FX Focus
Reprinted from

SPECIAL REPORTS FROM FX WEEKFEBRUARY 2016

COMPARING APPLES
AND APPLES

The question that mostwhich would allow a fair and unbiased
frequently causes politicians
comparison of costs – a true comparison of
to be labelled ‘out of touch’apples and apples – so everyone is having toconcerns the price of milk.
do it in their own little world. That, I think,
Knowing the cost of basic
makes it very difficult,” says a senior industry
commodities is seen as theparticipant. “Obviously, the costs of doing
essential ingredient for anyone running abusiness have increased and there is more ofhousehold or a business – it is the verya need to look at your all-in cost of execution,building block of being in control and on top
including the costs of balance sheet, capitalof what is happening in the wider context,
market impact, etc. But for some of theseand it’s a crucial indicator of whether
elements, like measuring slippage, there issomeone really knows their audience.
no standard and that’s tricky.”In foreign exchange, this has not always
Then there is the increasing choice ofbeen the case, but in the rapidly evolving
counterparties, venues, execution styles andenvironment that values transparency abovemethods. Five years ago, for example, theall else, the casual observer may
concept of an order in FX, in the
expect market participants tocontext of a client placing one
have a fairly good grip on
with a bank and the bank
“There isn’t thatcosts. And yet, in an
working that order as ansingle level playing field,
industry that hasagent for a commission,
which would allow a fair,enjoyed decades of
did not exist.
unbiased comparison ofgrowth, in terms of“Now you have thevolumes and revenues,
situation whereby acosts – a true comparison
the acute change ofclient may not be usingof apples and apples”
focus from growth toa bank to trade as
Senior industry
cost control is proving
principal, but asking their
participantrevealing. In other words,
counterparty to act as agent
not being able to tell the priceand execute their order in theof milk, or in this case the overallmarket, and we will pay you X per
costs associated with FX, is painfully evident
million to do that. That is an explicit cost,and no longer good enough.
which for a lot of market participants is still
Dealing with the challenge is difficult,a very new concept,” says the senior industry
with the FX market being so fragmented,participant. “Some of these costs are explicit
and as the interaction between consumers
and quite clear. Some of them are implicit
and providers becomes more complex andand hard to quantify. So the challenge, I
less clear.
think, for the market now is to figure out“There isn’t that single level playing field,
how they can basically determine what their

FX FOCUS February 2016

true total cost is, and then make theinformed decision about who they should
trade with and how they should trade.”
All of this fragmentation and variety of
approach makes measuring costs
challenging from both a producer andservice provider point of view, as well asfrom the customer’s. Determining yourbusiness costs is very different from amarket-maker trying to figure out how muchit will be to show a price to a client.
Customers have always complained about
rising costs, and in the FX world their efforts
to demand more for less have been more
successful than most. FX clients have enjoyedyears of narrowing spreads, free execution of
fixing orders and many perks in exchange fortaking volumes to providers. This mentality isvanishing, even if at a glacial speed.
A long-standing veteran of FX markets
says it is best execution requirements thathave put asset managers firmly in thespotlight, as they now need to show asset
owners they have made the best possible
decision with the best available tools at theirdisposal and a proper audit trail.
“It is not just the buy side [that] has thismuch more complex landscape to navigate. Itis [the realisation] they have a duty of care to
the owners of the assets to achieve best
execution,” the person adds.
But, while clients have enjoyed adeclining cost base and many (seemingly)
free lunches, providers have seen theiroutgoings rocket – a situation that might beviewed as ironic if it were not so difficult.
Regulations such as the Dodd-Frank Act

Photo: amasterphotographer/Shutterstock

With clients expecting more transparency,
it is vital for firms to be in control of costs.
The key is determining the true all-in priceof execution. By Laura Matthews

MARKET STRUCTURE FEATUREand Basel III, where some provisions haveforced products on to the sell side’s balance
sheet that were not there previously, havecreated a significant amount of extra charges
associated with FX, especially for banks.
Nowhere is this more evident than in theFX prime brokerage (PB) space, where therising expense of capital and events such as
the Swiss National Bank’s removal of the capon the franc in January 2015 led marketmakers to change their business practices,
rendering certain clients and flows moredesirable than others in an effort to combat
higher expenses and reduce risk.
“Some businesses, especially thosewhere the banks acted in an agency capacity,
had always been very balance sheet
friendly,” says a head of FXPB at a
multinational bank. “The fact that futurescommission merchants are now required tocarry those positions on their balance sheets,
applying whatever multiplier is applicable tothat asset class, has completely changed theproposition. Items that had incredibly littleor absolutely no balance sheet impact are
now generating capital charges, with someasset classes more meaningful than others.”

Whose turn is it to pay?
There is also the question of end-users being
able to distinguish between explicit costs, i.e.
spreads, and implicit costs – the inevitabilityof paying for something which at a glance
seems to be free, as proved to be the case withbenchmarks.
According to Harpal Sandhu, chief
executive officer of trading platform Integral,
while the explicit costs of trading may haveincreased in general, customers are getting
better execution today, which has lowered theimplicit costs – the cost of actual trading –whether in the spread or in the market
moving away from them.
“A very good example of this is in theWM/Reuters process, where five years ago
people assumed WM/Reuters was free – ‘I
don’t pay anything’,” he says. “And theywould have completely overlooked that
although there was no explicit cost in tradingof WM/Reuters at the midpoint of the fix rate,
there was a significant implicit cost in that themid-rate itself could be moved against thecustomers.”“Market-makers are clearly being forced
to offer better prices than they were before
because of that transparency, and customers’market knowledge has led to market-makers
charging less for the services they provide,”
Sandhu adds.
For the sell side, this translates into having
to be more selective with clients. As service
providers take stock of all their trading costs
there has been a shift in attitude towards coreclients mattering more than volumes. Thisproviders. Consequently, they are not
has a ripple effect on customers andnecessarily leveraging their volumes withcounterparts who also need a sharper focus.
providers to have the best rate cards.
“One piece of it is that brokers need to“A single firm may be dealing with thebecome more of a partner with oursame provider for the same instruments, butproviders,” says Bryan Seegers, head of eFX
different units are paying radically different
pricing and execution at ADS Securities inprices,” Campbell says. “Consolidation in
Abu Dhabi. “The brokers need to be morethis area, starting with an understanding
selective with who they give their liquidity toof the totality of a relationship with aand who they take liquidity from.”
counterparty and its associated costs, canAs a result, intermediaries such as ADS
have great benefits. Then, it’s a matter ofare becoming more selective in how they givenegotiating better deals in terms of being
business to providers and who they willable to get those costs under control.”
accept business from on the client side to“We have typically seen that as sort ofensure no harm is done to the relationship.
the third phase of cost for a lot of firms; they
“It means no longer sweeping thelook at the people, they look at thebook, having the analytics
technology, but many of themaround our flow and being
haven’t necessarily gotten to“A firm may
smart enough to say, ‘hold‘what am I paying to thebe dealing with theon, wait a second’, andliquidity providers andsame provider…
not just send it to thewhat am I paying to thebut different units
provider and run themcounter-parties?’ andare paying radically
over; to be able to look at‘how can I consolidate
the decay of the trade
my agreements withdifferent prices”
immediately and say,these organisations to getDavid Campbell,‘that is not good business,the best deal?’,” he adds.
Broadridge
based on the pricing being
provided, [so] let’s get rid of it
Objectives matter
quickly and move that client to a less
So is it possible to have an overall cost
aggressive price stream to protect ourthat would allow competitors and producproviders because they no longer have theers, as well as clients to compare how good
staff and resources to do this themselves’,”they are at managing resources? Philsays Seegers. “We are now a partner to them
Weisberg, managing director of Thomson
to ensure damage isn’t done and, if it is, toReuters, thinks such a question is missing
mitigate it as soon as possible.”the point.
While the emergence of technology is“People immediately go to transaction
empowering the buy side with the kind offees, but I really don’t think that is the mostinformation that allows them to haveimportant part of the equation. The mostmeaningful conversations with other market
important part of the equation is what are
participants about costs, some may be
you trying to do? It makes a big difference ifentering such talks at a disadvantage.
you say I want to minimise the variance
Capital market professionals at Broadridge between a benchmark and where I am
Financial Solutions are finding fragmentation
executing each day, and what I care about iswithin the different parts of the businesshaving certainty every day when taken
could be preventing them from benefiting
individually. Or I want, on average, tofrom economies of scale.
minimise that every day or alternatively I“What we see from a cost perspective iscare about absolute return,” he says.
that over the last few years, as people have
In other words, the key to achieving
looked to FX as a newer asset class, there has best execution and firm cost control isbeen internal fragmentation within firms
process – a way of simplifying and focusing
when it comes to technology as well as
on objectives.
people,” says David Campbell, head of“We’ve been talking about bestcapital markets strategy, global technology
execution for many years, but now I thinkand operations at Broadridge. “So it’s
we are in a position where a lot of people
possible a firm could have multiple
view best execution as a process, andoperational groups dealing with FX andwithin that you need to make sure you
multiple systems dealing with FX – that has
have the right analytics to help deliver
led to a definite rise in cost.”
against all of those requirements in that
He explains that on the revenue andprocess,” the industry veteran concludes.
expense management side, many firms have“That is where I think the world is headed.
potentially fragmented their FX businessThat’s a natural consequence of thatinternally, meaning they have fragmented
complexity – you need to simplify it again
relationships with their counterparties andand help people navigate it.”February 2016 FX FOCUS