Why are banks and sell-side institutions coming under increasing pressure to achieve even greater efficiencies and economies of scale from their investment in FX platforms and electronic trading technology?
IG: The upcoming regulatory environment with increased transparency of execution is a big deal, and will put increasing pressure not only on the business, but also the technology investment that drives and supports the business. With increased transparency and reduced risk appetite, margins will come under pressure at the same time as the business demand for new technology to support the changing climate and trading model. TradAir was created to specifically address this. We fully believe that banking institutions will need to be more flexible and dexterous in managing their market making capabilities, across asset class. Flexible and bespoke solutions are the only way to fully achieve targets that maximise flow, not just with the tier 1 banks, but across the regional and non-bank players as well.
HS: FX margins — and the business models of yesterday — are under pressure because of what I would describe as a perfect storm, fuelled by three distinct developments: 1) Doing business became more expensive because of regulatory initiatives that push for increased transparency and raise capital requirements for banks. 2) Competitive pressure has increased due to advances in FX trading technology by firms like Integral, which allow smaller institutions to go head-to-head with the largest players in the market and successfully compete for all customers. 3) FX markets are democratizing in the sense that liquidity is no longer almost by default concentrated with the flow monsters; rather, it remains accessible throughout the buy side, where it is exchanged directly amongst peers. Great examples of the latter are the RFX Network™ that we launched together with Russell Investments and our Open Currency Exchange™ (OCX™). Both feature easy-to-use peer-to-peer matching capabilities right out of the box. Finally, across the board, FX market participants have become more sophisticated as illustrated by the surge in the use of trading algorithms and TCA analysis.
PM: Because they’re making less money but still have demanding shareholders. There’s competition from disruptive service providers who can charge lower fees in some segments of operation. So they’re all appointing Heads of Digitisation/Innovation with an implicit mission to eliminate as many costly human beings as possible. Internally, they have to serve the same number of customers with fewer sales people. Externally, they want their customers to self-serve on single dealer platforms as much as possible. To achieve either they must turn to technology solutions to deliver greater efficiency and productivity.
DW: The most basic answer is that as new non-bank competitors enter the arena, margins on FX trading are declining. This, coupled with customers tending to use more vanilla products than hitherto, has put increasing pressure on justifying the investment and ongoing running costs of some FX platforms. What we are seeing at Eurobase is clients moving to put more asset classes on the same platform and extend its utilisation to a wider range of the bank’s customers.
In what ways can technology providers deliver products and services that will facilitate the new ‘capital-light’ business models of many institutional FX trading firms?
IG: From the outset TradAir recognized the new “capital-light” model that has now come to dominate our market. We had “light footprint” as our goal. We pioneered the richest HTML5 trading and pricing GUIs which allowed no-install and no compatibility issues at our bank clients and their clients. This reduces the need for internal IT and help desk support. Our server backend was built from the ground up on a hybrid hosted and cloud-based server infrastructure which we fully support and monitor so it requires no IT spend or management. Our core offerings such as TLA Analytics are available using market standard and inexpensive services such as Google BigQuery. Our clients benefit not only economically, but in time to market, increased volumes and optimization of flow, staying well ahead of the curve.
HS: Technology providers like Integral are uniquely positioned to assist in this upgrade. One of the most innovative approaches is our subscription-based FX Exchange branded as OCX™, which we launched earlier this year. A monthly subscription of $275 provides an institutional FX trader unlimited screen trading on OCX. We see this as the most cost-effective access to global FX markets offered today. API connections are available as well at a very attractive price point. Since all of Integral’s services are cloud-based, all of our customers benefit from the ‘capital-light’ approach that is inherent in that business model, no matter to which one of our services they subscribe. FX trading firms don’t have to hire dedicated IT staff, they don’t have to run their own data centers, and there is no capital expense to licence software.
PM: In two ways. Firstly, technically, by offering to host much of the e-trading and e-distribution infrastructure on behalf of the bank (saving internal systems and management costs). Secondly, commercially, by moving from capital-intensive perpetual licence models towards opex-based recurring fee models. The typically entrepreneurial spirit of independent fintech firms allows this business agility.
DW: From our historic engagement in agency trading, we had developed functionality that suited the model very well and are now seeing a lot more interest from banks wanting to adopt “On Behalf Of” and “In the Name Of” trading coupled with the detailed functionality of our rate manager to support this trading style. This, alongside the work we are doing on client classification and regulatory reporting for MiFID II and other regulatory initiatives, gives us a complete solution for a “Capital Light” trading platform, which also delivers reduced operational risk.
The FX market was seriously tested earlier this year following the Swiss National Bank debacle. What role can technology providers play in helping to create so called “shock absorbers” which might help to protect trading firms and market participants from some of the most serious effects of future Black Swan events like this?
IG: It’s crucial that core engines, algorithms and underlying technology are capable and equipped to protect the business, and react to unique events. Being a market maker means you can not only create different streams On USDMXN, but also when you stream these, how do you know what is the most profitable coverage strategy that you can apply to it? As a market maker if a client is abusing your prices? How able are you to be able and identify in real time your P&L loss and switch him to a different stream? One lesson the market learned from the SNB incident was that protections must be multi-layered and complex and should include market volatility, position levels, trading activity, and manual failsafe controls. More than creating shock absorption or circuit breaker functionality, the entire front office architecture must be built utilizing event driven principals. While most providers simply normalize data flows for presentation, our solutions are integrated into an event driven architecture that utilize data and BI as real time inputs to the core engine, algorithmic layer, and client, enabling the entire ecosystems to learn, react and protect the business.
HS: While it is true that many banks and brokers increased capital requirements for their customers depending on macro-economic developments, or on the currency pairs being traded, it remains to be seen how much market risk trading firms will be able to actually pass on to their customers in that manner. Our goal always has been to help our customers with proactive risk management, whether or not passive shock absorbers are in place. For that reason, Integral developed FX Yield Manager™, which uses powerful analytic tools to enable FX banks and brokers to dynamically segment and profile their customer flow, while automated risk warehousing with real-time hedging allows them to manage yield. It represents the affordable state-of-the-art risk management suite that has been missing in FX. The unique built-in risk dashboard offers a view of real-time and historic market risk and yields across all channels and currencies. Designed as a cloud-based solution, FX Yield Manager has access to unlimited resources, deploys in days, and does so for a fraction of the costs it would take to build such a system in-house.
There is a huge shift in liquidity risk from banks to the buyside taking place right across the sellside markets. Do you expect to see FX participants relying more heavily on non-bank market-makers and the liquidity supplied by buy-side market-making firms, and if so, what implications might this have for the nature of liquidity management technology in the future?
IG: On the contrary, we see the bank market makers playing a more significant role, particularly outside of the G3. Banks, who best understand their markets and flows, are best positioned as the primary liquidity source to clients. As they become more automated and electronic with their price generation, distribution and risk management, they will not only play a larger role within their core marketplace, but the global market place as well. G3 pairs have become commoditized, and as with most commoditized markets, buy-side market making firms play a more active role, however we don’t see participants necessarily relying more on non-bank liquidity, rather it’s the anonymous ECNs that have become dependent on these providers. In the direct disclosed market, which is where we see execution moving, bank providers are still the primary source, with non-bank market-makers adjusting to gain share.
HS: Non-bank market makers have been steadily increasing their market share in FX markets, ever since the first HFTs set their sights on that market almost a decade ago. And the choices of liquidity sources have only become more complex. In our view, if an evolving FX market infrastructure helped create additional liquidity sources, the technology aggregating these various liquidity sources has to keep pace so OCX is a perfect example for a technology solution that aggregates dozens of non-bank and bank market makers into a single liquidity pool while making it a seamless experience for our customers. There is no need for them to establish new relationships with a third party, go through credit setups, manage STP protocols, etc. - everything is handled by OCX behind the scenes. OCX’s advanced market design delivers unparalleled execution performance by combining direct, indirect and resting order liquidity in a single unified matching engine. Unlike legacy FX platforms, which fragment liquidity into separate rooms, OCX has just one liquidity pool. Even as FX markets are becoming more complex, we want to keep things simple for our customers.
DW: Non-bank liquidity provision has been a feature for some time, but what is new is the advent of these non-bank market makers and their liquidity is easily plumbed into the market. The challenging area is around the credit intermediation of these new players into the lucrative genuine buyside (corporates and asset managers).
To what extent do you expect to see agency trading models being adopted in FX and will broader take-up of these require significant re-engineering of existing buyside and sellside platforms and trading infrastructures?
IG: Regulation will be playing a much more significant role in FX Spot Trading, there is no reason to think though that banks will change their models completely to an agency approach. Banks need to be able to show prices based on their views of markets, positions, and risk and by doing so they make money, reduce risk, and provide unique opportunities for their customers. Recycling prices is not good for the market and affords little opportunity for differentiation and making money. Instead what is needed are systems that enable True market making and offer protections against undue risk and that simultaneously records all captured information including market, trading, and pricing data. Finally the systems need to present it comprehensively so management and even regulators have complete transparency to pricing and trading practices. Complete transparency is built in to our technology offerings.
HS: The short answer to the second question is no, if these systems were designed properly. Both the agency trading model and trading via a dealing desk carry inherent pros and cons. Depending on the particulars of a situation, one business model might trump the other, or vice versa. Integral’s technology fully supports both the agency or STP model, as well as managing the positions/risk or “B-booking”, so our customers don’t have to make only one choice. They can pick the execution model that is more favorable for the task at hand, and change that if need be depending on market or specific customers’ order flow. Integral’s technology is designed to support business decisions, not to limit them.
PM: To a huge extent, for two reasons. Firstly, capital adequacy legislation will limit the amount of capital that can be placed at risk, so many providers will revert on back-to-back or agency trading. Secondly, there’s such a decline in margin for highly liquid pairs that it may be pointless offering that capability to certain client segments in any case. On the other hand, regional banks in particular will have (by definition) local currency expertise that they can and should take principal and proprietary risk in. So technology providers need to provide systems that are flexible enough to cater for a diversity of trading and business models.
DW: We are firmly convinced that agency trading is seeing an unprecedented resurgence and is a field in which we already have ready-made solutions for given developments in this business. What is requiring engineering are the regulatory impacts on this model of trading and we have just finished a project to bring our solution up to date with regard to current regulation as well as forthcoming requirements in January 2017 for MiFID II compliance. One of the key challenges in this is the correct classification of clients, a record of the totality of engagement with the client as well as key links to trade enquiries, executed trades and any other activities surrounding client interaction. A full audit trail is required for all this along with the ability to prove best execution and finally correct routing of trades that you are required to report to one of the regulatory depositaries. We had already developed a lot of this to make our sales trader functionality fully compliant with regard to voice trading (still a popular choice with a lot of bank customers) and the work we have done for MiFID II completes the jigsaw.
What impact does the lack of communication and standardisation (price data and operational rules for example) amongst trading venues and platforms have on the efficiency and transparency of the FX market and what practical steps can be taken to address this?
IG: Market participants and software venders have become very versed at normalizing data, and can deal with the lack of standardization. It’s the nuance of not just the rules, but underlying performance metrics and success rates regarding interaction with the various venues and participants where the impact of efficiencies play the biggest role. Measurement and assessment begins with data storage and analysis, and the fluidity of being able to dynamically adjust execution decision making in real time. Utilization of past performance or stagnant settings as utilized by most Total Cost Analysis (TCA) assessments, while they may be practical, do not lend themselves well to OTC markets. Moreover, technology has gained ground in this arena. The TradAir Total Liquidity Analysis (TLA) exemplifies this, providing real time feedback and analysis directly into execution processes themselves, creating significant efficiencies.
HS: FX markets have been and will likely remain a complex and customized affair amongst multiple trading parties. The original innovation which Integral brought to the FX market 12 years ago, was the ability to access all of these bespoke sources of liquidity and combine them in to a single accessible pool for customers. It remains one of the key reasons customers derive so much power form the network.
FX sell-side institutions are also facing the need to take a much more pro-active approach to the management of conduct risk in the sales and trading environment. What part can technology providers play here in formulating solutions to address the problems?
PM: Good computer systems are simple to use for the educated user. Really good computer systems can be so intuitive that an intelligent but ill-informed user can quickly become a subject matter expert. So UX design is key. This effect can be applied to sales and trading applications as much as anything else. There is also a carrot and stick. The carrot is that the GUIs make the job easier and more efficient. The stick is that by trapping user behaviour, some discretionary sales and trading habits such as adding margin or spread can at last be measured, and therefore managed and audited.
DW: The big news in this regard is the current initiative by Central Banks and Regulatory Agencies to move to a single Global Code of Conduct for the Foreign Exchange market to be introduced in 2017. A lot of what is required revolves around having the ability to monitor trader activity in both real-time and through audit and exception reports. The advantage of a single global code is that your global platform can now be part of the solution. The ability to track trader behaviour is paramount and our decision to further develop our tools to achieve this has been vindicated especially around our voice trading regulatory compliant modules. For senior managers subject to the SM Regimes this should help aid a good night’s sleep!
As FX becomes an increasingly technology-driven business, do you expect to see a much sharper differentiation of service levels by banks who may focus their sales and personal relationship initiatives on some client segments leaving the rest to be catered for by automation?
IG: The FX world is becoming increasingly automated on both sides of the transaction, requiring better and tools, data analysis, and personalized pricing to stay ahead and win the business. However we see automation being utilized across segments, not only for those that are fully automated, but also adding efficiency for those segments that are relationship driven. The Sell side is going to be looking to monetise their client relationships whether they are voice, electronic or hybrid, and will need the tools and technology to services to clients irrespective of their trading style. At TradAir, we have designed the TradAir Sales Manager specifically for this purpose, providing sales and sales traders the front office tools they require to manage all types of client across sales channel. Data analysis, automated pricing, coupled with manual intervention and overlay provides clients the best of both worlds, delivering personalized pricing while improving win percentages across multi dealer environments.
PM: Automation of both client self-service, and the sales desk itself, is a hot topic right now. Banks have realised for some time that they need to provide their clients with convenient execution tools (both their own single-dealer platforms and MDPs) to allow their limited sales resources to focus on the higher-value segments of the market. What has changed recently is the expansion of the SDP to segment-targeted offerings – for example workflow-enhancing tools with STP for the corporates, or mobile notifications and order management for institutional users, plus at the same time providing their sales staff with much richer decision-support dashboards and spread management to enable them to more efficiently service their voice customers. In effect, this means that technology and automation across the board supports sales relationships rather than threatens it.
DW: It has always been the case that for plain vanilla trades, banks have sought to have them executed in an automated manner leaving sales-traders to concentrate on more complex requirements and to cross-sell. With the advent of new regulation, segmenting clients has become an essential tool along with the ability to apply multiple margins for credit, risk, capital utilisation and good old-fashioned sales mark-ups. This now needs to be done in a structured way and with many banks adopting agency trading, for some customers this inevitably means they need to execute either electronically or, if by voice, the sales-trader will need to be acting on the customer’s behalf on an electronic platform. This enables the full customer engagement to be totally captured in real-time with the totality of any trade enquiry or trade available in comprehensive audit logs and reports.
Given the growing importance of UX in the “e” world where do you expect to see further innovation to improve the user experience of FX trading platforms during the next few years?
IG: The technological advances surrounding visualization have come a long way in providing and delivering advanced services to all participants in the trade cycle. Its imperative that users are able to quickly receive and consume information on a real-time basis without having to delve into various pages or spreadsheets to do so. It is also imperative that the ability to change pricing or streams be easily and efficiently done, irrespective of location. At Tradair we have focused on the user experience by enabling our users to intuitively digest analytics and change and monitor change in price generation and coverage in real time. Our innovation team has been leading the way in advanced visualization across device, and have developed a patent pending trading methodology specifically for touch trading. TradAir will lead and continue to innovate is this area, and make of the most of advancements in both hardware and software, where the rate of change is significant.
PM: User experience and digital banking are hugely important to allow banks to really engage with their customers. No longer is a basic trading interface acceptable for users. High quality UX has become the norm for consumer applications, particularly with the rise of the smartphone, and as the next generation of traders come through, providing them with convenient, efficient and relevant UX will make or break the success of a trading platform. Sell side players that invest in UX now will see their market share and customer satisfaction increase hugely in the coming years.
The social media revolution continues to sweep across the capital markets. If FX finally joins the bandwagon how can technology providers help to shape the agenda in terms of how it can best be leveraged and deployed by FX market participants?
PM: There are many fears about how social media can and should be employed in the capital markets. For years Bloomberg’s messaging was our own “private” social media tool of choice. I feel that regulation will impose constraints on how much social media can be integrated with trading systems directly, but players like stocktwits (http://stocktwits.com), and distruptors like Symphony (https://symphony.com) are actively looking to use technology to help shape the way social media is used.
DW: We are already seeing social media news and sentiment tools appearing, and it is likely that these will become part of the feeds that influence price engines. As banks begin to bring the e-benefits to a wider range of products, we will see more integration to social media.
FX players around the world are preparing for exciting new trading opportunities associated with emerging currencies such as the Renminbi and the next wave of financial instruments including Cryptocurrencies. What advice would you give to sell-side institutions who may be concerned that their trading platform architectures are not properly geared up for these fast paced developments?
IG: Our advice would be to being to explore other technologies that are able to ADAPT. Just as the currency markets are continuously evolving to accommodate new currencies and methodologies such as Blockchain, technology also continuously evolves, and utilizing these advancements enable firms to stay one step ahead. This doesn’t necessarily mean sell side institutions should focus on technology innovation and frameworks, in fact we believe quite the opposite and built TradAir around the principal of providing banks and brokers the innovative framework they need to stay ahead, allowing them to deliver their clients proprietary applications, algorithms and features efficiently. Sell-side institutions have in most cases have inadvertently become technology companies, and find a large portion of budget addressing legacy, rather than utilizing the latest technology to uniquely service clients and gain market share.
HS: My advice is the same that it has been for years: drop your proprietary systems and replace them with services like ours. Let Integral worry about the integration of Renminbi or cryptocurrencies and about developing the necessary functionality. For a shared IT infrastructure like ours, the economics for adding additional functionality are so much more compelling that those proprietary systems just can’t compete. And for our customers, these economic benefits translate directly into lower costs of these services, which in turn allow them to provide even more attractive pricing for their customers. So even if a bank or broker were able to build and operate a system that was as sophisticated as ours, they would have to charge customers so much more in order to recoup their investments, it would price them straight out of the market.
DW: Certainly central banks and banks are paying a lot of attention to blockchain technologies and indeed the whole wider question of faster payments brought on by changing customer habits associated with the e-revolution. Coupled with the advent of new instruments, a re-examination is needed of the functionality of trading platforms. A lot of banks are realising that their old siloes with legacy systems in areas such as cross border payments are unable to keep up with the pace of change, allowing shadow banks to “eat their lunch” while still being predicated on the banks payment systems. This is leading to a re-assessment of how to recapture this lost lucrative business, and developments like our Siena e-Payments platform is allowing this.
Looking ahead, in what ways might we see a new generation of digital propositions linking FX trade execution platforms into a wider portfolio of currency services?
HS: Integral already offers the entire FX life cycle as cloud services and therefore goes far beyond basic trade execution services. We have developed an integrated suite of services, all of which perform together seamlessly and can be subscribed to on an individual basis, determined by the business needs of a customer.
PM: Providing consolidated technology platforms that connect traditional FX execution with pre- and post-trade services is not only going to provide cost efficiencies for the banks, but also hugely improve the digital user experience. No longer will clients have to log in to a myriad of systems to settle, confirm, allocate or manage their trades and orders. In the next couple of years, many innovators will be offering integrated workflows such as currency netting across blocks of trades, simple options hedges, deposits/extensions, FX/payments integration. These will become the norm across all digital channels, with mobile delivery increasingly overtaking traditional desktop and voice channels.
DW: As I have said in previous answers, you just need to look at the case of cross-border payments as an obvious example. Customers are demanding better technology in the payment space and fintechs have sprung up to satisfy this demand while still effecting the payments through the banking system. Banks need to urgently invest in expanding their execution technology to other traditional banking areas and no further evidence is required than looking at survey data. One survey of FTSE500 treasurers showed 63% were dissatisfied or highly dissatisfied with their bank’s e-payment services, while another study showed that 80% of corporate customers choose their bank on the basis of technology offered and, more specifically, on the online and mobile services offered. As a result we built a full solution that resolves the cross-silo issue in the e-Payments space and allows banks to effortlessly link their trade execution platform to a first class solution in this lucrative area of the FX market.