As the FX marketplace matures in the accessibility and transparency of currency pricing, the need to redefine and simplify workflows becomes paramount. The quality of electronic trading improvements has led to a bifurcation of trading requirements. On one end, high-touch orders requiring a significant amount of trader oversight have benefitted from enhancements in accessing market liquidity, often in conjunction with algorithms and/or other active trading strategies. At the other end of the spectrum, low-touch orders, trades with a smaller nominal value, still make up a large part of daily execution needs. Within the context of these low-touch orders, market demand for intelligent execution strategies coupled with an increasingly high focus on the quality of execution have driven the case for automation within FX Connect.
Managing low-touch orders inside an Execution Management System (EMS) such as FX Connect generally requires a similar level of detail to ensure best execution principles are met in the same capacity as high-touch orders, however, these smaller value deals can often comprise a substantial percentage of the overall daily execution blotter. This activity may detract a trader’s attention from more pressing needs; other asset class activity, general market surveillance or directly managing more sensitive FX executions.
Certainly, within the FX Connect platform, aggregating and netting currency exposure offers significant benefits to the asset owner and creates efficient execution pathways, but this opens up two interesting observations. First, and perhaps most importantly, what is the appropriate benchmark for any currency execution? Ideally, managing the execution at the point of incurring the FX liability is one thought process. If the FX execution can occur concurrently or just after the underlying security execution, an asset manager can reduce operational implementation shortfall and minimize volatility risk associated with waiting for a potential transaction opposite in direction and quantity. And this begets the second observation - does any trader have insight as to the certainty and timing of such potential transaction? This ‘operational implementation shortfall (OIS),’ defined as the opportunity cost incurred from the time of the security transaction completion to the arrival price on the FX Connect blotter, represents the target for automated workflows. The opportunity cost associated with OIS is equivalent to the uncompensated premium of selling a 24hr put or call option pro-rated for the amount of time the liability exists. In the context of an execution framework, netting is still beneficial, either cross-currency or same currency, however this benefit diminishes over time and typically with an hour from when the FX liability was created.
The need and benefit to netting transactions becomes suboptimal if the waiting time extends beyond a reasonable amount of time and the order is exposed to market volatility. The poster child for this type of implementation shortfall is clearly the day the SNB pulled out of the EUR/CHF and USD/CHF market, leading to a 25% appreciation of the CHF in a short amount of time. What’s the point of netting a transaction to reduce spread risk when the market has moved to that degree? A frequent response from the buy side tends to negate this volatility risk, typically along the lines of sometimes this favors the underlying account, and sometimes it doesn’t, but it all comes out in the wash. By identifying each fund’s unique execution benchmark, however, their best execution process can be managed and the benchmark risk reduced inherent to any underlying currency transaction.
Different in many ways from an algorithmic strategy, automated execution workflows can simplify and accelerate the execution process. The execution of the low-touch orders can be completely automated within FX Connect and managed via a number of user defined rules. Execution parameters may include counterparty restrictions and minimum number of banks quoting, as well as aggregated spread. Even in the context of potentially high levels of automation, the trading oversight can be managed from an entirely hands-off viewpoint to a fully managed process, all the while creating execution efficiencies for the trader. When synthesized with the underlying security transaction, automated execution can significantly reduce both operational and actual implementation shortfall. However, the measurement and refinement of any execution process demands independent analytics to implement a justifiable and repeatable execution process in accordance with market and regulatory evolution. To help complete the execution lifecycle, BestX, the industry standard for FX TCA, operates independently within the FX Connect GUI, and allows clients’ access to the feedback loop critical in evaluating and improving execution performance.