Foreign
exchange
The relationship between the buy side and the sell side is changing; perhaps
nowhere is that clearer than in foreign exchange. As the dual forces of
regulation and technology drive change in the FX industry, the asset
management community faces a number of challenges and questions – not
least among them, how best to access liquidity, and how to integrate the
trading of FX with that of other asset classes.
While in equities and fixed income, some of these questions are being
addressed by the rise of new platforms built on a collaborative model with
buy-side and sell-side participation, in foreign exchange it remains to be
seen if there is a market for such an innovation. On the technology side, key
concerns for the buy side now include whether to use the daily fixings, or
to put faith into FX trading algorithms instead; whether to automate smaller
trades to free up resources; whether to outsource; and how to monitor
trading activities to ensure best execution.
One of the challenges in FX is that the sell side is moving resources away from
developing services such as TCA for the buy side; this raises the question of
whether the leading asset management houses might be better placed
to develop their own TCA or buy from an independent vendor. But in that
case, what happens to the smaller firms that may not be able to justify the
necessary budget?
Broker selection is another area of interest in FX; the particular concern now
may be whether the sell side has the resources and the commitment needed
to adequately serve the buy-side’s needs. Then there is the question of how
many and which venues are right for the buy side, and particularly whether
the proliferation of new FX venues may stretch the available liquidity too
thin. Among the impending EU legislation, reporting of every transaction
is required; there is also the need to provide collateral and mandatory
central clearing for derivatives. And of course there is the question of what
will happen to so-called “last look” practices, which may be headed for
extinction in the coming years.
All of this is just the top layer; beyond that, regional markets have their own
concerns. There are market-specific challenges for FX desks located in
Asia, for example Hong Kong and Singapore, as well as in other markets
like Indonesia or Japan. Relationships with custodians are changing; there
is a widespread feeling on the buy side that the service they receive from
custodians has historically not been the best. Expectations are evolving and
it may be the case that the buy side will increasingly come to demand better
service.
K&KGC research in the first half of 2016 has indicated that the buy side would
like to move away from custodian-directed auto-FX to agency or matched
principle solutions; asset managers have also indicated a preference for onsite technology offices including programmers. There is also evidence that
more asset managers are considering starting to use FX algorithms, especially
in Europe including the UK.