Phil Weisberg: Evolution of a Market Structure


Phil Weisberg, Global Head of FX Thomson Reuters, wrote a piece within Reuters online Exchange Magazine, part of the “Innovation Issue.” The article speaks about and is titled ‘Evolution of a Market Structure’ within the foreign exchange industry. You can read the entire article below:

It is not often that entire industries have the opportunity to completely restructure, but that is exactly what is happening right now in the world’s largest financial market, foreign exchange (FX). A combination of increased public scrutiny and regulation is shifting long-standing industry dynamics and driving participants to rethink their fundamental strategies. This process has created challenges for banks, as well as for their clients including the corporations and asset managers that rely on the FX market on a daily basis.

Historically, currency trading has not taken place on organized exchanges but rather on a bilateral basis between a liquidity provider, typically a bank, and a liquidity consumer. Using this so-called over-the-counter (OTC) trading method, the FX market has become one of the most efficient and liquid in the world, with $5.3 trillion traded on a daily basis, according to the Bank for International Settlements in 2013.

Not all OTC asset classes work quite so well, however, and during the 2008 financial crisis the system was put to the test and gaps emerged. Reforms subsequently mandated by leaders of the G-20 economies consequently introduced greater transparency, as well as centralized trading and risk management, to OTC derivatives trading.

To understand some practical implications of these changes for FX market participants, consider a few of the challenges faced by the group treasurer of a large multinational consumer products company with operations all over the world.

As a result of selling goods in numerous currencies, as well as having overheads in multiple countries, the company has continual exposure to currency fluctuations. The corporate treasury department is responsible to assess these exposures on a daily basis, determine appropriate hedging strategies and limit any impact on the bottom line.

The FX market offers multiple ways to hedge currency exposures, from a simple swap or forward that would lock in a rate at which to buy or sell at a future date, to more complex products that can be structured to pay out at pre-arranged levels. But in many emerging markets, governments still exercise strict exchange controls that mean the currency is not deliverable and these products cannot be used. In such cases, non-deliverable forwards (NDFs) have become an important hedging instrument whereby the difference between the agreed rate and the spot rate at settlement date is cash settled.

Recognizing that the FX market continued to operate without incident during the crisis, US regulators exempted FX spot, swaps and forwards from the most onerous requirements of the Dodd-Frank Act, but NDFs and FX options were included in the regulation, thus creating challenges for the corporate treasurer.

Under the Dodd-Frank Act, NDFs will be traded on swap execution facilities (SEFs), a new type of trading venue that has the potential to bring greater transparency than traditional bilateral channels, with multiple participants bidding for every trade. The corporate treasurer will now therefore need access to SEF-enabled NDF trading.

The Thomson Reuters SEF was launched in October 2013 and offers Dodd-Frank compliant trading of both NDFs and FX options. On the Thomson Reuters SEF, to which more than 200 firms are already connected, a multibank request-for-stream mechanism and accompanying connectivity and documentation allows clients to satisfy their Dodd-Frank clearing and reporting obligations.

Meanwhile, exceptionally low volatility in major currency pairs since mid-2013 has led firms that trade FX for profit to scale back their activities, which has in turn contributed to an environment of reduced trading volume. Although volatility will eventually return, greater focus on compliance and risk means that banks in particular will focus on new opportunities, with some now seeking to match buyers and sellers on an agency basis rather than taking the other side of the trade as principal market maker.

The reallocation of bank capital away from principal risk-taking will impact bank clients such as asset managers, who must now begin thinking about assuming more of that risk themselves. This will involve the ability to directly and efficiently access a range of pricing sources in advance of execution, as well as the need to analyze and report on execution quality post-trade.

Thomson Reuters FXall platform equips clients with proven workflow and transactions solutions to support these requirements and more. The FXall Execution Quality Analysis tool (EQA) enables comprehensive review of trading distributions across single and multi-bank requests, by currency pair, and by instrument type; reveals insights about how to trade more efficiently; highlights important trends; and facilitates identification of performance enhancement techniques.

With regard to technology investment, banks are now less interested to engage in a technology arms race to chase the marginal point of market share. Instead, they are looking for ways to leverage industry standard technology wherever possible, particularly when it comes to technologies that allow them to efficiently and cost-effectively satisfy evolving regulatory requirements.

Thomson Reuters aim is to deliver technology that takes away the burden banks would face if they chose either to build in-house or to use smaller vendors. As a provider of scalable industry platform solutions, Thomson Reuters gives banks the tools and capabilities they need to support their FX business goals, whether it is access to the Thomson Reuters SEF, a desktop aggregator or a core pricing engine.

As the diversity of participants in the FX market continues to increase and in alignment with regulatory mandates, ensuring that all participants are held to consistently high standards of trading behavior is key, and Thomson Reuters is playing a positive role in this process.

In wide consultation with our customer base, Thomson Reuters recently published a revised rulebook for the Thomson Reuters Matching FX trading community designed to safeguard trading practices that enable a fair and orderly trading environment. As the industry continues to evolve, initiatives like these that focus on fair access and acceptable trading behavior will help bring about benefits to the industry as a whole.

For the original article on Reuters Exchange Magazine website, click here.

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Phil Weisberg: Evolution of a Market Structure

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