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And Finally…

There seems to be (finally!) general consensus that the Fix isn’t the best mechanism in its current form as my sources tell me Fix volumes are declining “sharply”. So, either it needs to be changed or new methods need to be found; the problem with the latter, however, raises another long standing issue of mine – market data.

Understandably, those asset managers that do actually think about their FX execution (ie the professional firms) are drifting away from the Fix as far as they are able. This is one of the positive outcomes of this whole sorry mess – finally, the asset manager, who for so long has had the best of both worlds, has come to realise there are better ways of operating.

Why do I say the best of both worlds? Well, because hiding behind tracking error they have been able for years to submit unreasonable orders to be executed without any risk. This is not risk transfer in the purest sense of the phrase – to me risk transfer is you ask someone for a price and deal. The Fix is an easy out for asset managers – they need a benchmark and the Fix provides it and if, into the bargain, the bank trader has a residue balance they are going to lose money on, “So what? They want to see my business.”

So allegations of fraudulent activity has had one good result – these people can no longer ignore the issue because their investors (people like you and me) are now aware of the issue and, hopefully, want something done about it.

The problem FX has, as has been discussed many times in this and other publications, is the lack of wholesale data to power transaction cost analysis or TCA. I applaud the recent Integral initiative to provide second-by-second data, as well as the raft of new products suddenly coming to market offering TCA, but this is an area we don’t want fragmentation – even across the banking industry.

Some time ago I argued that the issue of high/low was an accident waiting to happen, especially in the FX options space with barriers, because the mechanisms used now see less than 5% of daily spot volume – which is significantly different to the 15% they used to see.

My solution, such as it was, argued for a neutral provider to publish data from multiple sources, both public (ECNs and multibank portals) and private (single dealer platforms), and under certain criteria (multiple sources and minimum amounts to avoid abuse) the high/low would be set.

We are probably now at the stage where we need a ticker for spot markets. We again need a neutral provider, behind strictly protected Chinese Walls, to take in streaming data from multiple sources and publish rates accordingly for benchmarking. Integral is to be praised for doing this, especially for providing the data for free but unfortunately to support the size of trades these people are trying to execute we need a richer source of data, we need to know more about what is going on at more venues than one – even if that venue has multiple contributors.

The reason we need this is not for execution – again, repeating a long standing argument, total transparency and best execution do not go together – but to allow those executing to benchmark that action to an unarguable source of data.

TCA is the reason some customers are reluctant to use algos, both bank and privately provided; aggregated data will solve this issue.

This is not actually new, and I understand I have made this argument before, but new people are coming to this issue and sometimes we forget the basics behind the challenge of improving this mechanism. In fact, and I feel OK about breaking my independence to a degree by praising and naming an institution because this was such a good mechanism (it helps that they no longer exist!), this was done almost a decade ago with Lehman’s Algo Workbench.

Plenty have taken that methodology and enhanced it, but the core tenet of the strategy remains the idea today – take a customer order, guarantee them the mid-rate on the main market (in this it will be an aggregated market), charge the fee in a small spread and take the tracking error on your own books.

Better execution is possible but customers have yet to be convinced of the merits of the algos – better and more comprehensive market data will convince them. The FX market is a good moderniser and innovator – aggregated market data is an area it needs to modernise further.  Twitter: @lamboPnL

Profit & Loss

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