Q&A with Vikas Srivastava, Chief Revenue Officer, Integral, and Michael DuCharme, Head of Trading & Operations, Mesirow Financial
- What has been the most significant change in FX markets in the last year and why?
VS: Like all industries, the global pandemic has ushered in huge challenges for the FX markets and by far the biggest change has been the need to work from home. The institutional FX industry was set-up for people to work from trading desks, in offices, while surrounded by their trading infrastructure and support teams. To try and figure out how to manage a wholesale migration of this nature is something no one was prepared for or could have envisioned.
This shift occurred during the same period that we saw a huge volatility jump, hitting levels the FX market had not dealt with for some time. This brought its own set of unique challenges, with traders needing to deal with significant spikes in risk, all while working as a distributed workforce. It should come as no surprise that this led to accelerated structural changes, with a greater proportion of FX trading shifting towards electronic platforms in recent months, as well as greater adoption of cloud solutions.
2) How is this change affecting the market structure for FX? And what difference has working from home made?
MD: The pandemic has had a tremendous impact on FX markets, participants, and infrastructure. As Vikas mentions, we witnessed substantial volatility in mid-March, and we continue to grapple with reduced liquidity. The pandemic caused a massive decentralization in trading and operations with many participants successfully trading and handling post-trade activities from their kitchen table or bedside desk. That decentralization has worked amazingly well, giving rise to considerations about the advantages and disadvantages of continuing that model. For example, market participants might balance the potential savings from reduced office space requirements against the challenges of collaborating effectively when team members are dispersed.
VS: This decentralization brings greater unpredictability, and in this situation fund managers yearn for greater certainty from their liquidity providers (LPs) and technology partners. When your circle of interaction shrinks you are much more likely to fall back on your trusted relationships, as you can trade with greater confidence and reassurance. Working from home has made this a reality for many, who were without their colleagues and associates and, for those who didn’t have access to cloud and web-based platforms, access to the technology they needed to trade and manage risk effectively.
The shift by the buy-side to sourcing their liquidity directly from their LPs through single dealer platforms (SDPs) is evidence of this. The recent FX Turnover Survey for the US and UK showed that the move of the pendulum back to this reality of trading on SDPs was swift and sharp. It’s likely that this trading dynamic will remain as more fund managers enjoy the certainty and reliability of their banks when executing orders in an increasingly volatile market. As a technology company, we are seeing an increase in our sell-side clients seeking to upgrade their SDP systems and new clients looking to deploy SDP technology.
3) Is the buy-side interacting differently with FX as an asset class?
VS: The massive intervention by central banks has resulted in a stifling of volatility and risk in the fixed income markets. The risk that would typically appear in rates markets has found its way into FX markets instead, which is now functioning as a sort of pressure valve for macroeconomic developments. This is one of the reasons behind the greater volatility.
In recent years FX has been somewhat of an afterthought and biproduct in the process of constructing a portfolio, with fund managers engaging with FX for the purposes of hedging when considering their exposure to foreign assets. Due to the increase in FX volatility, while historical expected returns, risk, and correlations associated with fixed income assets have unravelled, fund managers are reassessing the role FX can play in their portfolio as they search for greater returns.
MD: At the same time we are seeing some changes in our currency risk management business. Clients are asking about better ways to manage liquidity, and some have expressed an interest in using currency options for hedging activity to enhance portfolio liquidity. We also see interest in outsourcing the FX trading function.
4) What trading behaviour changes has the buy-side made to manage the new risks?
MD: Technology has always been an important aspect of FX risk management, but the pandemic has put technology front and centre on most FX professionals’ agendas. Improvements in compliance, communications, and securing computer systems and processes are risk topics important to many buy-side members.
Additionally, the pandemic will accelerate FX participants’ drive to digitize their businesses, helping firms to become more electronic and less dependent on emails with PDF and excel workbook attachments. We have observed, however, that some old school ways of communicating resist being tossed on the junk heap of history: someone asked us to fax a document.
VS: I agree with Michael, especially as the buy-side has had to deal with tighter liquidity and higher volatility while working from home. As a result, we see buy-side traders focus their attention on electronic trading which is enabling them to achieve process automation while delivering on best execution to the asset owners.
5) How should the sell-side respond to these changes with their FX services?
VS: Fundamentally, as long as fund managers are working from home, an approach which is set to continue in some form or another for a while at least, there will be a need for direct provision of FX liquidity by their LPs on the sell-side. The desire for FX liquidity amongst fund managers will only increase if FX continues to experience high volatility. This provides an attractive business opportunity for banks and brokers.
Making the necessary changes within the bank to capture this market should be front of mind for decision makers. It is our opinion that the time to upgrade FX technology and take full advantage of recent and future changes is now. This is especially true at regional banks who can leverage their relationships with current and prospective clients to provide a reliable service.
MD: This is absolutely the case and taking a leadership role in promoting technological solutions and (gently) prodding their buy-side customers to participate electronically with them would be great for the industry. Sell-side firms often have more technological resources compared to the buy-side. Lending expertise, guidance, and advice to the buy-side would be greatly appreciated and likely highly beneficial to the FX community as a whole.