FX Market Structure Hampers Best Ex


Asset managers will find demonstrating that they have achieved best execution on their foreign exchange trades more difficult once MiFID II goes into effect on January 3, 2018.

Under the new regulatory regime, asset manager will need to demonstrate a “sufficient effort” in their attempts to attain best executions for their FX trades, which is a higher standard than the previous “reasonable effort” requirement.

“It means that you have to do everything that you can to prove that you did the best execution for your customer and it is not just the best price,” said Jamie Singleton, chairman and CEO of Cürex Group. “It’s a consistent process over time that takes into account explicit costs, implicit costs, and market impact.”

Requesting a quote from three dealers no longer satisfy the best execution mandate, he added.

In addition to adopting a more stringent best execution requirement, buy-side traders also will have to perform a market check before they execute their FX orders under MiFID II.

Traders cannot rely on taking a screen capture of their trading screen before they enter their orders and be in compliance with the regulations, according to Singleton.

If there were a market structure designed to make transparency more difficult, it would be hard to tell.

Unlike other over-the-counter markets, such as OTC derivatives and the credit market, the FX market lacks many of the essential features that can be used to benchmark a trade’s performance.

Jamie Singleton,
The Cürex Group

“There isn’t a best execution standard and no consolidated tape,” said Singleton. “A consolidated tape would make no sense in a market like this. The FX market is too huge and speed and time matters.”

The greatest hurdle for buy-side traders, as well as their legal and compliance teams, is how to factor out the ever-present phantom liquidity from actual executable liquidity.

Singleton cites an example of a $10 million dollar-zloty trade in which a liquidity provider may post its liquidity at the same price across 15 electronic venues and results in the dollar-zloty market appearing to be $150 million deep.

Once a trader lifts the initial $10 million, the remaining $140 million disappears, he said.

Singleton also noted that comparing aggregated FX quotes from various electronic markets further complicates calculations since not all FX quotes are equivalent. Some may be indications of interest while others could be indicative quotes or executable quotes, depending on how the quote’s originating market operates.

Some vendors that specialize in FX transaction cost analysis have popped up with toolsets to help asset managers navigate their FX best execution requirements over the past few years.

The Cürex Group has taken the approach of opening an FX ECN that only receives streaming actionable prices from the 13 large banks that have agreed to provide liquidity.

“We take executions and live data and use them to calculate the FTSE/Cürex benchmarks,” said Singleton. “Executions on our ECN are time stamped to the nanosecond, that’s nine points past the decimal point.”

The FTSE/Cürex benchmark is one tool that will help meet an asset manager’s best execution responsibility, but it is not the only tool asset managers will need, he added.

In any case, asset managers need to develop and have their best execution methodologies in place soon since their clients already know that their asset managers will be obligated to obtain the best execution on their behalf.

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