Bilaterally traded foreign exchange deals are much less transparent than equities. However, as Frances Maguire finds, even ahead of incoming regulation, much is being done to improve transparency.
Due to the bilateral nature of FX trading, pre and post-trade transparency can be hard to come by, compared to other instruments such as exchange-traded derivatives and equities. For equities, in the US, there are now stringent requirements to give customers best execution by displaying five other quotes to show that the best price at the time of purchase was chosen.
With the regulatory spotlight now on making over-the-counter (OTC) products more transparent through mandatory trade reporting requirements and the introduction of central trading through swap execution facilities, the lack of transparency in the equally opaque spot FX market is also being questioned.
In the retail market, strides have been made to tackle this age-old problem with the development of a bridge by Fair Trading Technology (FTT) between the two biggest platforms: the trading software MetaTrader 4 (MT4) and the ECN, Swiss Forex Marketplace (SWFX) run by Dukascopy, to give traders transparency of every single order.
Transparency has been achieved by ironing out some glitches. Obstacles, such as MT4’s partial fill problem, were resolved and the world’s first two-way bridge was born so that when an order is placed on either platform it is instantly replicated on the other. Traders can now view both platforms at the same time and see when the order is executed from MT4 into Dukascopy.
FTT has built a fully comprehensive solution. The T3 2Way Execution Bridge ensures transparency by guaranteeing that every participant gets the same price feed and that access to a transparent reporting tool via a direct login to a web page of FTT’s T3 2-Way Execution Bridge.
McLean Van Cleve, chief systems engineer at Fair Trading Technology, says: “Fair Trading Technology has developed the technology to not only send orders from the MetaTrader platform but receive them over the same bridge to ensure that orders placed in one client show up in the other. This will usher out the age of discrepancies in bridged MetaTrader systems providing a client with peace of mind that the trading view is accurate and giving them the flexibility to place trades from any platform, mobile, web-based or otherwise, and know that when they log into their MetaTrader terminal that all positions there will be reflected on the other side as well.”
Similarly, Tradency, provider of innovative trading solutions such as the Mirror Trader, has greatly enhanced market transparency to retail traders. Primarily, the Tradency Mirror trading platform publishes trading results of all the hosted third party systems instantly. As each trade is closed, the mirror trading platform dynamically re-positions the system in accordance with T-score [the platform’s scoring mechanism]. The verification of trading results, and instantaneous ranking, ensures traders are receiving critical information on a timely basis.
Greg Hay, VP Business Development and co-founder of Tradency, says: “In addition to performance verification, Mirror Trading connects system providers and traders in a neutral venue. Traders can conduct due diligence on the system provider prior to system selection. The Mirror Trading platform provides key information on the supplier of the trading signals.”
Furthermore, the next generation of the Mirror Trading platform has a feature called semi-Mirroring. This concept allows traders to join third party trades as they occur in real time, thus providing the trader with greater flexibility and control. “This greater degree of freedom ensures the trader is perfectly positioned to take advantage of trading signals combined with their own trading knowledge. This takes trading transparency to a new level,” says Hay.
With the recent integration of Currenex, Mirror Traders are able to have their trades executed in a true market environment. This option ensures large volume traders are getting best bid/ask available.
“The depth of liquidity on Currenex also allows strategy providers with large numbers of followers to get best fill available. The co-operation of Tradency and Currenex ensures that Mirror Trading products can extend their evolution by accessing the deepest liquidity and technology,” he adds.
For the wholesale, institutional market, the CFTC comment period on the proposed rules regarding swap execution facilities (SEFs) has just ended. The final rules are expected to be finalised during the mid to late summer, with implementation anticipated towards the end of the year.
As part of this process, Phil Weisberg, CEO of FXall took part in a public meeting organised by CFTC Commissioner Scott D. O’Malia for electronic execution facilities to demonstrate the current functionality they offer market participants in the swaps markets. Weisberg argues that the different client segments within the FX market have varying needs, depending on their strategic objectives and priorities, and that end-users of electronic FX platforms such as buy-side firms and corporates should continue to be allowed to chose which execution method best suits their needs. He says: “At FXall, clients can execute their FX transactions using a number of different methods, such as the RFQ (request-for-quote) system, which should be allowed to continue under new regulations.”
Weisberg believes that because most FX trades are executed electronically, the FX market already achieves the objectives of strong transparency, low systemic risk and appropriate oversight. Regulators on both sides of the Atlantic have acknowledged the diversity of OTC products and requirements. This has led to the exclusion of swaps and forwards from the scope of both Dodd- Frank Act as well as EMIR.
Weisberg says: “We believe that the market is best served by incorporating execution mechanisms that are proven to work and that serve the needs of all market participants. That said, SEFs should have the flexibility to determine which execution methods to use so that the SEF can operate different trading models for different swap products. SEFs should be able to use models such as RFQ or order book, depending on what makes sense for the product being traded and what will be practical for and accepted by users.”
Weisberg argues that FXall’s RFQ platforms already provide high quality pre-trade transparency. Before dealing, a participant may choose to obtain quotes from multiple parties contemporaneously, and also have the ability to compare quotes with reference prices for benchmark instruments. However, he adds: “SEFs however should not be required to send RFQs to at least five market participants if the client does not wish to, especially in swap markets that are less liquid and where transactions tend to be larger and trades more infrequent.”
He believes that requiring trading platforms to make a customers’ RFQ and the response – both price and volume – immediately available to the public would reduce the liquidity and ultimately hurt the price discovery process. “The client’s interest and the counterparty activity would be exposed to other market participants who would look to seek advantage of the position. This, in turn, would force prospective counterparties to post artificially wide spreads to the market and move the price discovery into private corners,” he says.
On determining the details of what transaction data must be publicly disclosed, Weisberg says it is important that policymakers strike the right balance between providing post-trade transparency and inhibiting liquidity. “In particular, disclosing the trade size can potentially hurt the liquidity and make it more difficult and expensive for market participants to get trades done,” he says.
The fragmented nature of the global FX markets has often been cited as one of the reasons that transparency is harder to achieve, but Harpal Sandhu, President and CEO of Integral, a multi-sided trading network for hundreds of FX businesses, says that fragmentation and transparency can co-exist.
He says: “These markets are fragmented, to some extent by market design. This is because there are such a wide variety of consumers of FX products, especially for spot FX. These consumers want to trade foreign exchange through a different mechanism. Each one of those mechanisms represents a market, and hence a pool of liquidity, and because they are discrete it leads to fragmentation. But fragmentation is not necessarily a bad thing; it simply means mass customisation, where everyone can get exactly what they want. You can have highly fragmented markets but still have transparency, both pre and post trade, for each one of the respective markets.”
According to Sandhu transparency for the FX market is coming, and in fact does exist in some form today. While the Integral network hosts many independent businesses, which are technically fragmented markets, the company integrates them with each other by inter-connecting them at the back-end, so that they get better execution for themselves and their customers.
However, Sandhu adds: “What we have been doing to promote trust in the foreign exchange market and to promote the lowering of friction and the introduction of more market participants is to add transparency ourselves by recording the trades that take place on the network and the prices that are being broadcast on the network and making them publicly available, free of charge.”
This started a year ago when Integral set up the TrueFX website displaying real time prices, on a tick-by-tick basis. “So transparency is coming and it is coming from market participants whose incentives are aligned with that of the customers, because if customers are happy and participate more, the market grows,” he says.
Although the related regulatory requirements have not been finalised, Sandhu believes that the market is most likely to veer towards the more conservative solution, which is trade swaps and outrights on SEFs and to centrally clear in order to ensure against inadvertent non-compliance. Furthermore, Sandhu points out, even if swaps and forwards are exempt from mandatory clearing in the US it will only be for two years, at which point re-certification of the exemption will have to be reviewed by the regulators. “There will come a point in the future when this exemption may not be accepted. Once the market moves to SEFs and clearing it is never going back,” says Sandhu.
But what is going to be mandated from day one is the notion of a swap trading repository. This is similar to what Integral has already been doing through TrueFX, but it will now be a regulated process where the trades will have to be reported to a swap trade repository, on an aggregated basis, so that all users can tell at which price those trades where done.
Sandhu says: “Greater transparency will mean the margins for the market makers will be less but the costs for the consumers will also be less, and with lower costs, greater transparency and greater uniformity, we firmly believe that volumes will go up significantly and the net result will be a good thing for the overall market. FX will grow through greater transparency and it will be lead by technology companies, for the fundamental reason that technology companies’ economic incentives are in line with the customers’, and are aligned with the intent of the regulation in terms of increasing systemic stability and transparency.”
Sandhu says that while Integral has not decided whether it will become a SEF or not, as the final rules have not come out yet, the underlying technology for the markets that Integral hosts today is already SEF-compliant. “It will be up to Integral’s customers as to whether they want to register themselves as SEFs for their customers or it they want Integral to register as a SEF and they become users of it, but Integral has the capacity of becoming a SEF, and a swap trade repository, already.”
Whether the FX market will ever get to the point where some kind of best execution model can be developed in the future remains to be seen but it is clear that the technology is there already.