Not all financial infrastructure is created equal. If you were to look under the hood of ten buy-side institutions, you would find diverse approaches, workflows and tools across operations, dealing and analytics – the essential processes that make up the infrastructure of modern FX trading. In and of itself, the inconsistency is not necessarily a problem. FX is after all an OTC market whose varied participants have different needs; there may be a form fits function to a firms processes.
Regardless of the particulars of a firms approach, market participants need to be cognizant of the strengths and weaknesses in their model and ensure that it is fit for purpose, scalable to support growth, and adaptable to keep pace with an evolving marketplace.
Working with firms that trade foreign exchange, we find that current infrastructures fall largely into three categories – dated, mixed and integrated.
Dated may sound harsh, but the truth is some firms still rely on manual processes, desktop solutions and stop-gap macros that have not aged gracefully. Such workflows, with their inherently limited straight-through processing (STP), are marked by readily identifiable operational hazards. They can also conceal more insidious risks, such as key-man, liquidity and measurement risk.
Established workflows are sometimes treated with an if it aint broke, dont fix it reverence, since they may have served their purpose for years. Sometimes these processes require workarounds, or have known quirks. It has to be asked: who knows these quirks? Who knows the origins of the process and how to support it? Sometimes the answers to such questions highlight the degree of key-man risk extant in the process.
Digging deeper, one finds these approaches may not be able to keep pace with a rapidly evolving marketplace and are disadvantaged in terms process-induced FX risk (market risk) and limited price discovery tools. Almost universally, dated infrastructure lacks metrics. Such a deficiency critically limits oversight functions and prohibits analysis-driven process improvements. Fortunately, a combination of falling technology costs and regulatory and client pressures have relegated this approach to a shrinking minority.
The mixed approach – the current industry standard – can involve vended or internal workflow tools and systems, across order management and execution management. Such workflows exhibit fairly high STP rates and may take advantage of off-the-shelf compatibility between platforms. Efficiency is driven by the specific systems in use and their degree of integration.
While vended FX dealing applications have included front office tools for some time, some have only recently rounded out their offering to include tools for the back office. Importantly, the less time the front office has to spend managing and handholding the workflow, chasing exceptions and managing workarounds, the more time they can spend focused on execution. Even a great trader is not going to be able to overcome an inefficient set up generating delayed or inaccurate data.
Many widely used FX execution management systems predate the FX markets embrace of transaction cost analysis (TCA). As such, this piece of the dealing process has manifested itself in a multitude of forms within the mixed approach. Firms have typically done one of three things: engaged the services of an external TCA provider (dedicated to FX, or multi-asset), leveraged tools from their EMS provider, or used internal resources to collect reference data and provide analysis.
The inclusion of analysis raises technical and process integration challenges. Regarding the technical side of things, data has to be retained, exchanged, scrubbed and shared to enable analysis by external parties. Benchmarks need to be established and refined to ensure the analysis is presented within the appropriate context of the dealing desks mandate. Lastly, is the analysis conducted simply to generate a report, check a box and cover RFP questions, or is the feedback of adequate quality to drive refinement in the FX dealing process? Useful analytics like netting rates, the duration (and magnitude) of open market risk and granular analysis of counterparty performance can all feed back into the process and improve it, if done correctly.
Truly integrated systems are where the FX market seems to be headed. With this approach, there is a central, vertically integrated workflow across trade generation, execution, settlement, reporting and analytics; this may also hold true across multiple asset classes. New platforms and tools have emerged in this space, furnished by start-ups, incumbents and banks alike. Depending on their heritage, some systems are biased toward the execution management space, others around operational elements. A limited number of firms possess the scale to develop these fully integrated workflows in-house.
The key difference between the integrated and mixed approach is that these systems are strategically built with change and growth in mind, rather than assembled piecemeal in response to one-off catalysts. Solutions that support execution and operations at all stages of the transaction, while seamlessly integrating analytics, are the most suited to the increasing complexity of the FX market.
The technology treadmill continues to spin in foreign exchange. Even more change is coming down the way, including systems that incorporate distributed ledger (blockchain) technology. Industry players that have made investments in a flexible, modern infrastructure will be best placed to keep pace. Firms should closely examine their current approach to make sure something thats already dated doesnt leave them far behind in tomorrows market.
John Turney is the Global Head of Outsourced FX at Northern Trust
