This year, we hope, will be much different than last year. In January and early February 2020, the FX market seemed almost sluggish, reflected in suppressed levels of FX option implied volatility, which was hitting all-time lows. Then in March, pandemic fears pushed trading volume to unprecedented levels, and implied volatility across most currencies reached levels not seen in a decade, only to fall sharply in April. The global economic uncertainty presented from Coronavirus-induced stay-at-home rules left traders in uncharted territory.
In these volatile and unpredictable market conditions, buy-side firms turned to FX algorithms and their most trusted banks to help them execute larger orders in thin liquidity. FX options traders told us that they looked for ways to hedge against further uncertainty. Some said they were implementing different strategies or combinations of strategies that leveraged FX forwards, put or call spreads, and risk reversals. Bloomberg FX option pricing and back-testing tools showed that certain risk reversal strategies performed much better than FX forwards did under similar circumstances.
Today, FX professionals are weary. Covid-19 has forced them to abandon acres of screen real estate in their offices to work on a portable laptop at the kitchen table. In past crises, FX professionals were able to work with colleagues in disaster recovery sites with the benefit of business continuity and on-site technology support. This pandemic has left many working alone in volatile markets, relying on video conferencing while competing for precious bandwidth with the remote learning demands of their children. We saw significant increase in the use of the Bloomberg Anywhere and Disaster Recovery Service in 2020. These tools provided a wealth of data, news and market access that helped FX traders stay on track.
As Brexit unfolds, FX pros are looking at the best ways to adapt. While no one can truly predict the full impact of the United Kingdom’s (UK’s) exit from the European Union (EU), Bloomberg anticipated many different scenarios and prepared the data, information and infrastructure needed.
In 2019, Bloomberg received all necessary regulatory approvals to offer the same range of regulated services to EU and UK clients post-Brexit. Bloomberg Data Reporting Services B.V. received authorization from the Netherlands Authority for the Financial Markets to operate an Approved Reporting Mechanism (ARM) and an Approved Publication Arrangement (APA), to adhere to the Markets in Financial Instruments Directive (MiFID II) regulatory reporting. Our Dutch multi-lateral trading facility (MTF), or BTFE, now operates alongside Bloomberg’s UK MTF, and provide services on a cross-border basis from Amsterdam throughout the EU under a MiFID II passport. It provides eligible participants with request for quote (RFQ) and request for trade functionality for: cash bonds, repos, credit default swaps (CDS), interest rate swaps (IRS), exchange traded funds (ETFs), equity derivatives and FX derivatives.
Brexit is not the only government intervention on the FX community’s mind. Today, traders need to ensure that their actions meet the requirements of a variety of changes. In the European Economic Area (EEA), trades have to comply with all stipulations of MiFID II and be executed over an MTF. Under the next phase of MiFID, there may be more reporting requirements and tests to increase transparency. While Basel III’s capital standards are delayed, work on the transition from LIBOR is moving ahead, although the target dates for details may not be clear until after the end of 2021.
In the U.S., FX swap trades have to adhere to Dodd Frank laws and execute on a swap execution facility (SEF). Some worry that regulations may expand further under U.S. President-elect Joseph Biden’s administration, but it is too early to predict that.
Changes brewing in Emerging Markets
Meanwhile, regulations in Asia are changing rapidly and becoming much more stringent. What makes it even more complicated is that different countries are considering different stipulations. This could significantly affect trading, reporting and surveillance requirements, including who can trade what with whom, and how.
In anticipation of these changes, Bloomberg in Malaysia obtained approval from Bank Negara Malaysia (“BNM”) to offer foreign exchange electronic trade negotiation via Bloomberg’s Singapore market, under BNM’s new framework for electronic trading. This move will allow Bloomberg to provide uninterrupted service and help the BNM build a more transparent and efficient FX market.
Agreements have been inked in other countries, too, such as Angola, where the Banco Nacional de Angola (BNA) has adopted FXGO and a system for FX auctions. This allows commercial banks and corporates in Angola to trade FX spot electronically. Also, the new auction system provides a safe and secure environment for the BNA to perform currency auctions electronically, and for market participants to track and enter bids. The BNA adopted the new FX process in June 2020 and has seen wide acceptance for the new system.
Compliance on the mind
Meeting all the new regulations, we expect, will significantly increase the number of compliance, legal and regulatory personnel needed.
Some firms are considering incorporating due diligence checks into their trading workflows, so they can meet these ever-changing demands. Through FXGO, Bloomberg’s electronic trading solution, firm administrators can set up and manage all aspects of electronic liquidity, such as client enablement for trading, counterparty enablement, spread/credit buckets setup, allocations, and payment instructions.
Confirmation and settlement is one area where we are seeing efforts expand. Many traders still want to use voice trade for fixed income such as Bloomberg’s voice confirmation (VCON), which allows monitoring of trades on a blotter in one centralized location. Those who want a full confirmation matching service for FX can use services such as Bloomberg’s FX CMS, which compares and reconciles post-trade information submitted by the counterparties to an FX trade (including allocation information and settlement instructions) to generate an affirmation. The affirmation may then be transmitted to a customer’s custodian or used to effect settlement.
Understanding the true cost of trades
No matter what stage of the trading process, FX professionals are looking for new ways to save time, yet maintain best execution practices. For example, institutional investors such as Pictet Asset Management have decided to use a new tool that lets FX traders calculate the full cost of a transaction before execution. Normally, buy-side firms cannot see the impact of bank charges, broker or custodial fees on a trade until it reaches the back office. Now, with a supplementary cost tool on FXGO, a trader can see the best overall price in real-time, achieving best execution and the most cost-effective decision for their firm.
Everyone is looking at algos
Market volatility often moves prices faster than the eye can see, necessitating a digital response. In 2020, Bloomberg saw a significant increase in the number of participants, the number of trades and the volume traded using algorithmic orders. This may be due in part to Covid-19, but also due to the increasing levels of buy-side sophistication. The flow was not only in G10 currencies, but also in more than 175 currency pairs across algo strategies. We have also seen an increase in time-weighted and liquidity seeking algos, which price-takers are making use of to achieve their best execution despite choppy and thin liquidity conditions.
An algo’s ability to reduce the overall cost of FX trading is making the buy-side increasingly open to using them. FX dealers are also investing in innovative technology that presents pre-trade, in-flight and post-trade analytics integrated directly through Bloomberg to optimize user decision making and leverage FXGO’s execution and straight through processing tools. This gives the FX community real-time access to the bank’s view of liquidity and order execution.
Automation is no longer a luxury
Algos are a perfect example of why FX professionals can no longer ignore automation. Without a clear digital pathway, a company’s financial activities pose unnecessary and costly logjams in its day-to-day operations.
Financial firms such as asset managers, pension funds and hedge funds need to continually upgrade their technology. While this can require investment, the benefits can far outweigh the cost. An upgrade in trading tools is essential to meet global regulations, but it also allows them to do in seconds what used to take hours. In addition, it enables financial firms to remain competitive and grow their business within their country, throughout the region and within world markets. Having newer technology gives companies a distinct advantage over their competitors.
Electronic trading platforms can compress the process into a consistent, reliable workflow that draws on sophisticated execution, accounting and reporting tools. Particularly important is e-trading’s ability to produce prices from multiple liquidity providers simultaneously to help instantly identify a counterparty that suits the trading strategy.
At today’s fast pace there is little time to call or chat with liquidity providers for smaller deals. Traders do not want to waste time finding the best price for each trade and risk losing any market advantage they may have had when they began assessment, or potentially tip their hand. A digital route creates a quick solution and allows FX teams to spend time on large trades or more profitable tasks.
For more complex structures, where chats and telephone conversations can be a valuable part of the negotiation process, manually booking trade details can be time consuming and error prone. This process, too, can be enriched by scraping actionable trade data from chats or quickly capturing data from voice trades for digital affirmations. By automating the process and integrating it into the wider trading system, FX pros can better monitor their markets and reduce the risk of human error when processing orders.
The high cost of inaction
A digital FX workflow should include tools for reliable price discovery, netting, account allocation, order staging, flexibility in execution methods, and straight-through-processing (STP). Many trading desks require sophisticated solutions that include smart order routing, algorithmic trading and transaction cost analysis. Middle office, back office, and compliance teams need tools to increase efficiency while reducing operational risk, from trade capture through confirmation, matching and settlement.
All of those needs can be addressed via electronic trading. Today, nearly 75% of all FX trading globally is done electronically, which will continue to increase as new technologies reduce risks and costs, and increase efficiency and performance. Even emerging markets, which traditionally trade via telephone, are increasingly embracing e-trading to improve deal capture and risk management.
Trading electronically is no longer a luxury, but a necessity to ensure efficient liquidity distribution, price transparency and best practices. The regulatory environment is ever-changing and penalties for non-compliance are rising. Requirements for best execution no longer simply mean getting the “best price” and firms need to comply with all regulatory and internal policies, all while facing pressure to reduce transaction costs.
Today, more than ever, it is vital that asset managers transform their work flow into a digital one. Efficiency is particularly important, as FX professionals globally are being asked to do more with less. While they may fear the technological leap necessary to make the transition, the cost of inaction can be quantified not only in lost efficiencies, but in the dollars and cents of missed opportunities.