The surge in electronic FX dealing is enabling corporates to use transaction cost analysis to better define, achieve and demonstrate best execution.

The old adage ‘what isn’t measured cannot be managed’ rings true for most aspects of a corporate treasurers’ work.

And in recent years, corporate treasurers, for various internal and external reasons, have placed a renewed interest in measuring, and thus managing, the effectiveness of their FX trading activity.

TCA: an introduction

Transaction cost analysis (TCA) is one of the most effective tools to do this. Offered by the large majority of dealer platforms and various other firms, TCA utilises a set of data and tools used to define, track and enable corporates to take the first steps toward establishing best practices for transacting in the currency market.

It does this by analysing the trade against a series of performance benchmarks. Most common is comparing the price achieved versus the market price, over the period of the order. The second common benchmark is the difference between the market price when the trade was made versus the average price actually achieved when completely filling the order.

In the FX market, analysis such as this is particularly useful given the fragmented OTC market structure and range of liquidity sources and execution methods, says John Cooley, Head of FXall at Thomson Reuters.

It is important to note, however, that best execution in the FX market doesn’t necessarily mean obtaining the best price for each trade. A long-term perspective needs to be applied to see the average pricing over a broader time horizon. Combined, short-term (deal to deal) and long-term (the average performance of trades over a three-month period) should enable treasurers to achieve a better understanding of their FX performance.

“TCA can then help a market participant make better decisions about when, where and how to trade,” says Cooley.

Corporate interest

Thomson Reuters’ Cooley is seeing a growing interest in TCA, especially amongst those companies with large trading flows and multiple counterparties.

“The growth of electronic trading has certainly facilitated TCA, because not only is the trade data more accessible but perhaps more importantly is the fact that time stamps of electronic trades are precise, which means the analysis can be much more accurate,” he says.

For corporate treasurers, the biggest benefit of doing this analysis is that it gives the ability to achieve better rates on high-value transactions by making better trading decisions.

And Cooley states that those decisions have become more complex. “For example, a treasury team may ask: what time of day is best for a particular currency? Which dealers should I ask to compete for a particular trade? What is a fair price given the size of the trade and current market conditions? Should I use an algorithm, and if so, which one? Effective TCA can help answer these questions.”

Code of conduct

Now might be a better time than any to take a renewed look at TCA, as best execution is set to come under the spotlight with the introduction of the new global code of conduct for foreign exchange.

Published by The Bank for International Settlements (BIS) Foreign Exchange Working Group (FXWG), the code of conduct identifies global best practices and processes that are meant to inform corporate practice, and assist in developing and reviewing internal procedures.

“The FX Global Code represents a big step forward in defining best practices and it applies to institutional market participants globally,” says Cooley.

“It covers, among other things, execution, risk management and compliance. TCA is very relevant to this because not only can it be part of an effective trading process, it all provides a tool for compliance and risk teams to identify potential off-market trades for review.”

Want to know more?

Hear more about the changes occurring in the FX landscape and how corporate treasurers can stay ahead of the game in our upcoming webinar with Thomson Reuters.