Tackling credit risk in the global FX markets: in discussion with Andy Coyne and Jon Light at Cobalt

Why is credit management an issue for the FX industry?

Credit management has evolved into a significant and pressing challenge for the FX industry over the past decade. The main issue is that credit is not allocated or managed correctly at trading venues in real-time and often the person with the credit risk is the last to know. Many of these risk systems sit downstream and are slow; some even require manual processes.

More worryingly, many solutions for managing a client in distress involves the use of kill switches, terminating market access. This actually increases risk as it locks the client into a bad position and moves the responsibility of closing the position to the prime broker who takes time to verify positions, often leading to significant litigation risk. This is just one example of how the mismanagement of credit is negatively impacting the FX industry.

This is having a knock-on effect throughout the FX market. There is a pressing need for a live credit management solution built for modern distributed electronic markets, and in particular automated trading. This is why we developed Cobalt’s live credit management solution.

Why has credit management technology not evolved at the same pace as FX trading technology?

While electronic trading has evolved beyond recognition since its introduction, the infrastructure that supports it – including functions such as credit management – has failed to adapt to the changing financial market landscape.

Legacy technology and complex cost structures are largely to blame, with incumbent technology providers protecting revenue models without considering the negative impact on the health of the wider FX market.

We fully believe that live credit management is essential to the evolution of the global FX market,and we are leading the charge to bringing its technology up to speed and creating a more efficient, orderly future for all participants.

What institutions are most impacted by their lack of ability to manage credit effectively?

Prime brokers are suffering the most from the credit management challenge, with the number of those operating in the FX market halving over the past ten years. Those that remain have significantly trimmed their client base, focusing on better capitalised firms.

The reason for this is quite simple. The risk of suffering a significant loss from a defaulting client has not justified the returns for prime brokers. These losses not only happen through significant market events such as the SNB crisis but also after algos have lost control or where thin liquidity and electronic orders cause losses in the tens of millions of dollars.

What is Cobalt doing to tackle this challenge?

Cobalt has developed a unique and ground-breaking platform that utilises high-throughput technology to control credit and associated market access rules throughout the trade lifecycle, in a way that significantly reduces risk whilst not disrupting the traditional means of execution.

Crucially, our solution is co-located amongst all the main execution venues, meaning it is fast and operates a low latency messaging infrastructure that can guarantee the delivery of over one million messages per second.

Furthermore, credit can be managed using all traditional market methodologies: NOP, DSL and most importantly margin. It can be pushed dynamically to clients and trading venues in real-time, meaning that a client in a distressed situation cannot increase their position but is able to unwind it and eliminate the risk.

Electronic trading has evolved beyond recognition in recent years, and it’s now critical that credit management catches up. Live credit management is the future for the global FX markets and Cobalt is leading the charge in creating a more efficient, orderly future for all participants.