Commentary

Jos Schmidt
Traders Magazine Online News

Reducing the Regulatory Burden on Public Companies, Yes Please But...

In this commentary, NEO's Jos Schmidt discusses regulatory requirements and needs in the Canadian equity markets.

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August 1, 2013

Gaining Sway

Trade-cost analysis takes hold with currency traders

By James Armstrong

The dust is beginning to settle, after a string of lawsuits from pension plans and other institutional investors alleged that the sellside mishandled their foreign-exchange trades. While the courts are still working out whom is to blame, the buyside is turning its attention to how to address FX trading challenges in the future. More and more, they're using trade-cost analysis, a tool borrowed from the equity world, to improve FX trading and get better returns for their investors.

What they're discovering, however, is that TCA for currencies isn't the same as it is for equities. Firms who offer TCA for foreign-exchange transactions need to really understand the FX market. The buyside today is looking not just for firms experienced in transaction-cost analysis, but for experienced TCA firms that are also able to apply their analysis to foreign currencies.

"There's no question that undertaking transaction-cost analysis for FX takes a person with the expertise and knowledge to understand the risk management principles," said James McGeehan, co-founder and chief executive officer of FX Transparency, which provides TCA for currency trading. "The market is extraordinarily nuanced."

James McGeehan

With no set exchanges, currency trading takes place in a decentralized, over-the-counter marketplace where no public volume information exists. There's a "buyer beware" attitude, as participants are not automatically obligated to provide best execution. In a market with little regulatory oversight, trade-cost analysis can help buysiders feel confidence that they're getting a fair price. The complexities of the marketplace make TCA tricky for FX, but TCA providers-both brokers and independent vendors-are attempting to rise to the challenge.

According to McGeehan, the buyside started demanding TCA for FX in the wake of legal battles over substandard executions. In October 2009, California Attorney General Edmund Brown filed suit on behalf of the California Public Employees' Retirement System (CalPERS) and the California State Teachers' Retirement System (CalSTRS) alleging fraudulent pricing of foreign-currency trades. That triggered a string of lawsuits against custodian banks filed by buysiders saying they had gotten terrible execution on their FX trades.

"There was a wide swath of the market that was not prepared for those news headlines," McGeehan said. The result was that the buyside increasingly wanted TCA for their FX trades. "Some people jumped in right away, but I still believe there's a large piece of the market that needs this service."