Trades now more analyzed than ever to make sure they are covering the right risks at the right cost.
The foreign exchange (FX) market has undergone massive technology-driven changes over the last 15 years and especially since the financial crisis. The crisis in fact has prompted corporates and other market participants to re-evaluate their approaches to the market and regulators to pursue initiatives to rebuild trust.
In the first of a series of articles addressing FX issues impacting corporates, iTreasurer talked to Phil Weisberg, global head of FX at Thomson Reuters since the start of 2013 (and more recently head of rates and credit as well), about trends and developments that treasury executives should consider when approaching the FX market. Subsequent articles will explore these areas in more detail.
Mr. Weisberg is particularly attuned to FX changes given he was the CEO of pioneering electronic FX trading platform FXall from 2001 until was acquired by Thomson Reuters in 2012. Before that he managed currency derivatives globally at J.P. Morgan Chase.
The FX market has undergone two fundamental changes in the last 15 or so years, according to Mr. Weisberg. The first, electronification, is hardly news to participants in the financial markets, whether the FX, securities or derivative markets. A decade ago, FX trades were pursued via phone and instant-messaging-type services, and that has shifted to more structured, time-stamped and highly automated transactions, where prices are often determined by computers rather than a person.
“The other big trend has been when a corporate trades with a principal, the price now reflects the principal’s total cost of doing the transaction, including its ability to move the currency around. It’s implicitly taking credit risk trading with the corporate as a counterparty, and it bakes all those costs into the spread,” Mr. Weisberg said.
Banks remain the predominant principals in the FX market. Fifteen years ago they readily extended credit to corporate customers to facilitate FX transactions and required little if any collateral; today, credit support agreements—or annexes—have become par for the course, requiring corporates to handle extra compliance and operational layers.
“A corporate that wants to buy dollars, sells a US dollar put to a bank, and then sees the dollar depreciate wouldn’t have had to post collateral in the past, but that’s changed,” Mr. Weisberg said.
Other new concepts have emerged, such as FX prime brokers, which enable participants to “rent” a bank’s credit line along with other market participants but not necessarily execute FX transactions with them.
“The combination of these changes means that people now think about FX transactions as market-risk transfer as well as credit and operations risk, and either that’s all included in a single price or the separate components are fused together,” Mr. Weisberg said. What that means for corporate treasurers is they are now expected to analyze the FX prices they receive, using tools such as Thomson Reuters’ Eikon, a tool used for pre-trade data and analysis. They’re also required to demonstrate the process they went through, from identifying an FX risk, to turning it into a transaction to transfer that risk, to evaluating whether the transaction was done effectively.
“Before, FX used to be something that was a byproduct of the business. People thought about what hedges to do but less about whether they were doing them at the right rate and getting a fair price for transferring or taking that risk,” Mr. Weisberg said. “That’s all pretty new, and many folks do that now but not everybody, and everyone tends to do that in different ways, and not always in the best way.
For example, a corporate treasurer with FX risk has traditionally looked into the best price to hedge it at a single point in time. In the past, a corporate hedging revenue would have likely aggregated its revenue and hedge it once a month to minimize the number of trade tickets. But as in other financial markets such as equities and options, electronic trading has slashed costs to such an extent that splitting a large transaction into 100 or more smaller ones can still be cost effective, enabling the treasurer to mitigate the risk more effectively by spreading the hedge over a period of time.
“So people have to think about whether they’re going to eliminate a risk at a specific point in time, and so pay a market-impact price stemming from the risk transfer, or can they hedge it over the course of a week or a month,” Mr. Weisberg said. “If the latter, what benchmark do they choose to measure whether they’re doing a good job?”
Thomson Reuters and competitors such as Bloomberg and 360T aim to provide the plumbing to enable today’s electronic transactions, connecting corporates and other institutions to market makers to get prices and ultimately route trades. That plumbing the functionality to take transaction requirements out of a corporate’s treasury management system (TMS) and then filling the TMS when the transaction is done. The platforms also provide transaction protocol and aim to ensure it is properly followed.
Thomson Reuters provides a cloud-based order management system to manage the trade process; for example, enabling the requirement of two principal approvals before a trade is executed, or aggregating FX exposures from numerous local offices and netting them at a central desk to pursue the hedge. It also operates a central limit order book displaying bids and offers that effectively enables customers to trade anonymously in the name of their bank
The decentralized and global nature of the FX market has led to concerns about market participants’ behavior. The forex probe into allegations that banks colluded to manipulate exchange rates for their own financial gain is ongoing. The Financial Stability Board (FSB) issued best practices in 2014 for trading FX, and the Bank for International Settlements’ Markets Committee established the Foreign Exchange Working Group (FXWG) last year to strengthen FX-market conduct standards and principles.
Headed by Guy Debelle, assistant governor at the Reserve Bank of Australia and chairman of the Markets Committee, the FXWG anticipates finalizing by May 2017 a new code of conduct as well as developing proposals to incentivize adherence to the code. Executives from corporates including Airbus and Rolls Royce are participating in the FXWG as part of a market participant group making recommendations to help shape the code.
“The high level issue for corporates is that they’ll need to understand more than before about what the responsibilities of each party in an FX transaction are,” Mr. Weisberg said.