“It’s no secret that Africa has embraced technology, and this can be seen in the adoption of digital payments and mobile money services,” says Ryan Tolmay, Sales Manager, Africa Sub Sahara at 360T. “This cultural change has pushed the sell side to look at what digital services they offer their clients and trading is no exception.”
“From a bank standpoint,” he continues, “we see that there has been a focus on their internal workflows. The ease of access to and adoption of technology to optimise specific areas including liquidity sourcing and price distribution have been key focus points.”
“We see great potential for expansion of electronification across the board where many African countries still have a large portion of the FX execution done on a manual basis,”
Ryan Tolmay
Electronification has particularly touched corporate treasury activity in the continent’s more mature markets, such as South Africa. Naturally, this wave has brought unique risks with it.
“Best execution in emerging markets can mean different things,” says Tim Hutchinson, Head of Electronic Execution and FX, Markets at Rand Merchant Bank (RMB.) “The choppiness of the liquidity, the fact that few regional players can market make certain currencies, all of whom are at different stages of their electronic trading journey, puts corporates in an interesting position.”
Is electronification posing more challenges than it solves in African e-FX? Here’s a look at how market participants are handling them and what moves we may see soon.
Electronification is not a silver bullet
Tolmay notes that the potential for electronification on a continental level is huge. “We see great potential for expansion of electronification across the board where many African countries still have a large portion of the FX execution done on a manual basis,” he says.
Corporates have realised the benefits of automating execution and are now exploring its use for other treasury activities
“With the use of already developed infrastructure that can support the management and price creation for local market currency pairs, both the buy and sell sides would tend to move towards transparency and faster execution that electronic FX trading provides.”
However, Hutchinson is quick to point out that electronification doesn’t solve issues automatically. Corporates have realised the benefits of automating execution and are now exploring its use for other treasury activities.
The goal here, Hutchinson notes, is to give more time back to treasury departments that enable value-added work. But just utilising electronic channels doesn’t guarantee a client best execution.
“It’s been quite fascinating to watch how Request for Quote tickets from clients on a multi-dealer platform sit open for quite some time,” he says. “This tells me that not all of those banks can handle client requests in an automated fashion. As a result, clients are disadvantaged here because markets by their nature are moving continuously. This is something we’re encouraging our clients to be curious about when using the likes of a multi-bank-portal seeking to get best execution. Clients may not have the tools to automatically scan a best execution report, but being curious about what they’re seeing from their banks pricing behaviour is beneficial.”
“Clients may not have the tools to automatically scan a best execution report, but being curious about what they’re seeing from their banks pricing behaviour is beneficial.”
Tim Hutchinson
He lists a few examples of events to look at. “Why certain banks take longer to price back than others, how often price updates are generated, how their requests are handled at different times of the day as well as the consistency in decimal places within quotes between providers. It may sound simplistic, but banks that quote manually tend to quote up to four decimal places since the Dollar-Rand is priced that way in the matching market.”
“Banks with electronic quoting abilities go up to five places,” he continues. “These are some of the things we’ve been encouraging treasurers to be much more conscious of.”
The core issue here is the definition of best execution. What does that phrase mean specifically when dealing in an emerging market? Treasurers will find going back to first principles useful when figuring this out. First, given southern and broader Africa’s market, receiving optimal liquidity is critical and is an important pillar within best execution.
Analysing a trade’s market impact is also critical. Execution report analysis will offer insights into this factor. Lastly, treasurers must ask whether they received the best price. Typically, market participants rush toward just this factor, so analysing it is logical.
Hutchinson’s point about quotes sitting on MDPs for far too long highlights how manual execution delivers less than optimal execution. For instance, most MDPs offer price refreshes four times per second. Assuming a manual quote takes 5 seconds to put together, clients are exposed to 20 price changes.
“All of this pushed us to have more conversations with clients about different execution styles and what’s best suited for you,” Hutchinson says. “What do the differences between RFQ and Request for Stream (RFS) look like, and what is their impact on clients and their executions?”
Figuring out the best fit
Getting a hold of all the factors corporates must look for in a bank partner can seem intimidating. Hutchinson has spoken about looking at internalisation rates in the past and encourages his clients to ask questions about them.
He defines the internalisation rate as the percentage of risk a bank passively trades out with its other clients, with a higher rate indicating better performance. Notably, this definition doesn’t hold across each bank.
These definition changes occur due to the diversity of liquidity providers banks access, all with different degrees of sophistication. Banks that seek to exit risk into the market tend to produce the highest market impact for clients, and looking for this quality is critical from a treasurer’s perspective.
“Data is critical,” Hutchinson says. “Internalisation rates, price markouts of execution, holding times of trades for internalisation rates by deal and ticket sizes are a few data sets that are important.”
He adds that the client’s willingness to work with the e-FX desk at their bank to design workflows fit for purpose is also important. There’s an entirely new dynamic in how the market now operates versus a few years back [in particular the Dollar/Rand market ], and clients will benefit from understanding how banks value client flow and what can be done so that both parties benefit.”
Recently, algorithmic (algo) trading has emerged as a potential solution for illiquidity and reducing market impact. What does this picture look like in South Africa?
“It’s in its infancy in the local market,” Hutchinson says. “Local banks haven’t brought much to the market for a few reasons. One, it is a big investment (even on a white labelled basis), and not every bank is at that stage of its journey to justify that cost.”
“Illiquidity and choppiness in the Rand market are also a factor,” he adds. Treasurers are also not (as yet) fully versed with algo workflows, and this contributes to the low uptake. Hutchinson notes that with global banks setting up shop in South Africa, algo trading practices ought to expand more locally.
Handling central bank compliance
Outside of South Africa there are additional challenges unique to the continent. Currently, the African banking landscape is a mix of regional players and Super Regional banks who operate local liquidity centres of excellence.
Clients will benefit from understanding how banks value client flow and what can be done so that both parties benefit
Central banks tend to guide the markets based on their counterparty liquidity transfer expectations. This approach works well in a voice-driven and manual environment. Relationships with the central bank lead to a better understanding of their expectations, ensuring compliance.
As banks increasingly pursue electronification this introduces an entirely new dynamic of how best to ensure compliance. Hutchinson explains. “You’ll find (as an example) a client who has a footprint across East and West Africa, may wish to maintain a relationship with their bank across markets seeking to establish consistency in operations . However, due to the dynamics unique to those markets or internal capability rollouts, you’ll find that service offerings aren’t very consistent across subsidiaries.”
He mentions that RMB has been working to increase consistency across multiple markets through its e-FX tooling. While better experiences are being created, this attempt has come with certain challenges. “A lot of e-FX capabilities don’t naturally consider elements such as central bank spread guidelines, compliance with pre trade quote guidelines etc,” he says. “We’re being challenged as a market to think about doing these things.”
Hutchinson notes that banks have witnessed some interesting developments, like rethinking the role of central pricing engines. While these engines deliver prices and maintain spread guidelines to clients, can they be used to interact with central banks too?
“I think what makes it challenging is the complexity behind these e-FX mechanisms,” he says. “Identifying clients and identifying which central bank guidelines to apply to them, etc is complicated and might result in some breakage.”
“It’s a really interesting dynamic in our local market right now,” he continues, “where we’re not trying to just optimise prices for clients, but also align with what central banks are looking for. We have to make them comfortable that despite moving onto this digital platform that can sometimes run autonomously, we can maintain their guidelines.”
Banks have a significant role to play here in terms of education. 360T’s Tolmay is bullish about electronification’s growth prospects. “Growth is expected from the more mature markets on the continent,” he says. “Drivers will include the local regulatory environment, the continuation of infrastructure development, and of course, local demand.”
While the markets in southern Africa have traditionally been more advanced, Tolmay says his attention is focused on other areas. “We expect continued expansion of electronic trading to continue in southern Africa where the FX markets have traditionally been more advanced. However, the uptake in both East and West Africa may prove to be key in the coming years.”
Electronification can drive more transparency for central banks, giving them insights into customer demand. And with these insights come more demand for innovative products that offer transparency into different market functions.
The NDF picture and what the future holds
NDFs have traditionally received less demand in Africa. However, the NDF market is relatively young, with the first African NDF executed as recently as 2019 by Bank of America and Citi. Hutchinson says RMB has noticed a growth spurt in demand.
“The appetite is coming from a few places, but where we definitely see demand coming from is the offshore buy side,” he says. RMB’s position as a super-regional bank and its work in expanding distribution has led to its presence in multiple offshore FX venues. As these FX venues moved towards NDF, demand has grown, Hutchinson says. “A lot of these venues have made significant strides in Asia and LATAM NDFs. Naturally, they’re looking for the next growth phase which they see as Africa. We are in the process of activating our NDF market making capabilities on these venues to compliment our very successful USDZAR cash market making capability.”
He notes there are a few hurdles around regulations. For instance, US swap dealing regulations might lead some banks to build relationships with prime brokers to mitigate regulatory concerns. “We also see central clearing models that some venues are offering as an interesting way of accessing clients,” he says.
Hutchinson believes the NDF market is set to grow and is bullish about African e-FX’s potential in the near term. “Client conversations have shifted toward increasing efficiency and electronification is a part of that,” he says. “On an RMB level, I’m excited because we’ve been on this journey for a while now and the benefit it has for our next level of innovation.”
With more data and robust processes in place, banks can hope to engage more with markets and central banks. Electronification may lag in African e-FX, but it is nonetheless creating a rosy future for market participants.
Fintech increasingly makes it mark on the institutional space
Fintech’s focus on Africa has largely been on payments. Specifically, cross-border payments have benefited from the injection of technology that fintechs have brought to the market. The institutional picture extended this advantage, giving clients access to wholesale FX rates and payment platforms.
As subsea cables from Meta and Google continue to boost digital adoption, the institutional fintech scene is witnessing interesting developments. “Africa’s young population has more access to technology than ever before,” 360T’s Tolmay says. “This is resulting in greater tech literacy making them more inclined to adopt digital services from banks. Digital FX services form part of a greater client offering that banks are in a race to provide their clients.”
RMB’s Hutchinson details an interesting use case involving pre-trade rules engines. “One of my focuses at RMB has been delivering higher consistency in our direct-to-customer services,” he says. “Whether it’s a salesperson operating on behalf of a client using a voice channel or a client seeking to self-service on a digital platform, we want to preserve the level of pre-trade checks needed.”
Traditionally banks have codified these checks in their pricing engines, leading to a rigid structure incompatible with modern markets. RMB has been working with fintech providers to create modular and flexible rules engines that ensure prices delivered to clients are up to date and in line with compliance needs.
“We have been working with them to rethink our approach and processes in FX, but are also beginning to explore it in a cross-asset way (in particular Fixed Income),” Hutchinson says. “I think one of the hallmarks of the new world we find ourselves in is the concept of loosely coupled architecture. Older models were tightly coupled and created an oil tanker that couldn’t move.”
“The ability to connect to a third party service by API is a powerful piece of how we’re thinking of our architecture,” he says. When asked about how fintech fits into this puzzle, given its lack of knowledge about internal processes and compliance needs, Hutchinson explains that fintech is a part of the workflow, not all of it.
“We’ve configured our rules and connected everything to our pricing engine,” he says. “We can then send a call to this third party engine that delivers a yes/no decision based on the conditions we’ve given it. This has been a powerful move for us and this is how we see our pre-trade rules working.”
This move from a B2C orientation to an institutional one is highly encouraging in fintech circles. As technology adoption increases in the buy and sell side, fintech will likely make stronger appearances, leading to even more interesting use cases.
