Buyside to Buyside FX Trading On the Rise

Terry Flanagan

Buyside firms are increasingly trading spot foreign exchange with rival asset managers as banks open up their trading venues to new clients according to consultancy GreySpark Partners.

Russell Dinnage, senior consultant at Greyspark, told Markets Media that foreign exchange is moving to an equities-like environment as electronic trading increases and the provision of spot FX liquidity becomes a utility.

“The sellside will then need to incentivise clients to stay with them by offering a package of services that no-one else can provide and more banks are offering buyside clients access to FX platforms through their prime brokerage businesses,” Dinnage added.

The GreySpark report, Trends in FX Trading 2014, said that fund managers are increasingly accessing spot FX liquidity by trading with other asset managers in venues that were previously only for banks.

Dinnage said the top tier banks all have similiar trading platforms but as electronic volumes increase, they have to offer additional services in order to gain share.

“The Tier 1 broker-dealers all have single dealer platforms which are very sophisticated and volume friendly and which were all originally developed for principal trading,” he added. “They are slowly moving into a new philosophy for flow FX which is an agency trading model where they act as middlemen.”

The consultancy found that at least three Tier 1 banks are offering direct market access to their buyside clients to electronically trade spot FX in inter-dealer spot FX trading venues. Other banks also allow their clients direct connectivity access to inter-dealer spot FX platforms using bank ID codes.

The consultancy said the changes in spot FX trading could lead to increased electronic volumes in instruments as regulations encourage a shift from over-the-counter markets to exchange-traded products.

Dinnage said: “Under SEF regulations and best execution requirements it will be expensive for banks to access niche liquidity in FX options and non deliverable forwards. If they offer relatively standardised product on an exchange the buyside will be open to it.”

The report said sellside non deliverable forward trading could disappear completely and be replaced by exchange-traded futures.

On September 15 CME said in a statement that it reached a record in open interest for FX futures and options of the notional equivalent of $309bn. The US derivatives exchange said it had taken overtaken the previous record of $286bn on March 19 2013.

As the trading environment changes, another option for banks is to offer FX transaction cost analysis but Dinnage said the buyside does not normally trust banks to provide transparent analysis in any asset class.

“It would definitely be advantageous to the sell side to offer TCA if they solve the integrity issue on seeming impartial,” added Dinnage. “It is more likely that independent third party vendors will sell TCA benchmarks to the sellside and buyside.”

Michael Sparkes, director, APR at agency broker ITG Europe, said in a blog in August this year that TCA for the FX market is coming into the spotlight. ITG began offering TCA for FX in 2010.

Sparkes wrote: “As shown in ITG’s recent report on tradable data between London and New York before and after the 4pm fix, the costs from the order arrival time until trade execution are on average 17 basis points, 20% of the time. This is crucial as 17 basis points of implementation shortfall for up to 20% of all days can potentially cost asset managers millions of dollars of value lost from their funds.”

ITG said that as electronic trading drives new strategies in FX asset managers need pre-trade analysis on topics such as selection of algorithms selection, the performance of trading venues, the most effective time of day to trade a given currency pair and when to use an electronic platform rather than calling a bank.

“It really is a classic case of using data to support the decision making process,” wrote Sparkes. “As we move forward, asset managers who achieve competitive advantage will be the ones that adopt this approach in order to evolve their trading strategies in FX.”

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