Best execution across all FX Products?! Requirements being shaped before they are dictated by regulators.
FX got touched on the outside layers by MIFID II and other regulations. What exactly is, or should be in scope, results in interesting discussions with our customers. In my opinion, the clearest definition comes from UBS Investment Bank in their “Information on our MiFID order handling & execution policy”, which applies to Professional Clients within the EEA.
“Deliverable Spot contracts are not Financial Instruments within the scope of MiFID and therefore Best Execution requirements will not apply to stand-alone spot FX transactions*. Other FX contracts, for example deliverable and non-deliverable FX forwards, swaps and options, are MiFID financial instruments and thus potentially within the scope of the Best Execution requirements” * FX spot transactions may be subject to Best Execution requirements indirectly where they form an embedded part of an instrument which is in scope for Best Execution (e.g. FX forward).
Having this part cleared, I would like to move deeper into the world of FX.
Money managers currently get heat from their Pension Fund customers, which automatically effects trading operations on the sell side. Custodians are under pressure to deliver the necessary proof of best execution to their managers, which then would like to turn around and satisfy their Pension Fund’s request. Unfortunately, these processes are not in place in many “sell side” organizations and forces the money manager to satisfy best execution demands outside of their custody set up. At the beginning it might just be for FX Swaps, that the manager will have to get into the “multi bank” market but once they arrived there, why should they not trade all FX products on a best price?
The move towards “Aggregation” is rather resource intensive with a possible Prime Brokerage setup or implementation of bilateral credit lines with providers. For larger managers, such a setup has multiple benefits and the costs are miniscule compared to the current cost of execution. Further it will strengthen their “Institutional Order Execution Policy” in FX and allow them the claim of true best practice.
When our buy side customers take that route, we advise them to consider steering towards “multi market” rather than “multi bank” setups. Multi market includes Liquidity Providers and ECN’s, such as EBS, Reuters, Hotspot, Cürex and even SEF’s for certain products. This will result in an internal marketplace and deliver plenty of benchmarking and data gathering opportunities, which will help to fine-tune their execution strategies in the future. For such a setup, the use of a prime broker is requirement.
With the “sell side”, these issues start to cause a major headache. Now that more “buy side” customers generally are looking at aggregation to adhere to best execution requirements, banks are faced with three choices:
- Offer a dedicated execution person or execution desk.
- Offer an electronic best execution solution.
In my view, there is only one choice: Deliver proof of best execution electronically and replace “spread or markup” with commission. This proof should include the following: Type of order, applied execution strategy, time of execution (milliseconds) on parent and all child orders. Further should this information be delivered on all kind of orders like market, stop loss and take profit as well as to applied strategie like TWAP.
“Here he goes again” will many of my friends say. “We are principals of FX transactions and not brokers”. I fully agree, but believe that a short and precise drafted agreement can clarify this point and allow banks to walk this fine line. Three years ago, I started to look into creating such a solution. Designed it and together with smartTrade Technologies implemented it. “I do not let my trousers down in front of the customer” was the comment of one of my colleagues. In 2013 it was too early to do so but by 2018, my colleague might have his trousers down and see that even with trousers down, there is business to be done in FX. Hopefully, will he not have keept his trousers up to see that he has not spoken, nor traded, nor written down any revenue with a certain type of customer segment in months.
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