James what is your background and what attracted you to the world of currency trading?
I graduated from the University of Birmingham with a degree in Economics in 2001. This gave me an interest in the financial markets, which combined well with my love of numbers and statistics, which I have had since an early age. Following my graduation I entered a Management Training Program at HSBC in retail banking. This taught me a lot about customer service and time management. While I did work for a financial company it did not satisfy my desire to engage with the markets more closely. By chance I was made aware of a local company in Windsor which could provide this opportunity and hence I found myself with a job at Record Currency Management in 2004. I had an excellent grounding at Record; when I joined, the company had 25 employees and each member of my team covered all back to front office functions, including trading, reporting and reconciliations. As the company grew its client base it was necessary to expand the department and create specialist teams. I had already developed a natural affinity to managing the bank relationships both on a personal level and reviewing their performance, these naturally led to me heading the newly created Trading department. The attraction of the FX market itself is the fact that it is affected by everything in the financial world. This means that being an FX specialist requires knowledge in a plethora of areas.
Who are the key people involved on your side of the business at Record and what are their main day to day responsibilities?
I’m the Head of the Trading Department, and I have a team of four, whose responsibilities include robustly and efficiently achieving best execution on all of our client-driven trades, as well as supporting our Research department and the firm more broadly with providing market input and bank views into product development and ongoing monitoring. The Trading Department falls under the management responsibility of Dmitri Tikhonov, Managing Director and Head of Portfolio Management, with leadership also provided by our Chief Investment Officer Bob Noyen.
What is the trading team’s main objective with respect to trade execution?
Our key objective, and indeed obligation to clients, is to ensure best execution on every trade, subject only to any client-specific counterparty constraints. The trading team are not expected to deliver ‘alpha’ through trading discretion, but instead to minimise execution costs, and always ensure accurate, robust, client-specific execution.
What sort of firms are clients of Record and what range of services does the company provide for them?
Our clients are predominantly institutional investors, including pension funds, charities, foundations, endowments, family offices, other fund managers, and corporate and insurance clients. Our services cover both currency risk management, or hedging programs, and outright return-seeking programs. Within hedging programs, we offer both passive currency hedging, where our independent status, best execution capability, and expert program structuring ensures the program best meets the client’s individual requirements, and dynamic currency hedging, which on top of these takes advantage of Record’s 30-year established proprietary process to deliver asymmetric hedging to clients – i.e. allowing them to keep most of the currency gains in their portfolio, and be protected from most of the losses. In return-seeking programs, we take advantage of a range of risk premia and patterns of behaviour, which clients can implement in either segregated separate accounts, or pooled funds.
What currency risk premia and patterns of behaviour within the currency markets are you systematically trying to exploit for some clients to provide returns?
We believe there are distinct sources of risk in currency markets to which investors can choose to allocate capital in the rational expectation of a long-term return. These ‘currency risk premia’ are analogous to, although quite distinct from, the more familiar equity risk premium. The two currency risk premia that we have the longest track record of exploiting are the Forward Rate Bias (FRB), also widely known as the carry trade, and the expected appreciation of Emerging Market currencies as their markets converge with developed markets. In both cases we can explain the risk premium as a rational payment to investors who are willing to bear the risk of undertaking the economic function involved.
As well as these risk premia, currency markets show repeated patterns of behaviour which can also be systematically exploited. Two well-known patterns are Momentum, or the observation that tomorrow’s price movement in most currency pairs is likely to be in the same direction as today’s, and Value, or the observation that over time developed market currencies typically swing around a long-term ‘fair value’ level. Both of these patterns are familiar to Record, and both can be exploited in the expectation of return.
Record offers segregated mandates exploiting each of these, as well as combining certain of them in multi-strategy products. We also offer pooled funds principally exploiting the FRB in both passive index-tracking and active forms and Emerging Market currency appreciation, as well as more tactical opportunities.
What instruments are you mainly using and what factors influence how frequently you trade them?
The overwhelming majority of our transactions are in straightforward spot and forward foreign exchange contracts, but we make use of a wider range of instruments - including options, futures, swaps and repos – when they can better meet our clients’ objectives, and we are satisfied that we understand their behaviour in various scenarios, and the value they represent for our client. The frequency with which we trade them will depend on the program in which they’re used, and of course market movements – some of our programs, both in hedging and return-seeking, use stop loss mechanisms involving up to daily monitoring and dealing, and others, particularly passive programs, may take longer horizons and less frequent trading to minimise accumulated spread costs.
Once your in-house research team have developed ideas for new hedging or currency return strategies how do you go about modelling these and testing them?
The modelling and testing process is an integral part of the Research team’s product development process, and takes full advantage of the close relationships between the Research and Trading teams.
All of Record’s UK-based staff are located in one open-plan office in Windsor, as a deliberate approach to ensure constant and easy communication between teams – although the dealing desks are behind a glass wall so we don’t disturb the rest of the office when speaking to banks! Record has a unique currency rate database going back to 1979, which Neil Record gathered when founding the firm in 1983 – this historic data, plus of course the plethora of data available today, forms the raw material for modelling and back-testing new strategies.
Our bias towards predominantly systematic processes means we can model these processes historically without giving ourselves credit for any discretionary decisions with the benefit of hindsight, and the experience and judgement of our Research team, and particularly the members of the Investment Committee, ensure we are consistently on the alert for ‘curve-fitting’ and other modelling sins.
What external and internal risk management systems and methodologies does your team employ?
There are a number of different sources of risk in the mandates we run, which require different risk management strategies. Investment risk – for which the client expects to be compensated – is typically managed within the design of the product. This is both through systematic implementation – built-in stop loss mechanisms, position diversification by currency pair, rate, maturity etc., strategy diversification etc. – and through oversight by our Investment Management Group and Investment Committee, with the ability to over-ride the systematic process. We do not rely on stop loss mechanisms implemented by counterparties. Market and liquidity risk is managed through counterparty diversification and management, spreading trading throughout the day, and maintaining a ‘hands-on’ approach to execution rather than delegating it to an algorithm. Operational risk is managed by implementing as much ‘straight-through processing’ as possible, using a combination of third-party (Misys, Calypso) and proprietary systems. Finally, as across the industry, CLS is our preferred approach to managing settlement risk.
Is all your trading carried out electronically or do you still use the telephone from time to time?
At present the division between electronically traded volume and telephone volume is fairly equal. While the percentage traded electronically has increased over the years we can still see the benefit of using both methods to ensure best execution. Typically we will use the electronic channel for liquid currencies and smaller ticket sizes. In addition there is a tendency for electronic prices to widen in times of market stress to a larger degree than on the phone.
We have seen reduced volatility in FX over the last few years with very narrow interest rate differentials between developed currencies. Has that made your job harder?
It hasn’t made our job any harder from a trading perspective, but it has inevitably impacted a number of our return-seeking strategies. The narrowing of interest rate differentials amongst the G5 currencies has impacted returns for carry strategies overweight those pairs, although attractive returns can still be found with a wider pair universe, as shown by the FTSE Currency FRB10 index, and the prospect of divergent monetary policies across central banks is certainly re-awakening client interest in carry strategies. Momentum or trend-following strategies have also encountered some resistance in less volatile range-trading markets, but the merits of these strategies was demonstrated clearly in 2008 – paying off precisely during the sharply risk-averse fourth quarter, when other strategies underperformed – and again in the last quarter of 2012 and first quarter of this year, largely driven by the Yen. Overall, it is exactly this diversified behaviour between currency strategies that makes us so enthusiastic about the multi-strategy approach to return-seeking currency.=
What electronic trading platforms do you find most appropriate to use and what factors have influenced your choice?
In selecting execution venues we take into account the instruments which our programs use and the structure in which our individual clients are setup to trade. The majority of our programs require us to execute forward and swap trades, often to broken dates. The other key point to note is that we trade as agent in the name of our clients for some clients and for others we trade in the name of their prime broker – and never as principal. With these issues in mind we have found that point to point, request for quote/stream platforms suit our needs best. Over the past couple of years we have performed a thorough search across over fifty platforms. The result of this search is that we are still happy with our current provider FXall. We like the fact that our counterparties are aware that it is Record asking for a quote. Since they like our flow and know that it is not predatory they are able to create a pricing tier unique to us. In addition we have a high level of control with regards to individual counterparty panels and administration rights.
How do you go about sourcing the best liquidity at the right price?
The key things about accessing the best liquidity are experience and respect in the market. Without a combination of these two factors it is not possible to achieve best execution. We have access to a wide panel of almost 30 counterparties. This includes all of the large multinational banks and also a number of local banks who provide good liquidity in specialist areas. On a quarterly basis we formally review the performance of each counterparty and create reports to pin-point the strengths and weaknesses. This allows us to provide powerful and accurate feedback to our counterparties which they can use to tweak their pricing. Using this knowledge we can target the strongest counterparties for each trade while giving other counterparties a chance to show any improvements they have make since the most recent feedback.
Do you trade on any ECNs and if so, do you feel they have any shortcomings which you would like to see addressed?
We do not currently use ECN platforms as they do not currently provide streamed broken dated forwards. The majority of our trades are swaps or outright forwards and thus we prefer having a platform where we can ask for the outright price. We have not ruled out using an ECN in the future and we keep in contact with all electronic platform developments.
Do you use any FX algorithms and if so, are these proprietary and designed in-house or sourced elsewhere?
The programs, which we run for our clients, are predominantly systematic in nature. The in house order management system known as ROMP (Record Overlay Management Program) prompts the trades, which are due to be executed, however the execution itself is not processed by an algorithm. We are intrinsically interested in our counterparties’ algorithmic offerings, however they do not naturally fit into our method of trading.
What steps do you take to try and ensure best execution and what solutions do you use to measure your trading performance?
As mentioned above on a quarterly basis we produce a multitude of reports which can break down where our counterparties have won and lost trades. The breakdowns are mainly based on currency pairs, size of trade and the spot and forward elements of the price. We are also able to monitor whether counterparties have won or lost trades due to their spread or the skew of their price. We are currently in discussion with a number of independent Transaction Cost Analysis (TCA) providers in order to verify the quality of our execution. The most important element in choosing a provider is ensuring that the underlying data is of a high quality. All of the providers are able to show that the quality of their spot pricing database is suitable for our needs and so the key differentiator will be the quality of their forward databases and to a lesser extent the method of their interpolation between fixed tenors.
How did you go about building your trading desk IT infrastructure and was the trading software and connectivity technology provided by third party vendors?
At Record we have a bespoke, in house coded, order management system known as ROMP (Record Overlay Management Program). On a daily basis positions are monitored within ROMP and the trading application, linked to ROMP, prompts the necessary trades. These trades will be a mixture of rolling positions and adjusting position sizes. All of the economic details, apart from the price, of the trade are locked down and the trader simply needs to select a counterparty and enter the price. The trading application is able to create a file which is imported into FXall, in a similar way the economic details of the trade are locked down and the trader simply selects the counterparties to receive a quote from. Once the trade is executed another file is created and exported back to ROMP, which completes the necessary fields. This straight through process (STP) reduces the risk of errors and speeds up the process. Once the trades have been executed the trades are exported to Calypso. Calypso is a third party software system, which we use primarily for middle and back office functionality. Calypso then sends out any necessary trade notifications such as emails, faxes and Swift messages. Our Operations department are able to monitor whether the trade details match with the counterparty using Calypso.
In what ways do you think regulatory changes that are being applied to the FX marketplace as well as new clearing and settlement requirements may impact on your trading activities and the way they are currently carried out?
This is a massive topic and I’m not sure I can give it the justice it deserves in a few lines. I am personally involved in the assessment of how the new regulations are going to affect Record and our clients. The regulations can be split into two distinct sections; Dodd Frank and EMIR affect which instruments and entities are mandatory to centrally clear with a clearing house, and Basle III and CRD IV affect the amount of capital the bank needs to hold, more specifically for non-centrally cleared trades. At present (and these regulations are a moving target!) NDFs and options are the only FX instruments which will be mandatory to clear. The main difference for existing clients is the need to place initial margin with the selected clearing member and to have variation margin available for when positions are out of the money. For clients which currently use prime brokerage arrangements the transition will be relatively small as this will generally only require some additional legal documents as opposed to a different operational setup. It is still unclear whether all instruments which are mandatory to clear will be obliged to execute via a Swap Execution Facility, if this is indeed the case the main concern is that banks will pull liquidity from the less liquid currencies and thus increase the trading costs. The big question is how will spreads be affected for non-margined or even non-cleared trades? The likely hypothesis is that it will eventually become overall cheaper to clear or at least margin all trades, although there is no certainty how the market will develop and react to the new regulations.
When it comes to the trading side, how has Record tried to differentiate itself from other leading currency management firms?
Record is an independent currency manager and this removes any conflict of interests. Record as a firm is remunerated solely via management and in some cases performance fees and so our interests are fully aligned with our clients. We pride ourselves in the thoroughness of our counterparty performance analysis and the feedback which we provide. The feedback allows our sales contacts to have specific conversations with the traders with regards to where improvements can be made without qualitative judgements distorting the reality. At the end of the day we understand that the relationships we have with our counterparties are symbiotic. We seek to be active in the FX market for the long term and this is the key to the way we work. All of the above allows us to keep a wide panel of counterparties hungry for our non predatory business and this is reflected in the prices which we execute on.
Looking ahead, as Record continues to diversify its client base, where do you see the main challenges facing you and your trading team in meeting the requirements of increasing numbers of investors who are being drawn to the risk and reward opportunities of the currency markets?
I think as ever challenges will continue to come from a variety of sources. First and foremost, as a specialist independent currency manager, we have a constant obligation always to seek the best liquidity and pricing, wherever it may be found.
In future this may mean different trading venues, different locations – not that London seems to be losing its pre-eminence – or different instruments, particularly if regulatory changes imposed on counterparties force liquidity to change. There is also a constant challenge properly to understand clients’ needs, objectives and constraints, and then to design the best solution we can, always making sure the client expectations are reasonable and can be met.
We also exist in a competitive environment of course, and can never rest on our laurels – we have to constantly be on the look-out for product innovations and enhancements, while never complicating matters for its own sake. There are certainly plenty of challenges on the horizon – and it’s meeting and overcoming these challenges that gets me and all my colleagues motivated and excited every morning!