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The Balance of Trading: Is Matching the Answer?

As pressure on fund managers from underperforming equity markets has grown, so too has the search for increased returns from currency hedging or trading activities. More and more, managers are looking to enhance their returns by a few percentage points through better currency management.

Randy DuRie, partner at Summit,New Jersey-based Plimsoll Capital, expects the boom in currency overlay business to continue, and says, “From our viewpoint, there is great value in providing FX services to equity and fixed income managers. This can be done at a very low cost but can be a big gain for them – a few percentage points may not sound much but it can be the difference between an average and a good return. It is a question of core competencies – we are currently in discussion with several managers about this issue.”

One way to improve returns, according to some, is the provision of a matching system for managers, similar to that of EBS or Reuters 2000-2 in the interbank market. Doug York, senior vice president of trading at Campbell & Company, a Towson, Maryland-based CTA established in 1972 that currently manages around $3.5 billion, is a self-confessed zealot in his belief that a matching system will ultimately increase foreign exchange volumes. This is not to say that he believes the banks do not have a role to play in the FX markets – far from it. But he is firmly of the opinion that greater transparency for companies such as his would lead to an even greater volume of business for the banks – albeit on a reduced margin.

The matching concept finds solid support amongst many of the fund managers contacted for this article, several of whom have experience of the concept through their participation on Hotspot FXi, a matching platform that commenced operations earlier this year (see page 31). One fund on the Hotspot system suggests that greater exposure to matching would encourage many more managers into the market to offer currency overlay and other hedging services, thus providing the industry with an impetus for growth.

But the biggest barrier to such a marketplace is, believes York, the banks themselves. “They are wary of the concept because they fear disintermediation,” he says. “The banks believe that if you rolled out EBS for example – which I know is not possible – we would do all of our business on it and they would be cut out of the process. This is simply not right. Were such an event to occur, I doubt we would do more than 25% of our business over a matching system because we still need our banks to warehouse risk and be involved in the risk transference function.”

The fundamental doubt, York says, is that the banks believe that the matching concept will permanently and irreversibly damage their industry, but that the major buy side players believe it will actually expand their business. “Getting the answer to that quandary is at the core of the issue,” he adds, “But in our case, I can say that having a matching engine will increase our volumes.

“As a model player, being able to benefit from reduced spreads on a portion of our business enables us to trade much more,” he continues. “The scaling will of course be different firm by firm, but the reality is that less spread will increase volumes. The trade-off for the banks is, ‘Do you want to see more business with reduced spreads or vice versa?’ Banks are concerned about losing both market share and spread, but it is a paradox to try to preserve both.”

To illustrate his argument, York points to the explosion in trading on Eurex. “We trade on Eurex. There is a best bid and offer as well as the opportunity to look at the depth of market and place our own orders. This is true transparency. Our traders and researchers look at the depth of market, as well as volumes at each price point, and the increased transparency they see generates more business from us as an institution,” he says.

DuRie agrees that there are many benefits to be had from matching; however, he does not feel that Plimsoll is at a stage in which it needs it. “Matching can improve returns and some of our banks already allow us to place bids and offers on their systems and leave orders,” he says. “If there is a way for us to trade with other companies like ourselves and the credit issue was solved, it would be great, I can see the value in that but I think that there still needs to be someone in the middle.”

Prime Brokerage

The credit issue is seen by many as a block to an industry-wide matching system. However, there are two counter arguments. The first is the wider use of prime brokerage; a service that York says is “very valuable and highly appreciated by the buy side” and is at the heart of the Hotspot FXi offering.

“Prime brokerage is a solution to the credit issue, and fees appear to be contracting which tells me it is still a growing business,” says York. “We have recently been pitched prime brokerage at competitive rates, with superior STP and great prime broker spot execution. This lowers the effective rate, provides order consolidation, greatly enhances confidentiality and streamlines operations.”

One of the keys to solving the credit issue and to negotiating a strong advisor/prime broker relationship on the credit front is, York believes, to engage spoke banks that are leading institutions with very high quality credit. Campbell tends to deal no more than three months out, he adds, and posts “hundreds of millions of dollars” in collateral on these trades. “I think we are in a sweet spot as far as credit is concerned, and CLS [Continuous Linked Settlement] will improve things further,” he adds. “If a firm’s leverage is low – ours is four- or five-to-one and frequently below that – and it is responsible, with a diversified portfolio, then I do not think credit should be an issue. It needs to be recognised that the majority of firms using prime brokerage are using alpha spoke banks – we are talking very strong bank profiles and credit ratings. This makes the structure more desirable for the prime broker.”

Market Making

Murray Gunn, investment director at Edinburgh-based Standard Life Investments, says his company’s view on matching is more pragmatic. “Although we are obligated to get the best price, we do recognise that a role of the banks in the FX market is to make markets – and for that they need to be paid. We pay the spread to make up for the fact that we are not market makers. We provide one-way liquidity, but we are not what you would call market makers.”

Gunn also sees dangers to market depth if matching takes on a greater role. “If no-one is getting paid for making markets,” he says, “Liquidity could drop off sharply. A matching system works efficiently in the equity markets, but I am not convinced of its value to the wider FX market. We could see a lot more swings if market makers disappear, the market could be all bids or offers – it’s a danger.”

York is of the opinion that if the banks can be convinced of the value of true transparency, they will be better disposed to the idea of a matching engine. “It is not only about Campbell & Company’s volumes increasing, greater transparency is of interest to a much wider range of buy side clients. There are a lot of smaller businesses in all industries that currently do not hedge their currency risk because spreads are too wide and they don’t trust the process. If you knock down the barriers to free trade in the form of greater transparency, it would build confidence in many of these companies and ultimately raise volumes for banks.”


The subject of matching for the buy side and the issues surrounding it fascinate many, but it remains just part of the overall argument of the FX support services given by banks to the fund management community – indeed it is part of the overall debate over active or passive currency management.

York acknowledges that the banking industry provides a lot of innovation for global equity and fixed income managers, but suspects that the leveraged trading sector may not rank as highly in some banks’ business priorities. “Give us true transparency and we will transact more business,” he says. “This is not about eliminating the spread; it is about dealing closer to the theoretical mid-rate. We recognise that there is a spread in everything – our discussion is about marginally reducing that spread.”

York is aware that in many cases the corporate-bank relationship is dominant, something that can be a hindrance to the leveraged sector which has a significantly different profile. “I want to raise awareness within the banking industry of the needs of the leveraged trading sector,” he says. “The corporate often pays for its FX services through ancillary services such as the debt revolver, research and other traditional banking services. My paradigm is that if there are 19 high volume corporates and one leveraged player, the banks are less willing to let us realise our goal of increasing volumes at the expense of lower spreads on their corporate business.”


For Gunn, the interest going forward lies not in levelling the playing field so much as in widening the e-commerce net to the whole treasury function. “We will be putting our minds to how we can trade money markets on an e-commerce platform,” he says, “There is an argument for trading the options we use online, but I am not convinced they are suitable. Once you have STP for vanilla FX, there is little more to be done, so efforts have to be directed elsewhere.”

Gunn sees e-commerce coming into its own with a vengeance if moves – currently derailed – towards T+1 settlement are successful. “The whole push towards T+1 provides e-commerce with a big opportunity,” he says. “Currently, fund managers like ourselves deal in foreign equities throughout the day, then amalgamate them and trade the FX the next day. This cannot be done under T+1, so you would find that the fund manager would have to execute a huge number of small trades throughout the day rather than a few trades.

“I can envisage a time when the equity or bond trader puts a deal into a trade management system,” he continues. “Which then automatically goes to the e-commerce platform, gets the best FX rate and executes. When or if T+1 happens, I think e-commerce will come into its own.”

But for York, the biggest issue is in getting the banks to consider the merits of a matching engine. He accepts that any change will come slowly and grudgingly, and expresses the hope that it does not come too late in the overall regulatory scheme. “If we can achieve the trade-off between higher volume and narrower spreads – and I stress we are talking about narrower spreads as opposed to no spread – the banks will still see benefits from our business in terms of market information. It is worth remembering that a lot of the value in trading with a high volume player such as ourselves is in the flow, not the spread. The banks want to know what we are doing. They may make a narrow margin on the deal – and they don’t always – but they can use the flow to build a picture of the market for their client base. Maximising flow information is what dealing with us is really about and we accept this reality.”

If firms like Campbell are to achieve their aim, they accept that this means the market will have to “tinker with the holy grail of corporate profitability”. In terms of global businesses, he puts currency revenues in the top 10 of all industries and feels that eventually bank margins may narrow.

“Show me one industry sector in the world where margins and revenues have not narrowed dramatically over the past three years,” he says. “Automotives, energy, computers and tobacco have all felt the squeeze. In spite of the banks telling us they are facing similar pressures, they continue to make more money. My limited view as a buy side player is that if currency revenues were reduced in the next decade due to greater transparency, the current daily FX volume of $1.2 trillion could grow to two or three trillion dollars. It will not happen quickly because it will take many years to convince a lot of buy side players that true transparency exists.

“The banks’ job is to protect the information arbitrage and the spread. Ours is to reduce it – not eradicate it. This is a common issue to all buy and sell side relationships globally, across many industries. It is not about eliminating the profit margin, it is about achieving a compromise that benefits both sides equally. A higher volume of business at a lower margin does not necessarily mean lower profits,” says York.

This debate will no doubt continue to run, but ultimately, if enough buy side interest is there, someone will come along to meet those needs.

Profit & Loss

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