The importance of achieving greater post-trade efficiency is increasingly being recognised by the FX industry. Yet unlike other asset classes, overcoming the myriad of complex challenges that exist in FX post-trade has often prevented firms from seriously dedicating time and resources to improving these workflows. But as the industry increasingly embraces automation and emerging technologies, can streamlining post-trade operations finally become an achievable outcome? Nicola Tavendale investigates.
One of the unique characteristics of the FX ecosystem is the vast array of ways in which its participants can interact with the market and in many respects, the same applies to the post-trade space, says Kate Lowe, Global Head of TradeNeXus, State Street’s award-winning suite of post-trade solutions. However, according to Lowe this is also why unpicking and re-architecting components can be so challenging. “There is definitely a fear factor in upsetting this complex balance. While there is a huge level of straight-through processing, it is the many layers of repetitive matching and messaging that create potential opportunity for risk,” she explains. Lowe warns that there is a delicate symbiosis that exits between all the mechanisms and so breaking one link can cause unintended consequences to the others. Lowe adds: “The risks primarily lie in the complexity of matching and messaging many different versions of the same trade to ultimately guide it down the path to settlement. There is risk of breakdown or failure with each step, as well as an overall cost increase in relation to numerous reconciliations and remediation processes.”
Lowe explains that for buyside clients in particular, diverse FX trading strategies, a changing regulatory landscape, as well as underlying fund nuances have also driven bespoke post-trade workflows to meet those demands. In addition, the market is still lacking standardisation in some areas, such as the agreement to send and match certain fields like the fixing source and uniform approach to standard settlement instructions, particularly for the Russian ruble (RUB) and the Thai baht (THB), she adds. “These need to be agreed in order to achieve better levels of automation,” Lowe says. “Covid-19 has also had a major impact to the market, with re-prioritisation of many projects to be able to support business as usual remotely and through peaks of volatility.”
Paul Williams, Product Manager for Post Trade FX in Data & Analytics, London Stock Exchange Group, agrees, adding that during the pandemic, FX operations in middle and back office have continued to face plenty of post-trade challenges that cannot be overlooked. “Firms have therefore bolstered their systems resiliency in these uncertain times of fluctuating market volatility, including procuring cloud-based platforms, improved automation in back office workflows and reduced reliance on manual processes,” Williams says. In addition, he warns that there are also significant back-office challenges involved when connecting a variety of post-trade flows from multiple vendors to a growing number of clearing venues, settlement services, trade repositories etc. This is due to hidden single points of failure with little built-in redundancy when connecting existing integrations with trade execution venues, Williams explains, adding that this also makes it difficult to achieve appropriate cost benefits from upgrading and automating those out-of-date applications.
To address some of these challenges, several initiatives have included new models such as using distributed ledger technology and doing away with the need for reconciliations, dual-sided confirmations and settlement, Williams says. “We are seeing participants willing to explore such models, but primarily focusing on processing the nuts and bolts of their business,” he adds. “Firms are also continuing to consolidate their IT resources and are increasingly looking at what cost benefits can be achieved through automation and innovation.”
Straight-through processing and automation have already proved successful when applied to other areas of the FX trade lifecycle, but the post-trade infrastructure for FX is typically much more complex with a wide range of upstream and downstream integration challenges, says Mike Thrower, VP International Account Management at Broadridge Financial Solutions. “Post-trade processing for the FX class is distinct from other asset classes such as equities, fixed income or OTC derivatives,” he explains. “Given the often complex, highly integrated and fragmented nature of post-trade processing technical architectures for FX, moving to a more optimised simplified FX post-trade architecture is not straight forward.” As such, Thrower believes the key is to develop a realistic migration to a future state by breaking up the processing life-cycle and technical architecture into minimum viable products that can be deployed incrementally to move to a more optimal model.
Managing complex workflows
In addition, the fragmented architecture that is often found supporting post-trade FX increases operational risk by fragmenting transactional, static and positional data, warns Thrower. He adds: “A complex fragmented data architecture creates risk for internal reporting, external regulatory reporting as well as making decision support more problematic.” Thrower notes that external regulatory and market infrastructure changes have also driven the evolution of post-trade processing in other asset classes, such as equities and fixed income, but in FX there have to date been fewer major external factors. Instead, the technology and operational processes deployed in FX are often a result of multi-year incremental evolution, which according to Thrower has resulted in the fragmentation we see today.
However, the more complex and dated these systems become and the more reconciliation points they require, the more expensive this infrastructure is to maintain, says Mark Briant-Evans, Head of FX Business Development, IHS Markit. He warns that, in turn, this can lead to a greater risk of trade breaks and operational failures which can have serious financial consequences. “A more recent development is the growing importance of clearing in FX,” Briant-Evans adds. “To date, most clearing activity has been in the interbank market, but the new phases of UMR coming in over the next couple of years will bring the clearing of NDFs and FX options into sharp focus for the buyside.” As a result, he warns that this is going to put a lot of pressure on operations teams and systems set up for traditional bilateral settlement flows, as they will increasingly have to manage a parallel stream of cleared trades or the exchange of margin that will be required on uncleared flows.
“Fortunately, there’s a lot of innovation going on right now to help FX market participants manage all this complexity,” Briant-Evans adds. “MarkitSERV’s TradeServ platform is a great example of new shared infrastructure, built in partnership with the industry to simplify processes and mutualise costs. Offering a central platform on which firms can match and confirm trades and manage submission to multiple CCPs for clearing, we’ve seen a significant uptick in FX volumes in the last 12 months.” According to Briant-Evans, this is a key trend which is expected to continue as UMR phases 5 and 6 kick in and the cost and capital efficiency benefits of clearing in FX become even more evident, particularly for buyside firms.
A more consolidated view
The combination of regulation and the rise of crypto-currencies and digital ledgers has also inspired a new flock of automation tools looking to reinvent the old post-trade workflow, says Lowe. However, she warns that the challenge remains of how to seamlessly merge the old with the new. “The key ingredient to success is gaining a critical mass of adoption, because it severely dilutes the efficacy of any new application if participation is limited,” Lowe adds. “This has driven the need for historical competitors to form alliances and find ways to advance the market for mutual benefit. Without a network of engaged, active users, even the newest and most innovative technology will have little utility.”
Lowe explains that at TradeNeXus they are continuously analysing what additional services can be provided which will add value to their clients. “The goal is to seamlessly incorporate revolutionary tools into current workflows to avoid the need for clients to change their whole infrastructure,” she says. “At TradeNexus, we try to maximise the client integrations that are in place and add more workflows that stem off those integrations. This allows our clients, where possible, to integrate once and branch-off. It’s critical to choose a partner who can grow with your business, work with you to find solutions and provide thought-leadership to reimagine the status quo.”
Efficient post-trade FX operations ultimately require investment from buyside firms, with outsourcing presenting an effective risk mitigating and cost-effective solution, Williams argues. In addition, not all firms are at the same level, adds Williams, as post-trade services form a complex interlocking network. “Incompatibility between approaches can be costly or risky due to outdated systems,” Williams says. “For example, immediate investment in upgrades vs securing future investment in simplification and automation for greater operational efficiency is on the mind of every IT professional. This is particularly relevant as we exit from the pandemic with the need for a risk-based approach to IT spend on innovative technologies.”
Picking the right partner
According to Thrower, FX leaders are also starting to look to more mutualised cloud-based offerings that can deliver a robust, sustainable operating model. He explains that at Broadridge, they approach this challenge in FX by utilising standardisation and innovation to deliver a more efficient operating model for clients. “We are leveraging AI and machine learning to automate functions throughout the processing lifecycle,” Thrower says. “Cloud also enables us to be more responsive and more agile in our client engagements. These new technology innovations can deliver a lower cost operating model and greater agility, as well as reduced operational risk.” It is also critical to partner with the right firm, he warns. “The right partner needs to be able to invest in innovation to stay current and infrastructure to stay secure and robust,” he adds. “Also, leveraging insights from other asset classes and bringing them to the FX space can create transformational ideas and solutions.”
There is also help at hand for firms looking to manage the connectivity and data management challenges created by the increasingly complex landscape of execution venues and counterparties, says Briant-Evans. He explains that MarkitServ has also recently expanded its long-standing STP services to offer cloud-based connectivity and data normalisation ‘as a service’. “This completely removes the burden of managing both physical and logical post-trade connectivity from our customers, including complex data normalisation, morphing and enrichment tasks that can be very costly to set up and maintain in-house,” Briant-Evans adds.
Overall, the key advice he would give to firms is to look for an agile partner who is committed to evolving alongside the market, with a service model that embraces change on a sustainable cost basis. By doing so, he believes that firms should then be able to successfully avoid the pitfalls and high costs associated with one-off point solutions. “Yet on the flip-side ‘one-size-fits-all’ services are often incompatible with established internal processes and systems that have a high cost of change. Try to find a partner with a flexible approach to integration and customisation that allows you to build the right workflows for your business, while leveraging common networks and infrastructure where it makes sense. Finally, we’d recommend a partner who can bring real expertise to the table across all of your post-trade operations – not just in FX. A unified approach to post-trade infrastructure across asset classes will really help drive down costs, complexity and risk,” he concludes.