Treasury Today Country Profiles in association with Citi

e-FX: panning for the golden solution

Panning for gold in the water

The foreign exchange (FX) market has become swamped with offerings from vendors, both existing platform providers and new entrants, and corporates may find it difficult to choose the solution most appropriate for their needs. This article aims to shed some light on the latest e-FX trends in order to assist with this selection process.

Merely a decade ago, FX traders revolved around the central limit order books but now there are an increasing number of point-to-point connections within the industry, according to Phil Weisberg, CEO at FXall. “As the industry rapidly evolved, market participants battled to reach the finish line first – and succeeded in building up a slightly disjointed, decentralised infrastructure. Now people are trying to figure out how to rationalise all of that and look at it in a more holistic way,” he says.

There are many different FX platforms in the market today – inter-bank platforms, aggregators, ECNs (for anonymous aggregation of pricing) and multi-bank platforms. Electronic FX trading has been the market standard for inter-bank transactions for ten or more years with “strong single bank trading tools offered by all international banks”, according to Alfred Buder, European Treasurer at Flextronics. And large corporates were swift to follow this trend. Research published in 2011 by GreySpark Partners and Best Execution indicated that over 60% of FX deals are now conducted online – and predicted that this figure will reach 90% by 2014. “Trading online is so much better, safer and more economical than old-fashioned phone trading,” says Buder, “and multi-bank platforms are fast becoming the market standard.”

FX arms race

Around five years ago, it was believed that multi-bank platforms would dominate the corporate FX field – it made sense as corporates were looking for quotes from various banks. However, the reality was that the same banks that were supplying quotes to these multi-bank platforms were also investing heavily in their own single dealer platforms. As a result, together with the fact that corporate traders were loathed to disrupt longstanding service relationships with their banks (and possibly give up the best possible pricing), single bank FX platforms have been giving multi-bank platforms a real run for their money (as outlined in the January 2012 edition of Treasury Today).

But the balance is beginning to shift again. Established multi-bank platforms are pulling out all the stops to compete with these comprehensive single bank tools. FXall, for example, has recently announced (July 2012) that clients are now able to submit FX option request for quotes (RFQs) to multiple banks and execute the deal electronically on the same platform they use for trading in spot, forwards, swaps, and non-deliverable forwards (NDFs).

Moreover, the multi-bank e-FX space has grown quite dramatically and consistently, not least because the end users (who used to trade primarily over the telephone) can now get the same benefits of using multiple trading counterparties, while also reducing manual input, improving STP and reporting – and retaining the breadth and depth of product.

It’s not just about price and convenience anymore; established multi-bank platforms are placing a lot more focus on the FX trader and are making the market aware of this fact. Says Tod Van Name, Head of Bloomberg FX: “We have made considerable changes over the past few years to enhance the functionality of our platform and to improve our clients’ workflow. The updates we make are reviewed carefully with both the unique needs of our users and the impact to the broader FX market in mind. Those in the business for the long run really appreciate that.”

Van Name agrees that shifts to multi-bank e-FX are taking place and notes that the flow in volume across the available platforms – particularly the inter-bank platform – has declined simply because there are other alternatives. “As technology changes, people are looking for alternatives that may increase their efficiency and may reduce their transaction cost. Some ambitious vendors are now trying to take advantage of that requirement,” he says.

Opportunity knocks?

Against this backdrop, the FX industry as a whole is rethinking how its infrastructure and processes are working – and this naturally gives new market entrants the opportunity to break into the FX bubble. Or that is the theory. In today’s dynamic FX environment, an overwhelming number of new trading platforms (eg traFXpure) and services (eg FXSpotStream) are being released – with high hopes.

Some of these new offerings have been built in co-operation with specific liquidity providers who are looking for alternative ways to access the market in order to keep transaction costs down. This primarily involves trading over application programming interfaces (APIs) as opposed to systems where you have to click and deal, according to Van Name.

The bulk of these new products tend to benefit the bank-to-bank or inter-bank market and were developed as a result of high frequency trading (HFT) concerns and the kind of liquidity that HFT brings into the market place. “Some of these products have been introduced in an attempt to keep that liquidity pool more amenable to the liquidity providers themselves,” he says. Yet, Van Name is quick to point out that he does not believe a wholesale shift in the way the corporate markets trade right now is likely.

Buder, too, does not see a much diversified FX trading market in the near future as the new offerings are simply not giving the corporate treasurer what they want. “A corporate treasury department can only work with a few tools and these have to be embedded in a straight through process,” he says. Staying with one platform that can provide this smooth end-to-end functionality seems to be more important to the corporate treasurer today than shopping around many of the new initiatives – and understandably so.

FXall’s Weisberg remains sceptical about the success of the new ventures in the long run – one reason being that the cost of the enterprise is often underestimated by the ambitious vendor. History hasn’t yet written itself for the new entrants (many of the products are still at nascent stage) but for now, Weisberg feels that the global economic turmoil is pushing many entrepreneurs to walk away from loss-making ventures a lot quicker than they perhaps would have before. “It took [FXall] three years of losses before we managed to break even so we understand that it is very difficult to succeed in this industry. You have to be committed for the long run. And we are in an environment where the market seems to be unforgiving for ventures that are losing money,” he says.

So what can ensure, or at least aid, the success of any new FX entrant to the market? What must they be aware of and who can they learn from?

Old dog, new tricks

There have been several multi-bank platforms that have stood the test of time and have continued to innovate in-house over the years to adapt to the market’s needs, with FXall and Bloomberg’s FXGO among the market leaders. Chris Bae, Global co-head of FX Trading at Bank of America Merrill Lynch says that the experience and infrastructure in FX client solutions that several top tier venues have cultivated over the years are invaluable. For example, the algorithmic (algo) trading option – which these providers offer, among many other services – has become increasingly popular among the more ‘adventurous’ in the corporate space (see this month’s Question Answered for more on algo trading). FXall recently (June 2012) rolled out the algo facility to the market as part of a strategy to broaden the range of execution methods through their multi-bank platform while Bloomberg has been offering a form of algo trading since 2009. Recognising and adapting to these changing trends is essential to the success of a platform provider in such a competitive space.

It has worked for FXall – voted best independent multi-bank platform for the eleventh consecutive year running in 2012 – whose philosophy has been to use the same set of core technology and adapt it to the unique needs of their clients. “We leveraged 80% of our technology across clients where possible and that allowed our liquidity providers to use their existing interfaces with us,” says Weisberg. “Then we were able to adapt 20% of the system to be customised to the unique needs of each of our different client segments. It has been an effective economic model for us because replicating everything for each individual client set creates niches that are too small or expensive to serve,” he says. By serving multiple segments, while taking care of all the individual requirements, FXall’s business model allows its users the opportunity to learn about and utilise newly developed features across segments.

Similarly, Bloomberg’s FXGO platform is being recognised for its established reliability and capability in fulfilling the needs of market participants. Vodafone Hutchison Australia (VHA) is using the platform to manage FX risk, execute FX trades and obtain requests for quotes. Describing drivers for the deal with Bloomberg, Robert Partos, VHA’s External Treasury Manager, says that VHA had four main requirements: FX dealing, interest rate swap dealing, month-end valuations, and sensitivity analysis. “Since Bloomberg has come online, we have been able to use the system for counterparty analysis. This has been really useful as it feeds directly into our monthly reports.”

A feature or a company?

For any newcomers determined to challenge these established players, being able to differentiate between a feature and a company may be the key to their future success. Features are easily replicated by other players in the marketplace but companies are much more difficult to reproduce. When launching something new, the effort – and expense – of building the entire company infrastructure around a concept must be accurately determined, says Weisberg. “The bar is pretty high in financial services: it is increasingly becoming a regulated market; you need to have the ability to have the adequate legal coverage; and you must have a strong balance sheet that shows longevity and substantial resources for investment. A specific feature can be added on when required but it’s hard to justify an entire company being built around that,” he says.

Feature in a company

Options have only recently been introduced to the multi-bank e-FX market because of the product complexity and the fact that participants highly value their relationship with liquidity providers and the intermediation service that is provided by the dealing community. When FXall began to offer live option pricing on its platform, the challenge was to enhance the commitment that clients and liquidity providers have to each other rather than destroying it, according to Weisberg. “We’re aiming to add more value to the whole workflow and that allows the clients and providers to spend more time on risk management.”

Company around a feature

Price aggregation has been around for quite a while and there are many companies that offer this service. For certain FX market participants, aggregation could be beneficial but for a large segment of users in the market place – particularly real money accounts and corporations – aggregation does not bring all that much in terms of added benefit, says Van Name. “The spot market itself has become so narrowly priced and is such a commodity, I’m not really sure there is a tremendous amount of value in being able to narrow the spreads much more than that,” he says, offering the following example, “Foreign exchange on EURUSD now trades on five decimal places. A tenth of a tic on a million euros equates to ten US dollars in the difference between bid and offer.”

A good listener

But let’s put the old/new provider, single/multi-bank platform argument aside for now. The main goal here – regardless of vendor – is determining what the end user wants. Says Bae: “What’s important for Bank of America Merrill Lynch is that we find the venues and vendors that speak to what the clients’ needs are. So, while there does seem to be a wide range of innovation out there – for us, the filtering mechanism we employ in choosing a certain vendor involves adhering to those criteria.”

FX market participants looking to trade forwards or outrights or currencies that are outside of the major currency pairs will require an experienced provider that can offer a tailor-made solution and the relevant functionality. Furthermore, the ability to execute those trades on a straight through processing (STP) basis, providing optimum transparency for reporting is fast becoming a widespread demand. (With basic price aggregation services, this additional functionality would have to be sought elsewhere.) The corporate requirements include:

End-to-end functionality

Not only have the number of responsibilities of the corporate treasurer grown, but so too have the spectrum of risks that they are required to manage: commodity risk, interest rate risk, credit risk, and of course FX risk. Having a solution that can do the bulk of the trade (pre- and post-execution) is the ideal. Says Bloomberg’s Van Name: “We cater for the pre-trade analytics that go into understanding the news and impact of economic events that are driving the markets before you actually trade. Following the execution of those trades, the post-trade analytics (ie monitoring mark-market, daily revaluation) across multiple asset classes can be assessed.”

Regulatory compliance

Corporate treasurers are now looking for what platform/providers can do to help them remain compliant while not disrupting the flow of business. “If end users are not exempt from regulation and have to trade NDFs or FX options, they will want to trade on a platform that allows them to trade in the same way that they have been accustomed to before, but obeying the more recent rules,” says Van Name.

Same end goals

The more successful vendors have demonstrated that they listen to, and learn from, client feedback. “At this point in time, it’s crucial that FX vendors are listening to the requirements and needs of end users, given the dynamic nature of the market and competing products,” Bae says.

Decision time

At the same time, corporates need to pick platforms that are supported by and linked to their relationship banks, according to Buder, and this automatically limits the selection boundaries. “That usually eliminates a lot of providers and leaves corporates with the decision to either use a couple of single-bank platforms or one of the market leading multi-bank platforms,” he says.

For those credible vendors that fulfil the range of criteria listed above, though, the corporate trader needs to work with them on a consistent basis, giving the right feedback to assist product evolution. A long-term commitment to enhancing the product and continuing to raise the service level is an essential component in the chosen provider’s business model, according to Weisberg. “It’s very difficult to look across all the available platforms as the features that are important to many of the clients are going to end up in most of the systems. It is really a question of the full suite of capabilities, commitment to the market and customers, and how people run their businesses,” he says.