By Daniel Carpenter, CEO of Meritsoft (a Cognizant Company)
FX volatility rises in as monetary policies across the globe diverge, heads of desks will no doubt be working night and day on trading strategies that enable them to make returns. While the recent return of volatility to certain currency pairs may well open the door to profit making opportunities, investment banks will be left paying increasingly more in brokerage fees and brokerage houses operations teams will be hit with an increased operational workload.
Dealing with multiple client, all with different rate card structures, many of which are not digitised, becomes an even greater challenge during times of market turbulence. On a typical USD/EUR swaps or forwards contract, there is so much to consider: the currency pair itself, time-to-maturity of the asset, and whether the trade is being executed over the phone or electronically, among other factors.
While the information needed to calculate brokerage fees on a trade such as a complex currency swap will be available to the trading desk, the key data needed to justify passing along costs may not accompany it. After all, when prices are franticly changing from one second to the next, fees will invariably vary significantly. As a case point, a bank may receive a bill from their broker, reflecting numerous different types of FX trades. But how do they reconcile at a transaction level, before accurately calculating fees including appropriate trade discounts?
If this wasn’t enough, it can be extremely complicated for the bank to accrue the appropriate charges against the appropriate book. The challenge is, during bouts of price volatility, the exact amount that a counterparty broker charges a bank cannot be fully assessed until the bill comes in after the trades are completed. This presents somewhat of a problem as outlined in our post-trade survey report last year. The findings showed that more than half of respondents reported that very little automation is apparent in their processes for managing trade expense.
Banks can no longer afford to stick to old practices like waiting until the end of the month to pay trade expenses based on rough estimations for reconciliation purposes. With such extreme levels of price volatility, and lower margins driven by a competitive market, savings need to be identified daily. For instance, a bank may well be trying to execute a trade for a spread designed to profit from an uptick in the value of, say, USD/JPY, and a spread conversely aiming to profit when the value of the same pair falls.
The challenge is that if the bank in question can’t easily identify and track the different elements of the trade, there is no way for it to know which broker rate to apply. It may well be that, by the time the trade gets into the back office, all the broker sees is one element of the trade. Accuracy, timeliness and digitisation are key to ensuring, a bank does not end up paying more in fees.
While volatility has levelled off somewhat over the past week, if FX market participants have learnt one thing from the year to date, it is to expect the unexpected. Banks will need to get a better grasp of the intricate level of detail involved with trade expense. Brokerage is clearly under threat right now from an unpredictable forex market driven by the Fed returning to tighter monetary policies, which is why now is the time for banks to start to digitise and automate, and crucially turn these activities into a detailed daily process.