Structured FX Derivatives and the challenges of automation

Increased investor demand for structured FX derivatives can be attributed to a number of factors, including a geopolitical and economic environment that disrupted traditional currency correlations with surprise events such as tariffs, trade wars and reshoring breaking historical models and temporarily decreasing the appeal of sophisticated multi-currency strategies.

With the return to more predictable policies and managers, this gap has closed explains Alexandre Gabovich, cross asset executive director at Makor Securities.

“Diversification, protection against extreme moves and yield enhancement are once again top priorities for institutional and corporate investors,” he says. “Structured FX products, able to offer asymmetric payouts, trade multiple legs simultaneously and capture correlation or volatility anomalies, have thus regained strong momentum – especially in a context where traditional assets offer low yields.”

Hedging drives derivative demand

Demand for better ways of hedging risk is another driver for increased use of structured FX derivative products.

“A good way of looking at a trader’s job is that they manage house and market risk,” says Alan Dweck, COO buy-side solutions at SGX FX. “The constant pressure on traders to find better ways to manage these risks leads to increased demand for new structured FX derivative products – and not just options.”

He agrees that the complexity and breadth of potential products make it more difficult to automate this part of the market, noting that liquidity providers could be more responsive in terms of embracing competitive electronic trading for these new products and moving away from voice trades that make it hard to establish best execution.

As for whether there is a particular technological innovation that could accelerate the electronification of structured FX derivatives, Dweck refers to the potential for applications to speak to each other.

“If you have a complex derivative structure you can hedge the individual components on your desktop without having to go to one person to do it all, opening tickets in the right sizes, executing them and managing that flow entirely on the desktop without challenging integration,” he explains.

“For many, the initial experience of the technology has been a little disappointing but that doesn’t make it worthless.”

Dweck reckons the technology is potentially revolutionary. “In the past, traders would have had a choice between a specialist provider and a multi-asset class platform,” he says. “They generally would not want to integrate lots of different asset classes and applications so would end up using the multi-asset class platform.”

This solution might be suitable for the majority of the client’s needs but it is a compromise as it is not built specifically for all the underlying asset classes. These applications are built for the buying and selling of assets but FX is not an asset – it is effectively a pile of cash exchanged for another pile of cash, nothing has been bought or sold.

The potential of interoperability

Interoperability would allow best of breed applications to be connected on the desktop and provide the trader or portfolio manager with a unified view.

“We are not there yet,” says Dweck. “A lot of firms are still using multi-asset class solutions and these are improving. But a rising tide lifts all ships and in the end there are opportunities and possibilities created by these sorts of technologies which will come into their own over time.”

One of the issues that has made the automation process for structured FX derivatives particularly challenging is that each bank has APIs developed mainly on the back of their single dealer platforms.

“So as a client, if you have a product with Bank A you cannot passport it to bank B – they are not interoperable,” says Romain Camus, head of Hydra at Digital Vega. “It is not open architecture and this has limited a lot of the electronification for vanillas.”

When asked whether there are any specific developments that would facilitate greater electronification, he notes that unpredictable cash flows make the electronification of derivatives products more dependent on everything around the product rather than just the pure execution.

“Two things have changed recently,” adds Camus. “The first is Amazon Web Services. Even 10 years ago it would have been impossible to do what we are doing right now because the technology just wasn’t there – the costs would not have stacked up. We now have the tools to build better tools.”

The second development he refers to is the platform Digital Vega has developed for structuring, pricing and automating FX options workflows.

“Prior to execution, users can structure the trade, look at different variations and see if it suits their risk profiles and needs,” explains Camus. “They can price indicative leads very close to the street price, RFQ and execute and after execution, follow the trade. They have the valuation of the trade, they know what it is worth, they know the risks, what the delta is, the life cycle, what happens to trades and the possible cash flows.”

In this scenario the customer is using the bank not for its platform but for its pricing capabilities. It is as if they have direct access to the bank’s trading desk and are cutting out everything in between.

“Of course, it takes a decent amount of time to build, test, launch and leverage such a platform but this was what was required to make this electronic,” he adds. “It is also about providing better tools for the banks. We sell a platform that is as good as the best single dealer platforms out there from the mainstream banks, except the price is even better because it is sourced from multiple liquidity providers.”

Hybrid products challenge automation 

Automating FX structured products is much more challenging than vanilla instruments or even simple FX options. Some standard products (such as FX dual currency notes, range accruals and directional baskets) can be electronified and processed using basic pricing algorithms and platforms.

However, Gabovich observes that as soon as more complex option styles or hybrid structures appear – correlation, barriers, multiple knock-in/outs, exotic triggers, dynamic adjustments – automation hits a wall.

“Managing complex Greeks, scenario generation, nonlinear models and especially client or structuring desk customisation needs all create obstacles,” he adds.

Technology advances and platform evolution have substantially improved structured FX workflow, especially upstream through basic pricing, quote dissemination and post-trade automation in terms of allocation, confirmation, reporting and lifecycle events.

“But most structured FX trades are still largely manual, selecting the structure, sales/trader/client dialogues, scenario negotiation and documentation, risk management and lifecycle monitoring,” says Gabovich. “Platforms enable booking, reporting and regulatory support, but product personalisation demands a strong human dimension.”

He describes the automation of vanilla FX options – and some simple exotics – as a breakthrough for the market in terms of real-time pricing, electronic execution, algo hedging and automated lifecycle events.

“These advances serve as a solid base for automating more sophisticated structures. Some structuring modules now allow basket, barrier and trigger management via APIs or graphical tools, paving the way for faster automation as demand and pricing models converge.”

One of the key questions in any discussion of the electronification of FX derivatives is what hurdles remain to bringing the full benefits of electronification to complex FX derivatives and how these obstacles can be overcome.

According to Gabovich, one of the key challenges to electronifying complex FX derivatives is the coordination required across multiple teams – sales, structurers, clients and IT. Successfully automating more sophisticated products depends not only on technological advancement but also on fostering seamless collaboration and communication.

“Sales teams need to communicate client requirements with precision and ensure that structurers have a clear understanding of their bespoke needs,” he says. “Regular workshops, joint product sessions and use of collaborative design tools allow both teams to iterate quickly on new product structures and workflow enhancements.”

Clients must be involved

Clients are crucial partners in the automation journey. Early involvement through surveys, pilot programmes and feedback loops helps tailor digital solutions to real-world user behaviour and preferences. Co-designing interfaces and documentation processes with end users can drive adoption and trust.

“Integration between product teams and IT is vital for translating complex structuring logic into stable, efficient digital workflows,” continues Gabovich. “Agile project management, shared sprints and embedded structuring expertise within IT teams can help turn theoretical models into practical, scalable solutions. Rapid prototyping, testing and ongoing refinement are necessary to keep up with market dynamics and regulatory changes.”

Bringing together representatives from each group within steering committees or working groups ensures alignment and transparency, supports faster decision-making and reduces silos.

Ongoing cross-training between sales, structuring and IT builds a common language and understanding, easing the translation of product complexities into code and vice versa.

“Ultimately, the key to overcoming hurdles lies in creating a collaborative ecosystem where digital innovation is grounded in the deep operational realities of FX structured product workflows, combining client input, structuring expertise and IT development in a holistic, iterative fashion,” suggests Gabovich.

On the two part question of what hurdles remain to bringing the full benefits of electronification to complex FX derivatives and whether the market must accept that the trading of some structured FX derivatives can never fully be automated, Camus suggests that the more the market electronifies, the greater the fear of missing out.

In this scenario banks will develop their APIs and as more banks come in, more clients will come in because the price will be better.

“It takes time to build this but it is definitely happening in terms of products,” says Camus. “Not every product will be electronified as it depends on the underlying market. For example, correlation swaps will probably never be executed this way, but all the commonly traded products are going to be electronified increasingly quickly.”

Multi-dealer platforms increasingly important

The key development in this context is that whilst the major players continue to invest in their single dealer platforms, there remains a growing acceptance that, driven by increasing buy-side demand, richly featured multi-dealer solutions have an increasingly important role in the ecosystem.

According to Camus, clients don’t want to have to use multiple different platforms. They want a price aggregator where they can see all the prices, consider the price from each bank and trade with the bank that gives them the best price.

“A good single dealer platform is not going to help these banks sell more products and they know it,” he says. “There is a huge amount of existential questioning and doubt within the banks over these single dealer platforms and whether it might be better to have price aggregators do the job for them and just pump prices into these aggregators.”

The other development that is impacting the market is growing interest from the broker community looking to expand their product offering.

“There is significant new revenue potential here because customers get excited about trading a new product, but many banks can take a significant amount of time to onboard them,” says Camus.

The extent to which structured FX derivative trading will be fully automated is a hard one to answer definitively given that FX is a fundamentally relationship-driven market.

The rationale for electronifying markets is to handle increased market complexity. Voice trading cannot handle millisecond or microsecond trading but relationships are what protect clients when markets are in turmoil or in the unlikely event that automated systems fail.

“There is and always will be a place for that human relationship, whether it is exactly the same as it is now in terms of needing to make a quote for something as generic as an FX trade or maybe for more complex derivatives,” suggests Dweck, who refers to his previous point about competitive pricing.

“If you go to just one source for a price, you can expect to be not quite as good as it could be – which is fair enough. You need electronic systems that aggregate and allow you to make better informed decisions and it doesn’t matter whether you’re talking about spot FX or some super complex derivative,” he says.

As for the extent to which efforts to electronify FX options have laid the groundwork for automating more structured products and the workflows associated with these products, he makes the point that the cash market drives the FX option market, not the other way around.

Derivative complexity will increase

“It’s the underlying markets that drive all optionality,” adds Dweck. “The underlying market is of foremost importance and these complex derivatives will evolve out of the underlying markets and become more and more complex.”

He suggests that there has been up to now a fair amount of the tail wagging the dog where a few competitive FX options platforms have come in that are independent of the underlying markets and try and work with some provider or other. 

“With all respect to them – and they are very good platforms by the way – that will not work in the long term,” says Dweck. “It is the underlying market that will drive a really good derivative product and that is what we have done with SGX FX. We have built an options trading platform and are looking to do more and more things with the underlying market to make options traders lives’ easier as they go for more complex structures. But as I say, I don’t see derivatives as just being an options question.”

While technology continues to progress, it is likely that certain FX structured products – especially those tailored for specific clients or featuring unusual bespoke features – will remain out of reach of complete automation for the foreseeable future.

“The complexity and customisation inherent in these trades often require a level of human judgment, negotiation and documentation that current digital solutions cannot fully replicate,” acknowledges Gabovich.

“As innovation evolves, new approaches may gradually expand the boundary of what is possible but for now, human expertise and discretion remain integral to the most complex and individualised FX derivative structures,” he concludes.