Managing Foreign-Currency Risks: Beyond Best-Price Trade Execution

Shocks to the financial world, such as Brexit, have increased volatility in the currency markets, and the uncertainty is expected to continue. While most watch on with caution, foreign-exchange (FX) traders across the world are faced with this and other factors – sputtering economic growth, divergent interest rates, and increasing regulation.

Why does this matter? The US$5-trillion FX market, which is almost 30 times that of the New York Stock Exchange, needs tighter regulation to help bring stability, transparency and a more levelled playing field. In turn, FX professionals have the additional challenge of meeting compliance mandates and increased IT costs.

And regulations such as Basel III are requiring increased levels of capital, credit and risk controls, forcing many banks to reassess their appetite for broad participation across all market segments.

The current practice of trading over the phone is subject to price slippage during volatile markets, and the currency pair can move multiple basis points in a few seconds

Further to increased regulation, there is still a significant need for clarity and consistency across jurisdictions. Aside from the stringent policies introduced by industry bodies, the rise of electronic trading and the FX Global Code are two initiatives that are helping FX professionals manage risk on a global platform.

All this has implications on CFOs and corporate treasurers, who are finding the job of managing foreign-currency positions and risks getting more complicated by the day. As they look for the best way to respond to the challenges, it is helpful for them to understand the broad trends that are changing the FX industry and the new ways FX traders operate.   

Electronic Trading

The biggest industry trend is the move to technology and automation, to ‘electronify’ the currency market. Today, nearly 75% of FX trades globally are done via electronic trading, according to industry sources. That figure is smaller in ASEAN and India, but adoption is accelerating.

Those who have embraced newer technology such as Bloomberg's FX electronic trading platform FXGO say it helps reduce risk, improves efficiency and reduces costs. Even regional market players that trade primarily by voice have found that automating the trade affirmation process can enhance efficiency and reduce the risk of errors.

The current practice of trading over the phone is subject to price slippage during volatile markets, and the currency pair can move multiple basis points in a few seconds. As more international banks ramp up currency transactional activities in Asia, phone trading can also have a greater margin for misunderstanding due to language barriers.

With e-trading, users can make real time price comparisons from banks, making it more efficient for price quotes, adhering to best practices, and maintaining a full audit trail.  

The close, personal business relationships developed over many years are still important in these markets, yet technology can provide automation and efficiency without compromising relationships. Additionally, it also accommodates local market practice and conventions.

In 2016, more than 800 senior FX executives attended a number of Bloomberg FX16 events in Asia to discuss challenges and opportunities. They showed overwhelming support for best execution through electronic trading, citing new technologies as a key way to mitigate risk and help keep the global and local marketplace vibrant and liquid.

The FX Global Code

Many, both inside and outside the FX industry, have been calling for a universal code of conduct to help minimize the risk associated with trading FX.

The FX Global Code, as it is known, is the product of months of collaboration among 21 central banks and 35 market participants from a diverse cross-section of the market. The Code seeks to restore public confidence in the wake of nearly US$9 billion in fines imposed for a variety of infractions. It also seeks to define the boundaries of proper and improper behavior and practice.

The primary considerations when selecting a trading venue should be the breadth and depth of liquidity, transaction cost, instrument coverage, and end-to-end workflow

The principles that guide the FX Global Code and the areas it covers – ethics, governance, information sharing, execution, risk management, compliance and settlement – are intended to promote a fair, robust, liquid, open and transparent market.

In light of the recent manipulation scandals, the handling of fixing orders is a focal point, and participants should “not intentionally influence benchmark fixing rate to benefit from the fixing, whether directly or in respect of any client related flows at the underlying fixing rate.”

While the final code will not be published until later this year in May, it’s clear that banks are pressing ahead with policies and guidelines, including topics such as execution around “last look”. This will most likely turn into a self-policing exercise with buy-side seeking sell-side guidelines so all participants will know how their orders are being executed.

The CFO Dimension

As CFOs and treasurers refine their FX strategies in the face of increasingly volatile currency markets, they should consider including the issue of electronic vs. voice trading in their due diligence. In ASEAN and India, where electronic trading is not yet prevalent, choosing a bank or other providers that have switched over from voice trading could be a competitive advantage.

The primary considerations when selecting a trading venue should be the breadth and depth of liquidity, transaction cost, instrument coverage, and end-to-end workflow. Best execution is no longer just best price, but also access to a full range of services like netting, staging, pre- and post-trade allocations, reporting and straight-through-processing. 

About the Author

Grant Coombe is Bloomberg APAC FX Business Strategy Lead. Bloomberg’s FXGO global trading platform provides liquidity from over 500 global firms, access to both on-shore and regulated markets, a complete range of pre- and post-trade services, and is commission-free. 

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