Buy Side Analyzes FX Trading Costs 

Terry Flanagan

Asset managers are increasing their transaction cost analysis spending in foreign exchange and their demands are becoming more sophisticated according to consultancy Aite Group.

In a report “Global FX Market Update 2015: Growth Spurts and Electronification Roadblocks”, Aite said fund managers have gradually moved from using TCA to analyse trades to managing trades.

“No longer are they just looking for data; today, they are also looking to their TCA providers to offer advice around that data,” added Aite. “In short, they want to know how to improve their trading process over time.”

The use of TCA will rise as foreign exchange trading moves way from voice trading. However the report found there is no conclusive data showing that the foreign exchange market is becoming more electronic. For example, in the UK, the share of voice transactions was 66% in April this year, up from 63% in April 2011.

Javier Paz, a senior analyst in Aite Group’s Wealth Management practice, said an email to Markets Media that resistance to electronic trading is relationship-driven with some clients choosing to concentrate their business with certain banks.

“The substantial share of voice FX swap volume being done by interdealer brokers (23% in UK, but only 8% in the US) has geographic differences where UK banks appear to be sending more FX swap business to interdealer brokers than US banks,” Paz added. “This could be due to regulatory differences and how banks’ capitalization requirements are being handled across the Atlantic when it comes to engaging in FX swaps activities.”

In the US FX swaps and FX forwards were exempted from the requirements for derivatives to be central cleared under the Dodd-Frank Act. However in the US this year the largest banks and asset managers began voluntarily reporting and centrally clearing FX non-deliverable forwards and FX options. The average daily volume of these two instruments is approximately $240bn according to Aite.

In Europe regulators will clarify their definition of a foreign exchange financial instrument in the consultation for the revised Markets in Financial Instruments Directive, MiFID II.

Earlier this week, France’s Societe Generale Corporate & Investment Banking said that its Newedge prime services business has added LCH.Clearnet as a new central clearer for foreign exchange allowing clients to clear non-deliverable forwards.

Gavin Wells, global head of ForexClear at LCH.Clearnet, said in a statement: “With existing members having cleared more than $2 trillion since launch and moves to mandate NDF clearing progressing, it is encouraging to see market participants proactively taking action to reap the benefits of clearing ahead of any potential move towards mandatory clearing.”

Paz said: “New regulations will certainly restrict the type of players who can play in certain markets. However falling spreads and transaction costs will have a much bigger impact on keeping new entrants out or nearly irrelevant than will regulations. This remains more than ever a market that requires scale to be profitable.”

The Aite report said the current over-the-counter foreign exchange has periods of strong growth alternating with flat growth or even temporary annual declines.

The study said: “As of April 2014, OTC FX trading volume at large fell roughly 8% relative to a year earlier, spot FX and FX options declined about 25% year over year, and FX swap volume actually increased 8% year over year. Due to a large increase in FX as well as cross-asset market volatility in Q3 2014, however, global FX volume entering Q4 2014 looks quite capable of pushing the year’s average up to $5.5 trillion per day.”

Paz said there  is a growing demand for emerging market currencies, particularly for the Chinese currency.  “Many European countries are positioning themselves as places seeking to have an edge when creating a market for offshore RMB trading,” he added.

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