The words ‘best execution’ may be gaining in importance as FX increasingly becomes an actively managed asset class. But this simple phrase means a lot more than just asking three brokers for a price, according to Achim Walde, senior FX risk manager/currency overlay, Metzler. 
Metzler has a long and interesting history. Based in Frankfurt, Germany, the company can trace its origins back to 1674, when Benjamin Metzler established a trading company. Metzler operates both a bank and an asset management business. Achim Walde has been making decisions on FX for over 20 years. Now, however, the industry is changing under the pressure of unprecedented regulatory and technological shifts. These have highlighted the increasing complexity of doing business in the FX space. 
“Best execution is a must, but not everybody agrees what it means,” Walde told the Buy-side Perspectives. “If I ask three brokers for a price and take the cheapest one, I could say that’s best execution. But that’s too simple. To really offer best execution it’s not enough to only offer the best price right now in this moment, you also have to offer best price execution over longer time periods, such as the whole day or a whole week.”
For example, Walde says that a trader might want to get rid of a currency trade, such as Mexican peso, in the morning. Applying the standard best execution policy, the asset manager would ask three brokers and take the best price, but the result would not be best execution because the Mexican peso is not as liquid in the morning as the afternoon and the trader could have achieved a better price by waiting until then. The point, he says, is to ensure that the client is being given a good price for the product being traded. 
These examples illustrate the evolution of the market towards a sophistication not previously seen. Historically, FX has been organised around the daily fixings held by the key exchanges. Spot FX still moves heavily at those times; however now one of the key questions facing the active FX manager is how to maximise the efficiency of interactions in the market. It is here that the decision the asset manager makes about TCA becomes important. 
At the most basic level, the decision boils down to whether to buy or build a TCA solution. Buying a service off the shelf allows for a simpler, quicker process that can simply be plugged in with the minimum of hassle. However, building an in-house TCA system offers the prospect of greater customisation and control – and potentially better performance. Walde notes that Metzler opted to build its own TCA system rather than use a provider. 
“A permanent TCA is a necessity for FX and it should be part of best execution,” he said. “The challenge now is data. Increasing the quality of TCA would involve seeing not only the price but also volume, which is nearly impossible. When you look at equities you can see volume and price, but not FX right now. Because it is OTC, I don’t know if it is possible. But I would like to see it."
What can be done, however, is to expand the TCA to analyse the possibility of best execution across the whole day, or even a week, and to be able to see inter-day seasonality, i.e. changes in the way FX trades within the context of several days. 
Global regulations are of great importance to the asset manager trading FX. There are multiple sources of regulation that have an impact on the trading desk, including EMIR and MiFID II in Europe, and Dodd-Frank and the Volcker Rule in the US, the latter of which obliges European firms such as Metzler to keep special track of their American clients. Then there is the fallout from the Libor scandal and other examples of alleged rate-rigging by financial institutions over the last few years. 
The FX market can be a dangerous place for traders that do not consider carefully their actions, particularly with regulation and enforcement in mind. On 20 July 2016, Mark Johnson, global head of foreign exchange cash trading at HSBC was arrested at New York’s JFK airport. He was taken into police custody by the FBI; he is accused of defrauding clients and fraudulently manipulating a currency exchange deal worth billions of dollars to benefit himself and the bank. It is alleged that Johnson deliberately traded in front of a client in such a way as to cause the price to spike, pocketing millions for himself and the bank at the expense of the client.  
The FX market is changing in other ways as well. Buy-side firms are being forced to adapt to changes on the sell side, including the reduction of support. Walde notices that the real FX brokers are getting fewer in number and brokers are getting smaller. There are also free-to-ride platforms, but overall broker lists are getting shorter and banks have fewer resources in both research and liquidity. At the same time, the sell side is increasingly trying to convince the buy side to use trading algorithms, but Walde is not convinced. “We don’t use algos because we don’t understand it,” he said. “If you don’t understand something, you shouldn’t be using it, but we use our own quantitative models incorporated in our currency overlay management.”
The concentration of flows to the bulge-bracket banks may represent a threat to liquidity, according to Metzler’s analysis. This is because the contraction of the market can lead to inter-day volatility. If all participants in the market are attempting to trade in a single direction, it becomes very difficult or even impossible to find the other side for the trade. This may lead to black holes in the market. Walde is concerned about this tendency towards declining liquidity. While various electronic platforms have evolved in recent times partly to help fill that gap, Walde questions whether these are sufficient. “People running trading books and taking risk on it is what is needed, and a platform doesn’t do that directly,” he said. “I don’t see what they add. We don’t need more infrastructure, ultimately we need someone with a trading book.”
Perhaps the most controversial change however is the shift towards the multi-asset trading desk, which has affected everyone from equity traders to fixed income traders. There are multiple different approaches to multi-asset trading. At one end of the spectrum is the simplest kind of integration, in which traders from each of the different asset classes sit next to each other in the same room. At the other end of the spectrum are the asset management houses that encourage the individual traders to start trading more than one asset class – for example, an equity trader also trading some FX. 
Walde’s view on the former is unsparing. “Sitting the traders next to each other is not true multi-asset trading – it’s cost cutting,” he said. “Multi-asset desks are not being created because it’s a better way to trade. It’s just cost cutting. If you want to trade well, you should have a specialised FX trading desk.”
That’s not to say that the individual traders can’t necessarily learn from information relating to the other asset classes, however. “Cross-asset information is a necessary thing,” he added. “The FX trader will always look at the fixed income and equity markets for information but you don’t need to actually trade to do that. We don’t see the need for traders trading multiple asset classes at once.”
Some asset management firms lack the resources or the personnel to run a dedicated trading desk. In these cases, some firms use back-office or custodians to carry out FX trades. But Walde has some strong advice for those firms.
“Don’t do it,” he said. “If nobody wants to trade FX, then outsource it to another asset manager, but don’t use a custodian. They’re not an expert in FX. It’s a complete no-go.”