FT Mandate: Why are so many asset managers turning to electronic trading?

Neill Penney: We see three main drivers - efficiency, best execution and, most recently, compliance with regulations such as Sarbanes Oxley. Since it was introduced in 2002, Sarbanes-Oxley has changed everything for our clients. Under SOX legislation, every institution listed in the United States needs to have its security and internal controls checked by an external auditor. For example, they may check that development personnel don’t have access to the production data base or that when a customer signs, the legal department receives documentation before the system can be accessed.

The more points of manual intervention there are in a process, the more checking will be required under Sarbanes Oxley. Dealing over the phone requires extensive manual checking of details such as the amount of currency dealt and whether the trade was executed by an authorised person. Manually checking SOX compliance is an expensive and cumbersome activity and is also prone to error. For example, they may check that access to the production database is strictly controlled, or that when a customer signs, the legal department receives documentation before the system can be accessed.

FTM: Have the best execution requirements in the Markets in Financial Instruments Directive (MiFID) also had an impact?

NP: It is not yet clear how MiFID will apply to foreign exchange cash trading, since the industry is still working through interpreting how the regulations should be applied for OTC-traded instruments. However, people thinking ahead are expecting that, even if the regulations do not yet apply to OTC, this represents a best practice that clients may well come to expect for all the financial instruments in their portfolio.

FXall has a wide range of customers with different reasons for trading foreign exchange, different execution priorities – for example, reduction of manual processing versus price improvement – and different auditing regimes. As a company, we want to allow our customers to demonstrate best execution in the most appropriate way for their business. For example, for a customer that deals exclusively with their custodian, best execution may be about receiving an independent benchmark rate for the time the order is uploaded from their order management system (OMS) and the time the order is executed. The client can then look at how far the market moved between the time when the order hit the traders’ dealing system and the time of execution – and determine slippage or price improvement.

Other clients are moving towards third-party execution – not dealing directly with their custodians. In this scenario, clients may wish to take the approach of executing trades in competition and comparing prices from multiple banks.

Then there are other customers for whom neither trading in competition, nor using an indicative benchmark, are appropriate, as they both require a more active trading methodology than the customer is comfortable with. For these clients, we offer execution via the benchmark fixings products supported by many banks. With this approach, trades are executed at published rates set at various intervals throughout the day, based on independently audited fixing methodologies. The rates can be checked by auditors and verified as a neutral benchmark. The customer can then prove best execution by producing an audited trade report.

FTM: How does electronic trading help asset managers save time and money by streamlining the FX process?

NP: Three years ago, the magic phrase was STP, or straight-through processing, which is the bedrock of electronic trading efficiency. Trade requirements are collected in the customer's OMS and can then be uploaded automatically to a trading venue where they will appear on the trade blotter. Once logged into the trading platform, the trader can execute on electronic prices from one or multiple banks. After execution, deal details are downloaded back into the OMS and disseminated through the organisation, so there is no need for manual re-keying. The whole process, from trading through to middle and back office processes, is far more efficient and less error-prone than telephone-based trading and manual trade processing.

Today, the most sophisticated users are moving beyond simple STP to automate complex workflows. A large asset manager may have a research division generating trade requirements across multiple accounts and an execution desk consisting of four or five people. For these institutions, it is important that orders can be managed by the entire execution team, making it easy for individuals on the team to share the work between them in whatever way suits them best – for example by currency pair or by client, perhaps with teams of traders assigned to the busiest areas.

Segregation of duties is another concern. Many asset management firms have introduced maker-checker rules, which require every trade to be approved by at least two individuals – one to build the trade and another to check it. Some firms also require a third person to execute the trade. Asset managers are looking for flexible trading and order management systems which can be configured to support their particular approval process.

As I mentioned, many clients are moving towards third-party execution, or trading with providers other than their custodian. When a customer trades with a third party, they need to notify the custodian that the trade has been executed, so that the custodian can settle with the executing broker. This notification process has historically been complex and time-consuming, but trading systems are now starting to introduce functionality to simplify it. For example, some platforms can generate automated payment notification messages in SWIFT format, drawing payment details (settlement instructions) from integrated Settlement Instruction Databases.

FTM: What developments do you expect in FX trading and order management technology for asset managers?

NP: We expect to see further advances in order and execution functionality, include more complex order types and the ability to submit orders for execution at a fix. Given the continued focus on best execution, asset managers and FX trading providers are also likely to turn their attentions to transaction cost analysis (TCA), which has already taken off in the equities market.

TCA allows asset managers to track the efficiency of their execution strategy in an objective manner that they can share with their clients. It helps fund managers compete for and retain business based on the strength of their execution efficiency. As people begin thinking about how the industry may interpret MiFID for FX, we are expecting TCA tools to increase in priority on our clients’ list of requirements for a trading venue.

TCA is one of many tools from the world of equities trading that is now being introduced into foreign exchange; others include algorithmic trading and electronic crossing networks, or ECNs. Historically, asset managers have been quicker to embrace new technologies for equities and fixed income than for foreign exchange. But foreign exchange is catching up. More than half of financial institutions now trade FX online, compared to just 10 per cent a few years ago. Now that online FX is mainstream, the pace of innovation shows no sign of abating. People are always looking for ergonomic ways to improve the system, new features and workflows, and ways of making or saving money. The evolution of e-FX will never stop.

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