Aggregated liquidity and smart order routing are important ingredients for FX brokers, but they are no longer enough to maintain a competitive edge in today’s FX environment. Gone are the days when brokers are simply adding a margin and hedging each position as they come, or just passively sitting on the risk from their customer flows. Ticket fees and small ticket penalties have also grown. Amidst tightening margins and increasing regulatory pressures on NOP, nearly all brokers have either pondered or gone ahead and implemented warehousing/internalization strategies to varying degrees.
Unfortunately, building the technology in-house to support robust warehouse management systems can be large, complex and costly projects to undertake, and is no longer feasible for even very large institutional banks, let alone by the majority of brokers. The good news is that technology advancements have considerably improved the availability of risk management software in the market, thus making it a far easier tech stack to outsource than it has been in the past. Despite the often nuanced requirements of the FX brokerage community, there are actually a set of clear and straightforward technology considerations a broker should look at in order to implement a more advanced and modern risk management programme.
Know Your Flow
Risk management is a multi-layered issue and requirements vary dependent on the brokerage firm. However, a common priority for anyone market making to a retail audience is gaining an unequivocal insight into customer flow. In other words, brokers need technology that enables them to identify and hedge certain types of client flows, but not others.
Data science may once have been limited to the realms of institutional markets, but thanks to progress in making this technology accessible to a broader audience, it is now possible for a broker to super-augment their understanding of customer flow through good, hard data.
And the good news is that the eFX brokerage market has data in abundance. Data science affords the broker with greater insight into their client base through its rich data sets, which makes it far easier to analyze the mark outs, understand the realized spread and importantly, understand the cost of hedging. With the right data science tools, a broker can have a birds-eye understanding of whether they are dealing with an informed customer whose flow may be sharp and should be hedged out, or whether they are dealing with more neutral flow that should in fact be warehoused.
When selecting technology to analyse customer flow, brokers should seek out advanced data science capabilities that are equally as easy-to-use as they are sophisticated. Some vendors now have reliable data science reports which offer an instant and intuitive view of complex and massive amounts of data, with every tick and event in the order workflow accounted for, thereby making client flow analysis a far easier task to measure and act-on.
Optimize Your Yield on Warehoused Positions
Once you have a clear view of the flow you should be warehousing, you need technology that will manage the position and risk based on your views of risk management. In the past, brokers who warehoused generally started out by manually managing this risk. But the truth is that building automation into a warehousing and risk management workflow is one of the key elements to succeeding in today’s market. “Auto-pilot” capabilities are a crucial component when managing P&L, positions and margins. As well as improving operational efficiency, automation helps remove margin for error and can help you manage exposure in the most optimal way possible, especially when tailored by currency pair, trading sessions and market environments. Such rules-based systems allow brokers to configure their risk management policies precisely across the risk management workflow in a way that quickly allows brokers to switch between different market environments.
One such technology that does it all is Integral’s award-winning Yield Manager. This risk warehousing tool delivers a continuous view of a user’s risk position and the markets in real-time, allowing them to monitor risk, manage risk and hedge risk for the most optimal outcome.
Used by leading global banks as well as established players in the broker community, Yield Manager provides a full spectrum of advanced and feature rich hedging applications that allows a user to define risk policies at a granular level based on short/long position or P&L. Traders can configure the warehousing workflow on a range of metrics, e.g. currency pair(s) or customer group(s), and the system offers the flexibility to automate the workflow process, manually manage it, or switch between both modes in real-time.
The carefully designed user dashboard is an essential ingredient for Yield Manager’s success. At a single glance, a trader or risk manager can quickly glean essential information regarding their risk positions at an aggregate or currency pair level. Changes to risk positions are presented cleanly, logically, intuitively and in real-time. In addition, the Yield Manager dashboard allows a user to define multiple tiers of risk tolerance levels for a nuanced look at where they stand.
Knowing How to Hedge is as Important as Knowing When to Hedge
It’s not only important to decide which customer flows to warehouse and when to hedge the resulting positions, but also importantly how to hedge the position. Again, that’s when technology should be an enabler. With a range of considerations and routes to market, having access to a warehousing tool that has an integrated Execution Management System (EMS) allows you to modify approach quickly and seamlessly through automation offers advantage.
For instance, access to mid-point matching execution offers access to uncorrelated flow to off-set risk at mid, resulting in the lowest possible transaction cost – zero! In fact, one of the biggest advantages of Yield Manager is that it’s fully integrated into Integral RiskNet, a midpoint matching facility.
The seamless integration of RiskNet into the Yield Manager workflow means that there is no need to separately monitor orders resting in RiskNet and their impact on overall risk positions in Yield Manager. From a workflow perspective, they are one and the same. More importantly, from a business perspective, this mid-point matching in essence allows brokers to extend their warehousing and internalization capabilities outside of their own franchises.
Employing algos is another way of auto-hedging to the market, since it may result in trading large flow out of a warehoused position. Knowing the difference between technology that offers useful configuration versus technology that overcomplicates things (and thus introduces operational risk) is something that thoughtful brokers will take the time to consider.
It is clear there are many considerations for the FX broker when managing risk. Listening to clients and bringing new and modern advancements into the FX technology stack has meant available workflow has dramatically improved. Importantly, with greater workflow automation and the ability to configure technology in line with the users exact risk requirements now ensures a brokerage can use technology to auto-hedge and warehouse risk optimally, conveniently and profitably.