The evolution of electronic trading in FX has been swift. Just 10 years ago, almost all activity was transacted over the phone, usually with a single bank liquidity provider. Now, the market is virtually completely electronic with immediate access to aggregated pricing from over 15 sources giving us greater insight to the best price in the marketplace.

“There are few limitations to the usefulness of going electronic but one has been a loss of the personal relationships between the sell and buy side,” said Jay Savely, senior vice president at Fidelity Capital Markets. “These relationships at times were very helpful in formulating trading strategies, hedging alternatives and flexibility with credit.”

Some of this relationship has been lost in the electronic model as there is little personal interaction and a loss of the understanding behind the trading flow. However, these limitations are far outweighed by the benefits of superior pricing, narrower bid/ask spreads and improved liquidity.

Aggregation of multiple pricing feeds has been the most beneficial result of electronic FX trading.
“While algorithmic FX trading models have increased in popularity, I expect much of the buy-side is still focused on risk mitigation and accessing the best FX price subsequent to the purchase or sale of a security,” Savely said. “Algos will no doubt continue to flourish but they will likely be defined to a specific subset of investors.”

As more asset managers focus on FX processes and execution quality, market transparency will increase. “There may even be regulatory focus on FX execution that requires banks and custodians to provide that transparency,” said Richard Coulstock, head of dealing at Eastspring Investments, Prudential’s asset management business in Asia with $97 billion in assets under management. “We are now seeing the SEC in the U.S. focus on bond trading platforms and trading practices. There will be a domino effect as this spreads into FX and across other regulatory jurisdictions. It will, of course, take time – but it will come.”

Savely cited increased transparency, consolidation in the electronic exchanges, improved TCA (transaction cost analysis), exploration of centralized (listed) trading, improved algorithms and a shift from principal to agency trading by some dealers as likely developments. “There is no doubt that the FX market is changing rapidly and the focus on narrow spreads, greater transparency and the mitigation of counterparty and settlement risk will greatly benefit all investors,” he said.

Accusations against custodial banks on FX pricing and their lack of transparency have pushed TCA to the forefront of FX trading. However, TCA analysis in the FX marketplace gets a bit problematic due to the decentralized nature of trading.

“While aggregation platforms are able to provide an analysis of the executed price versus that of other providers on the platform, this is only a fraction of the overall liquidity in the marketplace,” Savely said. “Likewise, any comparison against broader market pricing is not necessarily accurate as the investor might not have the credit facilities to access that pricing. Developments in refining TCA will continue and we welcome improved transparency in what at times has been an opaque market.”

FX TCA in Asia is at a very embryonic stage but over the next few years this area will become a main area of focus, certainly for international asset managers with assets in multiple currencies.

“One area where I believe FX TCA could make a significant difference is in analyzing custodial trades, trades executed by custodians and the executions advised to the asset manager on a post-trade basis,” Coulstock said. “However, obtaining transparency and cooperation from custodians is a perennial challenge.”

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