Recent changes in the regulation of foreign exchange (FX), bonds and over-the-counter (OTC) products bring challenges to traders, corporate treasurers, and portfolio managers when evaluating the performance of their trading decisions.
For many firms, the question, “How much does my FX trading cost?” is a challenging one to answer. Unlike equities, pricing for most FX transactions, along with bonds and OTC derivatives, contains no explicit transaction costs. Market makers bundle transaction costs into the bid/offer spread charged to customers, often making it difficult to unbundle the charges to see the exact price paid to execute the trade.
Recent headlines have brought increased attention to the legal and settlement costs incurred by a number of financial institutions in the $5.3 trillion per day FX marketplace. In addition, fragmentation of liquidity and reduced trading capital from banks are further intensifying both firms’ scrutiny over trading costs and the pressure to reduce them.
Regulatory changes due to the implementation of Dodd-Frank across a wide range of OTC derivatives have brought unprecedented changes to the trading environment. The traditional market makers for FX face increased capital requirements for trading activities.
At the same time, FX customers have lost confidence in traditional execution methods, such as reliance on custody bank execution and FX fixing orders. The traditional participants in the market are pulling back due to increased cost of capital, while investors and dealers consider the move from principal to agency trading. Firms need improved analytics to evaluate the cost of executing trades via the myriad of existing options -- such as direct trading relationships with banks and brokers; voice and electronic execution modes; order placement on ECNs, ATS, and SEFs; and algorithmic execution.
The expansion of platforms for trading exacerbates the challenge of understanding where the true market for an instrument stands and how to execute the trade to achieve the lowest total transaction cost. To get a full picture of the marketplace, firms need to scan and monitor across dozens of potential venues, including traditional bank trading platforms, ECNs, and alternative market makers. While on the surface liquidity appears deep, this can quickly evaporate under market stress.
Therefore, transparency is essential. Firms need to understand the market environment throughout the life of the order, from the accumulation of the position, to the posting and execution of the order. Market timing and market impact are important components, especially when people are moving large orders or when hedging positions around the release of economic indicators, market closes, or FX fixing times.Minor Huffman is Senior Vice President for FX Trading for SunGard's global trading business. He has over 25 years of experience in the financial services industry. Prior to joining SunGard in June 2014, Minor was the Global Head of Rates technology at Credit Suisse and the ... View Full Bio