to clients including why certain fixes might be used. Need to better understand the FX business being done one CIO underestimated his own FX volumes to us by 95%. Regulatory obligation to ensure best execution very hard to define let alone achieve. Need to understand and manage costs both explicit and implicit and to achieve the best possible value for clients. Need to engage with better quality TCA and make this part of the process, not a tick-box exercise. Need to retain execution structures that are operationally robust and to change the outcome without changing the infrastructure 20/04/2015 New Change FX 5

6 Measuring FX Costs Highly complex process requiring an understanding of implicit (market impact) and explicit (spread from mid) costs. For example, the cost of executing at the WM/R 4pm fix does not lie in the relationship between the rate at 4pm and the WM/R fix rate but between the rate at 4pm and the average rate for the day. The explicit cost of the WM/R fix might be small(ish) but the market impact cost is large. The market impact cost is instant underperformance and applies in particular to very large orders, and to the use of a 4pm fix. The 4pm fix turns small orders that could be done cheaply into very large orders (Asset Managers are generally the same way round) that cannot be done cheaply. TCA therefore needs to reflect both the implicit and explicit costs before reaching a conclusion. 20/04/2015 New Change FX 6

7 Average Costs of using the 4pm fix GBP cost vs. Frequency Noon 4pm GBPUSD AUDUSD EURGBP EURUSD USDJPY Average Cost Noon 4pm Noon 4pm Noon 4pm Noon 4pm Noon 4pm Noon 4pm Average Cost , , , , , , Basis Point Cost /04/2015 New Change FX 7

8 Change in costs since the widening of the 4pm fixing window to 5 minutes (Feb 15 th ) costs in BPs Noon 4pm Noon 4pm Noon 4pm Noon 4pm Noon 4pm Noon 4pm GBPUSD AUDUSD EURGBP EURUSD USDJPY Average Cost Before Feb 15 (BPs) After Feb 15 (BPs) GBPUSD AUDUSD EURGBP EURUSD USDJPY Average Cost Noon 4pm Noon 4pm Noon 4pm Noon 4pm Noon 4pm Noon 4pm Before Feb 15 (BPs) After Feb 15 (BPs) % Change 39.13% 66.07% 10.59% 46.12% 26.49% -4.90% -8.08% 16.22% % % 3.95% 22.12% 20/04/2015 New Change FX 8

9 Bad TCA TCA in FX cannot be done simplistically. TCA in FX needs to contextualise deals in detail: Understand the whole execution process. Time of deal arrival. Time of execution. Establish proxies where these are not available. Never simply take a random point in time and measure all trades against this. Results using this methodology miss the majority of the costs. They miss costs because the method does not compare individual deals to the market in which they were executed at the time of execution. 20/04/2015 New Change FX 9

10 What do you really pay? Banks P&L from FX remains in the billions, and a very high percentage of overall P&L. Costs are still very high for asset managers - we estimate that asset managers pay 5bps/deal on average. Prime brokers and custodians still regularly overcharge for FX services. We see 10bps as a fee for FX done with these groups sometimes even expressed as an explicit fee over a variable spread. Any asset manager can achieve a spot execution cost of 2bps, and we have seen that 0.5bps is possible. 20/04/2015 New Change FX 10

11 What next? Value the FX business properly Asset Managers own liquidity and need to take advantage of the fact. Speed up! We live in an HFT world - asset managers have a great opportunity to take advantage. Turn FX from a cost to a benefit for no additional risk. Marginalise the non market-making banks with credit structures that split apart price and credit as the Hedge Fund industry did 15 years ago. Access better liquidity by cutting out the middle-man go directly to the HFT world. Ensure you reference your deals as they are executed. Use an independent reference rate, not one that your banks can affect. 20/04/2015 New Change FX 11

12 NCFX NCFX is the only TCA provider to collect and calculate FX data to ensure that our price stream is accurate and independent. We do not use data from Bloomberg or Reuters which is directly affected by your banks pricing activities. Data is collected approximately 1,000 times a minute to create accurate mid-rate information. We create our mid-rates in way that means that they reflect the true market values, and cannot be influenced by banks or brokers. Our rates are not available to trade on, but only as reference data. 20/04/2015 New Change FX 12