Costs of FX Transactions Prove Elusive

Terry Flanagan

Measuring transaction costs on foreign exchange trading is difficult because the data needed to make the necessary calculations doesn’t get consolidated onto a single tape, as it does for equities. Instead, the data can only be collected at the point of execution, which in a global, 24-hour marketplace, is like trying to catch lightning in a bottle.

“The level of maturity in FX TCA is certainly not where it is in equities, where at this stage it’s extremely well-developed in a variety of ways,” Ian Domowitz, managing director and head of analytics at Investment Technology Group, told Markets Media. “In equities we are now reading FIX tags for information, and the notion of comparative databases has come of age. There are movements with respect to the integration of pre- and post-trade analysis for decision support. So it’s a very well-developed and still evolving cottage industry.”

ITG has launched FX Trading Cost Index Application, a tool for FX traders and portfolio managers. Updated daily, the ITG FX Trading Cost Index estimates the average cost of liquidity for 20 common currency pairs, taking into consideration the intended time of trade and notional trade value. The index also provides dealer and ECN calculations based on historical costs, adjusted for recent trends in cost levels and implied volatility.

“What gave rise to the FX trading cost index comes from one of the reasons that FX TCA is not as well developed as equities, and that is simply the data issue,” Domowitz said. “There’s no tape, there’s no source for actionable quotations unless you’re the customer of the dealer. The indicative quotes are not really worth anything in terms of information and analysis. The real action is in the actionable quotes, which is where we’ve concentrated.”

In fact, data sources for FX TCA “are literally almost non-existent without a lot of digging,” said Domowitz. “In other words, in equities if you need data, all you really need to do is write a check. In FX that’s certainly not true. As TCA starts to grow, we gather information across the clientele. That helps to inform a wide variety of analyses.”

The launch of the ITG FX Trading Cost Index application follows the rollout earlier this year of the ITG Trading Cost Index, which provides equity transaction costs across multiple regions and nearly 100 categories.

The FX Trading Cost Index estimates the cost of liquidity for predefined deal sizes at “times of interest” for 20 currency pairs, refreshed on a daily basis. “It’s based on actual quotations from twelve dealers and five ECMs, and it is estimated based on those costs adjusted for any recent trends in implied volatility and published roughly at midnight GMT,” said Domowitz.

The times of interest coincide with daily market events, beginning with the opening of the Asian markets, through to the London opening, and the U.S. opening at 13:30 GMT. “At 15:00 there’s options expiration as well as secondary news,” said Domowitz. “And of course, there’s the London fix.”

ITG is providing the FX Trading Cost Index application for free. “This is actually a gesture in many ways towards transparency in the FX market,” said Domowitz, “because this data is absolutely unavailable, to the best of my knowledge, unless you’re either a customer of the dealer, in which case you’re getting the dealer’s quotes.”

Featured image via adimas/Dollar Photo Club

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