THETRADETECHFX DAILY from the floor
What are the most common work-arounds when credit limits block execution? When credit becomes the constraint, the obvious answer is to move the trade to another counterparty. But it’ s not always that simple.
If you’ re trying to execute a large order and only some of your counterparties have capacity, you can end up splitting the ticket across several banks.
That creates a genuine trading dilemma. Do you execute the large piece first and potentially disadvantage the smaller accounts, or trade the smaller pieces first and risk signalling what you’ re doing before getting the bigger piece done?
Another obvious workaround is using a prime brokerage relationship or some other form of credit intermediation. Collateral is also a big part of the answer.
But this brings me to something I think is often underestimated: relationships.
Having good relationships with a bank’ s credit, onboarding and legal teams can make a huge difference. If they know you, understand your business and the documentation is already in place, you have a much better chance of getting something resolved quickly. If you only start the conversation when the trade is already blocked, you’ re probably too late.
FX credit constraints as an execution barrier
The TRADE sits down with TOBY BAKER, former head of FX trading at T. Rowe Price and co-founder of PeerLink, to discuss the fact that across the FX market, the problem isn’ t simply a lack of credit, it’ s that existing credit, collateral and legal capacity isn’ t always available where and when the trader needs it.
Which current solutions have been most effective in easing credit bottlenecks? I think the most useful solutions are the ones that tackle both sides of the problem- how credit is being used, and how difficult it can be to actually establish the relationship in the first place.
Dynamic credit allocation is definitely part of the answer. Rather than having rigid limits sitting against individual venues or workflows, it makes much more sense to look at the client’ s overall exposure and allocate capacity where it is actually needed.
Collateral is another big one. If a bank has greater comfort around the exposure because additional collateral is available, you should be able to unlock capacity without simply asking the bank to increase an unsecured limit.
But there is also a much more basic problem, which is onboarding.
ISDA negotiations, KYC and legal documentation can still take far too long. That is where master agency-style ISDA arrangements and centralised onboarding platforms could make a real difference.
What one change would most improve credit access for the buy-side? For me, it would be making onboarding much faster and more standardised.
It sounds like an operational problem rather than a credit problem, but in reality the two are closely linked. If it takes weeks or months to get an ISDA agreed and complete the onboarding process, then effectively you don’ t have access to that counterparty’ s credit.
And this comes back to the split-ticket issue.
A trader might have a large order to execute but finds that one of the accounts or counterparties simply isn’ t ready. They then have a fairly horrible choice: trade the big piece first and potentially disadvantage the smaller accounts, or trade the smaller pieces first and risk signalling the order to the market.
I’ d like to see much more use of master frameworks, standardised documentation and centralised onboarding. Once a client has been properly vetted, adding another fund or account should be relatively straightforward rather than effectively starting the legal process again.
How do you expect FX credit access challenges to evolve over the coming years? I think the pressure probably gets worse before it gets better.
FX is becoming more fragmented, there are more sources of liquidity, and banks are understandably becoming increasingly careful about balance sheet, capital and counterparty risk. At the same time, the buyside wants access to more liquidity without having to establish a completely new credit and legal relationship every time.
Over the next two or three years I expect to see more dynamic credit allocation, better use of collateral and more credit intermediation.
I also think onboarding will become much more automated. AI will help with some of the KYC and documentation workload, and master agency ISDAs could make it much easier to add new funds and accounts.
I’ d also love to see blockchain technology actually come to the rescue here. We’ ve been talking about shared, trusted data for a long time, and this feels like an area where the industry could genuinely benefit from it. Let’ s actually push this as an industry rather than having another five years of talking about it!
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