FX trading platform providers have experienced record success in 2005 as volumes of FX traded electronically continue to surge. As the market makes full use of technological developments taking place, traders have access to a range of liquidity pools in order to search for the best price and also to execute profit-generating strategies. These sources of liquidity also mean that it is possible to change the way in which FX is traded, with the option of trading more frequently. This has had an impact on system requirements for banking, as the volume distribution of FX trades has changed.
The electronic evolution has also changed the level of service a bank’s clients have come to expect, with multi-dealer platforms providing a greater value-added service. Online portals provide better on-demand service, giving customers an added freedom to access information as they need to.
It is also broadly acknowledged that FX risk arises from a broad number of sources within each bank. Therefore, it has become critical that this risk is identified and managed in a timely fashion. While the growing amount of customer business and proprietary trading activities are two obvious sources of risk, other less obvious sources include foreign currency payments, the equity business, and trading dual currency bonds. It is becoming possible to draw all these other sources of risk together with that generated on the desks and manage it effectively.
Haste not waste
The existence of real-time executable price feeds has brought about the ability to profit through rapid execution. Arbitrage trading – where traders can trade on a price for dollar/yen, for example, and gain from the price discrepancy between euro/dollar and euro/yen – has become an increasingly popular strategy. This type of trading is borne out of the availability of real-time prices and multiple sources of liquidity available in the market. However, it also generates large trades occurring in rapid succession, which need to be managed efficiently internally.
This changing, customer-driven FX business means numerous trades are occurring throughout the day, with particular peaks in activity generated by news or market movements. Client business generally produces a flow of low-value trades at a more consistent level of activity, but the ability to execute on-demand through single bank portals has brought the increased frequency of peaks in electronic volume.
The supporting systems need to be able to respond to this type of activity. It is now important to be able to handle a consistently high volume of trades but also manage additional peaks in trading activity generated by both clients and proprietary trading. Timing is critical, so not only should the system have the ability to support the trading activity, it must also provide essential information to traders to enable them to make those rapid decisions.
Having critical information to hand is the key to effectively managing positions and profiting from market fluctuations. Real-time price feeds, in addition to real-time profit and loss (P&L) and consolidated positions all displayed in a single screen, means that traders can process that information and have the ability to respond. Systems not only need to support the levels of activity generated from the trading activity itself, but provide this additional information in real-time. Therefore, system performance and scalability is now a critical factor in FX and will become increasingly so in the next few years.
While a trader’s screen can now provide a consolidated view of risk across multiple channels, it is also important to achieve this at an enterprise level. As greater sources of FX risk are now being identified, so has the need to be able to bring this risk together to gain a picture of total exposure and hedge the risk accordingly. The numerous non-obvious sources of FX risk mentioned previously can be consolidated to provide a high-level view of exposure in order for this to be communicated to the traders. As banks become more efficient at managing this risk, this will also have an impact on their FX volumes.
When adding these types of proprietary and hedging activity to the level of client-driven business, it is clear that FX volumes will see a considerable increase in the future. This activity needs to be managed effectively so it does not impact the ability to provide an efficient on-demand service to clients. Trades need to be managed throughout the lifecycle; from the front where rapid deal capture is critical, positions need to be updated and risk needs to be hedged, through to processing which must be highly efficient and streamlined.
Processing in client business should not be impacted by a volume of trades generated by proprietary activity or for hedging purposes. Banks have the option to provide additional processing services to clients through their online portals, such as the ability to match trades and monitor their progress through the back office; however, banks must be more efficient in keeping this information up-to-date.
Efficiency drive
Electronic trading has greatly shaped the FX market today and provides banks with numerous opportunities to build a successful client-driven business. It also presents opportunities for arbitrage trading that were less easy to identify in the past. However, it is also important that any gains made are not reduced by a lack of efficiency internally and that the client business is not adversely impacted by strains placed on systems by activity driven from within the bank itself. FX can be a key generator of profit, but only if this is not outweighed by the cost of the business itself.
Martin Cook is an FX specialist at Calypso in London.
