A lack of transparency in the $5.3 trillion a day global FX market is costing some institutions up to $40 million a year, according to research by Investment Technology Group (ITG).

“The key point is really transparency in the FX market. As you know, it’s virtually completely opaque at this point,” said Ian Domowitz, head of ITG Analytics. “We have a lot of clients globally that trade FX as part of their equity and fixed-income operations. We’ve discovered that the information’s just not out there.”

ITG used transaction data to construct a consolidated limit order book for each currency pair, based on data from banks and electronic communications networks (ECNs).

“We gathered truly actionable quotes, not indicative quotes, from a group of roughly 17 outlets: 12 dealers and five ECNs,” said Domowitz. “From that, we were able to provide numbers that correspond to what you might call a size-adjusted spread.”

One of the experiments ITG did was to extract some very active trading from its equity database. “Within the Peer database, we’re able to select out those with the highest turnover,” said Domowitz. “We can actually look to see, given the nature of the data, whether or not they require an FX transaction to actually do the conversion for their equity trade.”

ITG’s analysis spanned 38 currency pairs in order to determine transaction costs for various deal sizes as well as time of day and by currency. “The spread at the top of the book may be worth a million dollars notional, but if you need to do 50 million dollars, what is that actually going to cost you to take that liquidity in the market?” Domowitz said.

What it found was that on average, these costs were $13-$14 million a year for each firm. “That’s just money that goes up in smoke based on their demand for liquidity,” Domowitz said. “If they’re taking inferior prices in the market, and we do see them, that figure can rise to $40 million a year per firm on average. That is enough to get almost anybody’s attention.”

ITG Peer Database is comprised of approximately 20% of all global institutional trading volume.

“We have arguably the largest comparative database in the world with respect to institutional trading activity,” Domowitz said. “At this stage, we have historical performance information with respect to their costs and all sorts of market conditions, order sizes across 70 different countries; probably on the order of $10 trillion a year in terms of turnover. We have been using it to supplement our transaction cost analysis efforts on behalf of individual clients.”

The probes into FX trading at large banks have underscored the need for greater scrutiny of execution costs. “It’s an unregulated business,” said Bill Conlin, president and CEO at Abel/Noser, a TCA provider. I think now everyone’s under the microscope. The pension plans are interested because they want to make sure their plan has not been hurt by any standing instructions they have with their custodial banks.”

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