As the volumes of foreign exchange trading continue to grow, enabled by ever-more sophisticated order management systems (OMS), there are increasing concerns that the back-office might not be able to keep up. The extent to which straight-through-processing (STP) can either cope or even exist for the back office boys has become an issue.
“There’s a high level of STP in the FX market, certainly compared to fixed income or derivatives, but there are increasing issues surrounding FX reconciliation and exception resolution,” warns Axel Pierron, an analyst with research house Celent and author of a new report on FX trading and electronic systems.
It is his contention that a low level of STP in many buy-side firms, especially in continental Europe, might hinder electronic trading growth in particular as the back office suffers bottlenecks due to increased volume.
Commercial solutions
“A lot of commercial solutions have emerged to fulfill market need, designing systems that create an STP functionality,” observes Chip Lowry, managing director of State Street's Global Link subsidiary that includes both FX Connect and the recently acquired Currenex.
Within the dealer-to-client sector the main commercial platforms include FX Connect, FXall, Currenex, and Hotspot FX, with each having specialised in some way to offer a solution through customer base or STP services and all providing access to electronic trading.
Mr Lowry agrees that there are issues facing investment managers in particular. “In terms of efficiency or STP, it’s not best practice to have the back office have to talk again to the counterparty to confirm both price and trade details because the OMS and accounting systems are unable to communicate electronically,” he says. “For those firms that do have STP efficiencies in the back office they’re realising a substantially lower error rate – the big guys have figured it out.”
Ideally, the STP story should see a dealer hit an order button and all other parts of that transaction right down to settlement would be handled electronically. In truth the purchase order may be automatic, primarily using the FIX protocol, but in many cases the post-trade back office system cannot communicate with its front office partner easily.
“When seeking new business, the most obvious feature is that the front office may be automated but the back office jumps out as needing the most attention to strive for STP,” says Neill Penny, global head of product strategies with FXall, a multi-dealer FX platform.
One figure offered by a specialist in this area estimates that even within the UK up to 40 per cent of small-to-medium sized investment managers have a manual process to handle confirmations. As the number of deals expand exponentially back office staff come under increasing pressure.
Even those dealer-to-client platforms handle the STP process in differing ways and often with different standards.
But why should this become a concern now?
In part it is the overall growth of the FX market. Daily FX trading volumes increased from $1900bn (€1449.6bn) in 2004 to around $2600bn in 2006 and are expected to grow to over $3000bn. This includes growth in ‘real money’ trading most notably done in the past by corporates to cover currency risk on business, but increasingly a fundamental part of investment managers’ strategies to hedge risk on their international assets. This is separate to the higher growth speculative trading, a feature of hedge funds.
Another is the increasingly international nature of investment, with cross-border FX trading at 62 per cent in 2004, up from 54 per cent in 1998.
While markets like the UK, Ireland and the US may have a high level of electronic systems in the office, the same cannot be said of other European or global markets. “Many European markets are well behind in gaining operational efficiencies from STP solutions found in UK or US,” says Mr Penny.
Further liberalisation of the currency markets could see investment managers dealing with more entities that have a complete absence of electronic trading, confirmation and settlement applications.
Some are asking is there further need for regulating standards and point to the FIX protocol as a solution. “The market differentiator for the existing platforms is not based on standards but on functionality,” says Mr Pierron.
FXall, for example, takes orders that are automatically executed via QuickConnect into FXall’s Settlement Center for confirmation matching, netting, and settlement preparation. Settlement Center communicates with the counterparties using Swift.
“In asset manager-land we’re seeing them use FIX protocols for purchasing rather than proprietary systems,” says Mr Penny. “But as an implementor of systems we see no demand to move from Swift to FIX on the post-trade side,” he adds.
An obvious fix
Mr Lowry views FIX differently. “FIX seems the obvious standard. Swift is a standard to communicate with banks but it has a high cost to money managers,” he points out. “FIX grew from the equity space, it can do a lot but it is not quite there yet. You can mould it to your own specifications but not everyone would be using the same mould at the moment.”
But for Mr Pierron even a FIX standard will not solve certain issues. He also points out that it is the proliferation of electronic trading itself that is exacerbating the problem. Celent estimates that close to 50 per cent dealer-to-client volume is traded electronically and it expects this to increase to 65 per cent this year.
Paradoxically perhaps, the average value of FX deals has been decreasing but the number of deals have gone up, enabled by electronic trading (ease and lower pricing).
“With the increased volume of trades more exceptions are being created and resolving them is stretching the back offices capabilities,” warns Mr Pierron. “Remember even if there is implementation of a full STP system and full exception resolution process, the back office still needs a person to sort it out,” he adds. “Even with FIX there’ll remain human error such as incorrect order keying and that exception remains to be resolved by human intervention.”
