FX credit management is evolving rapidly as firms recognise the value of moving from inefficient legacy processes to platforms that offer a real-time, centralised view of their positions. Paul Golden investigates.
Management of credit documentation, relationships and limits is perhaps one of the last major issues in the FX market that has not yet been addressed. However, regulators are increasingly aware that there is an issue around overallocations, that the potential exposures are far greater than previously estimated and that there is a lack of control for many credit providers.
Historically – particularly in the spot FX market – banks have devolved their responsibilities to execution venues. There is a conflict of interest, however, because execution venues are paid for typically through brokerage and not credit administration.
“For those that really understand the problem, the issue of overallocation carve-outs is a problem because the aggregate of carve-out credit is significant,” explains Andy Coyne, founder of CobaltFX. “What we are trying to do is put the banks back in control of their credit, which requires a combination of technology and design.”
He defines design as the hard work of understanding how venues have basically set up their own version of credit modules that make it impossible for banks to be in control.
Credit as a profit driver
It is vital that credit is not only a control but also helps profitability. “We’ve been very successful in redesigning the way the credit is distributed to market endpoints,” says Coyne. “A lot of our clients now know and understand why our solution is better than previous technology solutions and it has also given us the insight to reimagine how credit for other products, such as FX derivatives, should be done. It is very important to have a real-time credit engine rather than something that is static in nature.”
In the realm of FX prime brokerage and bilateral business, the fundamental mechanics – the parties involved, their operational methods and the underlying documentation – have remained largely consistent.
“For those that really understand the problem, the issue of overallocation carve-outs is a problem because the aggregate of carve-out credit is significant.”
Andy Coyne
However, as firms increasingly scrutinise credit exposure and face tighter credit conditions, they are driven to explore innovative strategies for business expansion. An example of such expansion is a surge of interest in exotic options, which, in turn, necessitates more sophisticated control mechanisms to ensure risk comfort.
“Innovation is significantly enhancing our ability to resolve credit management challenges and exercise tighter control,” explains Haim Levy, director of product strategy at OSTTRA.
He also points to a significant shift in the market: “We are seeing a lot more non-bank liquidity providers and agency brokers entering this space, which introduces an entirely new set of challenges.”
A key requirement related to risk control of agency brokers stems from the natural business model that typically remains ‘flat’ (i.e., not holding large open net positions).
“If you know that a certain client – such as an agency broker – doesn’t typically hold large net positions, you strive to assign them a smaller credit limit,” explains Levy. “Credit management innovations are intelligent enough to recognise and manage a short, temporary spike in credit usage until it flattens.”
Accurate allocation key to success
Another critical aspect of FX credit management revolves around over-allocation and under-allocation of credit. Under-allocation can restrict business opportunities, while over-allocation substantially increases a firm’s risk exposure.
“The goal is to find a balance,” Levy emphasises. “Through optimisation, we are striving to create a holistic view of credit and then allow it to be dynamically allocated, rather than simply increasing credit amounts where a client is trading more actively.”
This means that if a client, trading directly with executing brokers or on ECNs, increases activity on a particular network, the technology can reallocate unused credit from less active ECNs to where the client is currently active. This is a far more efficient approach than simply raising the credit limit on that specific network.
The market is now seeking similar solutions for end limits, where tri-party agreement limits offer fungibility and the ability to reallocate or redistribute credit across executing brokers. This dynamic adjustment, whether over time or intraday, is based on real-time client trading activity, replacing the static allocation of credit for each relationship.
When assessing the advantages of more integrated, automated, and comprehensive services that offer dynamic credit management and enhanced process control, Levy highlights a significant benefit: “When a firm establishes a risk profile for a client, sets it up, and manages it by exception, that client will consistently be able to trade within their pre-defined risk parameters.”
Automated credit reallocation and management frees up operations teams to focus on other tasks, such as enabling sales teams to pursue additional clients, he adds.
“If you have a robust automated system for managing FX credit, only requiring intervention for exceptions, you can manage more clients with the same resources. Credit risk will naturally decrease due to the enhanced control, the ability to reallocate credit, or even automatically stop an account if necessary.”
Dynamic credit management is a huge efficiency gain, because banks can do more trades with less credit with carve-outs eliminated. Carve-outs are often described as the bane of the FX industry because they create systemic issues that regulators are concerned about.
Dynamic approach boosts market access
“The analytics we produce clearly and significantly prove that banks need less credit,” says Coyne. “Market access for trading teams and PB clients is vastly improved, meaning clients see more prices and better liquidity. We know that there are trades clients don’t see because venues can be limit-up for certain counterparties. So in terms of profitability, it’s very important.”
Derivatives markets – particularly FX outrights and swaps – are much more credit and balance sheet intensive, which is why it is important that organisations know how to optimise credit in those markets.
“Client feedback has a major role to play in the development process – you need to build things that people really need and want help with,” says Coyne. “We’ve had feedback from clients who were unaware of some of the credit management problems on the platforms they were using. We help them reconcile what they currently do to tidy up errors and get a clean data set before switching to dynamic management.”
This clean data is really important because it makes organisations aware of existing problems that they just can’t currently see. The dynamic process then gives them a huge amount of additional efficiency in the way it distributes credit in real time to market endpoints.
“In the derivative space you start to really unleash the power of it, which is important because credit is a significant constraint on execution,” adds Coyne.
Another compelling aspect of FX credit management is the extent to which market participant demands are shaping its evolution towards minimising human errors, reducing operational risks, and increasing market access.
Levy identifies two key drivers for product development: “The first is the analysis of long-term trends and we are always looking for ways to capture these. The second is client feedback, where a specific client or prime broker might have a particular operational trading preference that translates into specific requirements.”
He uses the rising popularity of exotic options to illustrate how market trends influence solutions. “This has created a requirement to specify exactly what type of exotic option attributes are allowed for a specific client,” adds Levy. “Simply stating that you allow ‘digital options’ in the trading agreement and in the credit monitoring system is too broad and risky.”
“Credit management innovations are intelligent enough to recognise and manage a short, temporary spike in credit usage until it flattens.”
Clients now demand the ability to specify higher resolution attributes such as payout timing, barrier type, exercise style and other restrictions to minimise risk. As the use of exotic options grows, risk management is moving beyond linear and delta models, bringing Vega calculations (measuring an option’s sensitivity to changes in implied volatility) into play.
“These are just some of the cases where client requirements are now driving the enhancement and evolution of FX credit management products,” says Levy.
Cobalt uses artificial intelligence to test what it has built and technology has moved on significantly such that banks are starting to recognise that, when there is no competitive advantage, a shared infrastructure is the way forward.
“Once clients fully understand what is possible, it reignites their imagination and they come to us with suggestions,” says Coyne. “Continual improvement is vital if you’re open to listening to your clients.”
From a client’s perspective, what should they prioritise when selecting a credit management solutions provider? The first consideration, according to Levy, should be solutions that support a holistic view of utilisation across all trading avenues and diverse range of calculations.
“Many platforms, ECNs and executing brokers will have different measurement methodologies, so you need a solution that can support all of them,” Levy explains. “The network is also extremely important. In order to achieve a complete view of risk, the credit system must capture the utilisation across all trading venues. Partnership with a firm with access to the complete set of trade data is critical.”
Finally, he recommends partnering with providers that have a proven history of continuously innovating, enhancing and expanding their product ranges and working in partnership with their client base to help them empower their business by reducing risk and operational overhead.
Coyne refers to domain expertise as a key criteria when selecting a vendor, noting that his firm has people who have traded, run PB businesses and understand workflow in depth.
“The chosen solution should deliver a significant bang for their buck immediately with the subsequent stages of delivery adding more and more efficiency to the whole process,” he concludes. “Understanding the journey that clients go on, making sure the technology delivers immediately and not having to take up a lot of the bank’s time in technical integrations are all important.”
FX Credit Management: New electronic tools to increase efficiency
FX credit management is evolving rapidly as firms recognise the value of moving from inefficient legacy processes to platforms that offer a real-time, centralised view of their positions. Paul Golden investigates.
Management of credit documentation, relationships and limits is perhaps one of the last major issues in the FX market that has not yet been addressed. However, regulators are increasingly aware that there is an issue around overallocations, that the potential exposures are far greater than previously estimated and that there is a lack of control for many credit providers.
Historically – particularly in the spot FX market – banks have devolved their responsibilities to execution venues. There is a conflict of interest, however, because execution venues are paid for typically through brokerage and not credit administration.
“For those that really understand the problem, the issue of overallocation carve-outs is a problem because the aggregate of carve-out credit is significant,” explains Andy Coyne, founder of CobaltFX. “What we are trying to do is put the banks back in control of their credit, which requires a combination of technology and design.”
He defines design as the hard work of understanding how venues have basically set up their own version of credit modules that make it impossible for banks to be in control.
Credit as a profit driver
It is vital that credit is not only a control but also helps profitability. “We’ve been very successful in redesigning the way the credit is distributed to market endpoints,” says Coyne. “A lot of our clients now know and understand why our solution is better than previous technology solutions and it has also given us the insight to reimagine how credit for other products, such as FX derivatives, should be done. It is very important to have a real-time credit engine rather than something that is static in nature.”
In the realm of FX prime brokerage and bilateral business, the fundamental mechanics – the parties involved, their operational methods and the underlying documentation – have remained largely consistent.
“For those that really understand the problem, the issue of overallocation carve-outs is a problem because the aggregate of carve-out credit is significant.”
Andy Coyne
However, as firms increasingly scrutinise credit exposure and face tighter credit conditions, they are driven to explore innovative strategies for business expansion. An example of such expansion is a surge of interest in exotic options, which, in turn, necessitates more sophisticated control mechanisms to ensure risk comfort.
“Innovation is significantly enhancing our ability to resolve credit management challenges and exercise tighter control,” explains Haim Levy, director of product strategy at OSTTRA.
He also points to a significant shift in the market: “We are seeing a lot more non-bank liquidity providers and agency brokers entering this space, which introduces an entirely new set of challenges.”
A key requirement related to risk control of agency brokers stems from the natural business model that typically remains ‘flat’ (i.e., not holding large open net positions).
“If you know that a certain client – such as an agency broker – doesn’t typically hold large net positions, you strive to assign them a smaller credit limit,” explains Levy. “Credit management innovations are intelligent enough to recognise and manage a short, temporary spike in credit usage until it flattens.”
Accurate allocation key to success
Another critical aspect of FX credit management revolves around over-allocation and under-allocation of credit. Under-allocation can restrict business opportunities, while over-allocation substantially increases a firm’s risk exposure.
“The goal is to find a balance,” Levy emphasises. “Through optimisation, we are striving to create a holistic view of credit and then allow it to be dynamically allocated, rather than simply increasing credit amounts where a client is trading more actively.”
This means that if a client, trading directly with executing brokers or on ECNs, increases activity on a particular network, the technology can reallocate unused credit from less active ECNs to where the client is currently active. This is a far more efficient approach than simply raising the credit limit on that specific network.
The market is now seeking similar solutions for end limits, where tri-party agreement limits offer fungibility and the ability to reallocate or redistribute credit across executing brokers. This dynamic adjustment, whether over time or intraday, is based on real-time client trading activity, replacing the static allocation of credit for each relationship.
When assessing the advantages of more integrated, automated, and comprehensive services that offer dynamic credit management and enhanced process control, Levy highlights a significant benefit: “When a firm establishes a risk profile for a client, sets it up, and manages it by exception, that client will consistently be able to trade within their pre-defined risk parameters.”
Automated credit reallocation and management frees up operations teams to focus on other tasks, such as enabling sales teams to pursue additional clients, he adds.
“If you have a robust automated system for managing FX credit, only requiring intervention for exceptions, you can manage more clients with the same resources. Credit risk will naturally decrease due to the enhanced control, the ability to reallocate credit, or even automatically stop an account if necessary.”
Dynamic credit management is a huge efficiency gain, because banks can do more trades with less credit with carve-outs eliminated. Carve-outs are often described as the bane of the FX industry because they create systemic issues that regulators are concerned about.
Dynamic approach boosts market access
“The analytics we produce clearly and significantly prove that banks need less credit,” says Coyne. “Market access for trading teams and PB clients is vastly improved, meaning clients see more prices and better liquidity. We know that there are trades clients don’t see because venues can be limit-up for certain counterparties. So in terms of profitability, it’s very important.”
Derivatives markets – particularly FX outrights and swaps – are much more credit and balance sheet intensive, which is why it is important that organisations know how to optimise credit in those markets.
“Client feedback has a major role to play in the development process – you need to build things that people really need and want help with,” says Coyne. “We’ve had feedback from clients who were unaware of some of the credit management problems on the platforms they were using. We help them reconcile what they currently do to tidy up errors and get a clean data set before switching to dynamic management.”
This clean data is really important because it makes organisations aware of existing problems that they just can’t currently see. The dynamic process then gives them a huge amount of additional efficiency in the way it distributes credit in real time to market endpoints.
“In the derivative space you start to really unleash the power of it, which is important because credit is a significant constraint on execution,” adds Coyne.
Another compelling aspect of FX credit management is the extent to which market participant demands are shaping its evolution towards minimising human errors, reducing operational risks, and increasing market access.
Levy identifies two key drivers for product development: “The first is the analysis of long-term trends and we are always looking for ways to capture these. The second is client feedback, where a specific client or prime broker might have a particular operational trading preference that translates into specific requirements.”
He uses the rising popularity of exotic options to illustrate how market trends influence solutions. “This has created a requirement to specify exactly what type of exotic option attributes are allowed for a specific client,” adds Levy. “Simply stating that you allow ‘digital options’ in the trading agreement and in the credit monitoring system is too broad and risky.”
“Credit management innovations are intelligent enough to recognise and manage a short, temporary spike in credit usage until it flattens.”
Haim Levy
Risk management becomes increasingly sophisticated
Clients now demand the ability to specify higher resolution attributes such as payout timing, barrier type, exercise style and other restrictions to minimise risk. As the use of exotic options grows, risk management is moving beyond linear and delta models, bringing Vega calculations (measuring an option’s sensitivity to changes in implied volatility) into play.
“These are just some of the cases where client requirements are now driving the enhancement and evolution of FX credit management products,” says Levy.
Cobalt uses artificial intelligence to test what it has built and technology has moved on significantly such that banks are starting to recognise that, when there is no competitive advantage, a shared infrastructure is the way forward.
“Once clients fully understand what is possible, it reignites their imagination and they come to us with suggestions,” says Coyne. “Continual improvement is vital if you’re open to listening to your clients.”
From a client’s perspective, what should they prioritise when selecting a credit management solutions provider? The first consideration, according to Levy, should be solutions that support a holistic view of utilisation across all trading avenues and diverse range of calculations.
“Many platforms, ECNs and executing brokers will have different measurement methodologies, so you need a solution that can support all of them,” Levy explains. “The network is also extremely important. In order to achieve a complete view of risk, the credit system must capture the utilisation across all trading venues. Partnership with a firm with access to the complete set of trade data is critical.”
Finally, he recommends partnering with providers that have a proven history of continuously innovating, enhancing and expanding their product ranges and working in partnership with their client base to help them empower their business by reducing risk and operational overhead.
Coyne refers to domain expertise as a key criteria when selecting a vendor, noting that his firm has people who have traded, run PB businesses and understand workflow in depth.
“The chosen solution should deliver a significant bang for their buck immediately with the subsequent stages of delivery adding more and more efficiency to the whole process,” he concludes. “Understanding the journey that clients go on, making sure the technology delivers immediately and not having to take up a lot of the bank’s time in technical integrations are all important.”