Deal or no deal: anatomy of an FX portal

Published: Jun 2013

There is no doubt that the natural evolution of foreign exchange (FX) dealing has seen it move well beyond its early status as a by-product of international business and into a space where more opportunistic FX traders (such as hedge funds) work with it to make considerable profit. According to bank-owned settlement infrastructure provider, CLS, FX is now the largest financial market by value.

The evolution of FX as a vital part of global commerce has brought a number of complex derivatives – and matching technologies – that, whilst enabling traders to be more in control of the risk, have also attracted the attention of regulatory measures, such as the latest Dodd-Frank and Markets in Financial Instruments Direct (MiFID) requirements regarding transparency, record keeping and reporting.

Indeed, as regulation around financial services increases, electronic solutions appear even more attractive because they offer the kind of audit trails and reporting functionality that old-fashioned voice trading does not. Few corporates look at their treasury as a profit centre, and the precise determination of when and how they trade is often something they do collaboratively with their banks: price and convenience may be hugely important in some deals but the relationship side of FX for corporates is equally so, especially in tough economic times.

There are three ‘buy-side’ models. Voice trading (over the telephone) is often favoured for large or complex orders. The other two rely on web-based portals and are offered as single-bank (eg bi-lateral) or multi-bank trading variants. It is not a case of either/or, but rather of using the most appropriate tool for the circumstances.

e-Portals make their mark

As the name suggests, the multi-bank portal allows users to obtain a range of prices, products and services from a range of banks whereas the single-bank option delivers the same from just one bank.

The single-bank option was first to appear. In the early days, a request for quote (RFQ) model was used. The treasurer would log in to the bank’s website, state how much was needed of a required currency, and receive within 30 seconds or so an automated quote. Once that offer was accepted all the downstream processes, such as clearing and settlement, had to be executed offline. Continual investment by banks in their technology has today created greater levels of automation and facilitated ever-lower latency of price streaming, more akin to professional traders’ requirements, to the point where users can instantly see the depth of liquidity in the market.

Few corporates look at their treasury as a profit centre, and the precise determination of when and how they trade is often something they do collaboratively with their banks.

The sophistication and capability of a system’s functionality today tends to be driven from the top downwards by the needs of the financial institution (FI) and pro-trader market, but the way in which users wish to work and interface with these systems tends to be driven from the bottom upwards by the needs of the retail market. In other words, users want a simple, intuitive interface but with all the clever behind-the-scenes trickery garnered from the top end of the market.

With the high levels of FX trade flow a system is required to handle, many pre and post-trade services have also been integrated with platforms to try to create as much of a straight through processing (STP) environment as possible. For corporates, trades are usually integrated up front into an order management or trade planning system and then uploaded into the FX platform before execution, with automated booking of these trades back into the treasury management system (TMS) or spreadsheet.

For a treasurer, the choice between single or multi-bank platform seems obvious at face value. Why wouldn’t they sign up for a multi-bank FX portal and get the lowest price at the click of button? Certainly the multi-bank portal’s arrival was seen by some observers as the death knell for single-bank platforms. But it has not been the case. Why?

It may be that the treasurer does not execute a sufficient number of trades to warrant subscribing to a multi-bank portal. But there may be another factor at play too. Just as retail supermarkets don’t always come out on top for customers when factors such as service, product knowledge, advice and even customer loyalty are factored in with price, so multi-bank portals may not always deliver best execution for a corporate treasurer. Another factor often considered when trading is the need to spread the share of the corporate wallet. Quid pro quo, a treasury may wish to ensure that its banks are getting a fair share of its business – even if that means a particular FX trade is executed on a non-competitive basis. The reason is simple: they may not want a certain bank – especially one with which they have a valuable line of credit – to pull the plug on the relationship because it was deemed unprofitable.

If one thing is certain, it is that the treasurer is yet to be presented with a one-size-fits-all FX solution and that until such a tool is made available, it is essential to understand the pros and cons of each in order to make the most appropriate choice in each situation.

All change as multi-bank portals arrive

In the late 1990s, encouraged by the rapid uptake of the internet for business purposes (driven in part by rising consumer confidence in web-based transactional tools), players in the banking and technology communities saw a niche in the FX market. Corporate treasurers were typically engaging in multiple bilateral relationships with liquidity providers. The new connectivity technologies would enable treasurers to request and receive FX prices from multiple banks, and place orders, all in ultra-fast time, through one central platform. A number of multi-bank platforms hit the market around mid-2001.

For the corporate, these portals promised more than just a convenient price discovery tool. They could also deliver workflow, enabling treasurers to see all their accounts, trades and the scope of their portfolios in one place. With further integration into SWIFT (via the automated MT101 request for transfer message) and the Continuous Linked Settlement (CLS) system, such a combination would eventually deliver post-trade services, right through to clearing and settlement. Connectivity between the front end of a TMS and corporate back office functions became a reality in October 2012 for 360T’s multi-bank FX trading platform, when it announced that Kyriba was to integrate it into its own software-as-a-service (SaaS) delivered TMS.

But the early rush to join the multi-bank platform race ended almost as soon as it began for some, with SunGard’s system, part of its STN Treasury unit, and Citigroup, Deutsche Bank and J.P. Morgan Chase’s Atriax failing to make the grade within a year or two of hitting the market. The (short) list of those that survived includes FXAlliance (aka FXall, a business originally owned by a consortium of 16 banks, but since July 2012 a part of Thomson Reuters), the aforementioned independent German-based global provider, 360T and the State Street-owned Currenex.

However, the breadth of products, currencies and liquidity providers available on each of these – and later arrivals such as Bloomberg’s FXGO – has flourished. Platforms now typically cover electronic trading across the range of instruments including spot, forward outrights, swaps, non-direct forwards (NDFs), options and deposits. All seek to add value in as much as users can access functions such as market surveillance, statistical and comparative analysis and portfolio and risk management. The number of banks available to trade with will vary by platform, but most major institutions will make themselves available in this way to their corporate clients.

At the technological heart of all multi-bank FX portals is the electronic communication network (ECN). For web-based FX trading, this has been around since 1999, being first offered by New York-based Matchbook FX. Multi-bank platform providers today, such as Currenex, Bloomberg, 360T, FXall and Knight Capital’s Hotspot FX, use it to stream quotes from the world’s major banks. Because ECN is a live exchange-type order book driven by spreads on all quotes, buy-side users (often FIs, but sometimes the pro-traders of MNCs) can actually move prices. Using an ECN-enabled platform means traders generally enjoy improved price transparency and faster processing than single-bank portals, whilst the highly automated process enables banks to lower their costs and widen margins.

Multi-bank versus single-bank

Why multi-bank? The multi-bank vendor argument against voice-trading is that treasurers seeking price differential this way will call their usual panel of banks for quotes, but by the time they have done the rounds the market may have moved away from them. The multi-bank portal automates the RFQ process, making it faster and more efficient. But large and complex deals may still require human interaction, this being borne out by the observation that very large trades remain resolutely voice-based.

The riposte to the single-bank model from a multi-bank perspective is that a major corporate is likely over time to accumulate a multitude of portals to manage. Arguably too, pricing is less favourable when there is no competition. But FX tends only to be part of a relationship and a wise bank will deliver greater benefits to the corporate that gives it a greater share of its wallet.

In terms of FX this may include extras such as client-specific pre and post-trade functionality. When a corporate transacts through its bank’s own platform, it may also have access to the bank’s proprietary trading algorithms and be able to automate its own trading preferences for best execution. This is a valuable selling point that has not gone unnoticed by multi-bank provider, FXall. Since mid-2012 it has been able to deliver some of these algorithms through its own platform, starting with Credit Suisse, Deutsche Bank, Goldman Sachs and J.P. Morgan. This suggests that more of a partnership exists between the three parties than had previously existed, perhaps because banks have realised that they can reach a wider corporate base if they make themselves more readily available to their clients, and platform providers know they do not have the benefits of extended corporate relationships.

In practice, a multi-bank portal will offer a range of execution methods. The traditional RFQ model, as discussed above, remains the dominant model. Other trading models, such as portfolio-trading (which facilitates trades across multiple allocations, currencies and forward dates) and active or direct access trading (which provides price streaming) require a higher degree of trader-sophistication, often reserved for in-house corporate traders, FIs or professional traders.

Most banks that have developed a one-to-one FX portal will retain it because there will always be clients that at one time or another have reason not to use a multi-bank option. There may be clients for whom the cost savings are irrelevant or are outweighed by other considerations. Indeed, if a corporate has a regular line of trade with a bank it may be that the bank’s FX portal effectively becomes a gateway to other benefits. Anecdotal evidence even suggests that some banks have been actively upping liquidity for favoured clients using their proprietary channel. Banks that have been investing in the well-being of their proprietary FX portal are effectively doing so as a means of investing in their client relationships, providing access to the whole pre-trade, trade, and post-trade value-chain (which may include underlying services such as trade finance or letters of credit (LCs) as opposed to just thinking about the narrow trading processes.

The multi-bank portal automates the RFQ process, making it faster and more efficient. But large and complex deals may still require human interaction, this being borne out by the observation that very large trades remain resolutely voice-based.

For all these reasons, the advent of the multi-bank portal has not overseen the demise of the single-bank option (nor voice trading). The advantages of multi-bank portals are obvious and many corporates have adopted them with relish (one enthusiastic group treasurer told Treasury Today that on savings alone his system paid for itself in just six weeks). But banks are in a unique position of being able to steer clients towards the most appropriate solution at that time, whether that means voice trading, their proprietary FX portal or a multi-bank platform.

There are clearly roles for all and the likelihood is that most corporates will continue to pick and choose the platform and the trades that suit them best, which means providers need to keep all channels open and work with the flow, not against it.

Don’t forget to ask…

When choosing a platform provider, treasurers will need to match the kind of instruments they wish to trade to those that the platform is able to deliver. But if the need is to trade in any significant volume, there is also a need to understand exactly the level of automation being offered, particularly around trade uploading (some systems may require manual shifting of files).

Most systems now offer a high degree of STP and treasurers will gain efficiencies trading electronically, but the degree to which execution and reporting of both competitive and non-competitive trading is enabled is important for treasurers even if ‘non-competitive’ trading is an alien concept for FI users.

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