day or a whole week .” For example , Walde says that a trader might want to get rid of a currency trade , such as Mexican peso , in the morning . Applying the standard best execution policy , the asset manager would ask three brokers and take the best price , but the result would not be best execution because the Mexican peso is not as liquid in the morning as the afternoon and the trader could have achieved a better price by waiting until then . The point , he says , is to ensure that the client is being given a good price for the product being traded . These examples illustrate the evolution of the market towards a sophistication not previously seen . Historically , FX has been organised around the daily fixings held by the key exchanges . Spot FX still moves heavily at those times ; however now one of the key questions facing the active FX manager is how to maximise the efficiency of interactions in the market . It is here that the decision the asset manager makes about TCA becomes important . At the most basic level , the decision boils down to whether to buy or build a TCA solution . Buying a service off the shelf allows for a simpler , quicker process that can simply be plugged in with the minimum of hassle . However , building an in-house TCA system offers the prospect of greater customisation and control – and potentially better performance . Walde notes that Metzler opted to build its own TCA system rather than use a provider . “ A permanent TCA is a necessity for FX and it should be part of best execution ,” he said . “ The challenge now is data . Increasing the quality of TCA would involve seeing not only the price but also volume , which is nearly impossible . When you look at equities you can see volume and price , but not FX right now . Because it is OTC , I don ’ t know if it is possible . But I would like to see it ." What can be done , however , is to expand the TCA to analyse the possibility of best execution across the whole day , or even a week , and to be able to see inter-day seasonality , i . e . changes in the way FX trades within the context of several days . Global regulations are of great importance to the asset manager trading FX . There are multiple sources of regulation that have an impact on the trading desk , including EMIR and MiFID II in Europe , and Dodd-Frank and the Volcker Rule in the US , the latter of which obliges European firms such as Metzler to keep special track of their American clients . Then there is the fallout from the Libor scandal and other examples of alleged rate-rigging by financial institutions over the last few years . The FX market can be a dangerous place for traders that do not consider carefully their actions , particularly with regulation and enforcement in mind . On 20 July 2016 , Mark Johnson , global head of foreign exchange cash trading at HSBC was arrested at New York ’ s JFK airport . He was taken into police custody by the FBI ; he is accused of defrauding clients and fraudulently manipulating a currency exchange deal worth billions of dollars to benefit himself and the bank . It is alleged that Johnson deliberately traded in front of a client in such a way as to cause the price to spike , pocketing millions for himself and the bank at the expense of the client . The FX market is changing in other ways as well . Buy-side firms are being forced to adapt to changes on the sell side , including the reduction of support . Walde notices that the real FX brokers are getting fewer in number and brokers are getting smaller . There are also freeto-ride platforms , but overall broker lists are getting shorter and banks have fewer resources in both research and liquidity . At the same time , the sell side is increasingly trying to convince the buy side to use trading algorithms , but Walde is not convinced . “ We don ’ t use algos because we don ’ t understand it ,” he said . “ If you don ’ t understand something , you shouldn ’ t be using it , but we use our own quantitative models incorporated in our currency overlay management .” The concentration of flows to the bulgebracket banks may represent a threat to liquidity , according to Metzler ’ s analysis . This is because the contraction of the market can lead to inter-day volatility . If all participants in the market are attempting to trade in a single direction , it becomes very difficult or even impossible to find the other side for the trade . This may lead to black holes in the market . Walde is concerned about this tendency towards declining liquidity . While various electronic platforms have evolved in recent times partly to help fill that gap , Walde questions whether these are sufficient . “ People running trading books and taking risk on it is what is needed , and a platform doesn ’ t do that directly ,” he said . “ I don ’ t see what they add . We don ’ t need more infrastructure , ultimately we need someone with a trading book .” Perhaps the most controversial change however is the shift towards the multiasset trading desk , which has affected everyone from equity traders to fixed income traders . There are multiple different approaches to multi-asset trading . At one end of the spectrum is the simplest kind of integration , in which traders from each of the different asset classes sit next to each other in the same room . At the other end of the spectrum are the asset management houses that encourage the individual traders to start trading more than one asset class – for example , an equity trader also trading some FX . Walde ’ s view on the former is unsparing . “ Sitting the traders next to each other is not true multi-asset trading – it ’ s cost cutting ,” he said . “ Multi-asset desks are not being created because it ’ s a better way to trade . It ’ s just cost cutting . If you want to trade well , you should have a specialised FX trading desk .” That ’ s not to say that the individual traders can ’ t necessarily learn from information relating to the other asset classes , however . “ Cross-asset information is a necessary thing ,” he added . “ The FX trader will always look at the fixed income and equity markets for information but you don ’ t need to actually trade to do that . We don ’ t see the need for traders trading multiple asset classes at once .” Some asset management firms lack the resources or the personnel to run a dedicated trading desk . In these cases , some firms use back-office or custodians to carry out FX trades . But Walde has some strong advice for those firms . “ Don ’ t do it ,” he said . “ If nobody wants to trade FX , then outsource it to another asset manager , but don ’ t use a custodian . They ’ re not an expert in FX . It ’ s a complete no-go .”
August 2016 www . buysideintel . com
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