What’s best practice when it comes to allocating FX business?
With FX banks again fighting for more flow, FX managers should consider anew how to best allocate their FX business to their banks (or even non-bank counterparties). With large MNCs, it is not unusual to allocate FX business to a dozen or more banks, which means it can be a challenge to share the FX wallet optimally without a tried and true method.
But even some of the more sophisticated treasury shops lack a method they have confidence in for maximizing competitive bidding, sometimes rewarding bank group participants that don’t meet their standards. Indeed, when The NeuGroup FX Managers’ Peer Groups 1 and 2 conducted their world-class principles project, they found that 28 percent of participants did not drop their least competitive banks routinely from further bidding, and only 6 percent did this in every case.
Such results indicate that either FX managers don’t have a strict rotational methodology they believe in, or that there are more instances of rewarding business to banks based on other considerations than FX managers are willing to admit.
Best-practice intuition…
Generally speaking, best practice for most firms is to invite credit banks (with real FX capabilities) to bid on business, but make clear that actually winning business depends on having the most competitive bid. Since corporates typically will invite five or fewer banks to bid on a given trade, spreading the business around requires a method to select the sub-group of banks invited to bid on each trade.
A common approach it to set a hurdle benchmark for the percentage of winning bids a given bank has to exceed to get invited to the bidding. Some firms bucket this by wins on an e-FX platform, wins on the phone, and wins on spot, forward/swaps, or options. While consistent winners will be rewarded with more opportunities to bid, consistent losers may be put in a penalty box where they are not invited to bid for a period of time. Certain actions by a bank (e.g., failing to roll a swap after assurances that it would) may also result in being sent to the penalty box instantly.
…vs. hard performance numbers
While rewarding consistent winners and penalizing consistent losers makes intuitive sense, the concern is that it does not actually result in optimal trading performance. For instance, it may impose a lag in how quickly loser banks can undercut the bids of the winners. Further, if there is inadequate rotation of bid invites to all group banks, and perhaps even non-relationship banks and non-banks, the opportunity for hungry counterparties to win business may not be adequately realized.
This is where market studies showing quantitative performance outcomes would be beneficial. The e-FX platforms could be useful proponents of such research, as they could use it to refine algorithms that they offer FX managers in their performance reporting packages. To offer real value, though, performance reporting tools would need to overlay the other considerations FX managers must consider, including credit/counterparty risk, STP integration, value-added advice provided, etc. And that’s no easy task—which is why best practice in allocating bid opportunities is not yet totally formulaic.