Asset managers need better handle on costs, processes

Panellists highlight the challenges they face in the pursuit of best execution

Stephane Malrait, ING: "If you trade under the principal model you don't know what the best price is"

Asset managers have to get a better handle on what happens to their orders after they push the button on the screens, and need a much deeper understanding of how prices are built up and distributed by market-makers in order to become compliant with the Markets in Financial Instruments Directive (Mifid) II, panellists at the ninth annual FX Invest conference said.

Discussing trends in electronic execution in foreign exchange, both sell- and buy-side panellists noted that more transparency around costs is needed for both sides to be able to demonstrate best execution under regulations set to come into force in January 2018.

"The multiple challenges the buy side faces come back to needing to know what you are doing," said Iskandar Vanblarcum, head of Emea sales in transaction for Thomson Reuters.

"Questions like: when you hit that button on your screen what happens to your order? We asked this question at one of our recent roundtables with 10 big asset managers and none of them could answer that," he said.

On top of regulatory drivers, recent scandals concerning the use of last look and benchmarks have also added to the buy side’s need for more transparency as trust between counterparties broke down, forcing clients to demand more transparency around what happens to orders and what the costs are.

Years ago, I would call FX the black hole of dark pools because there was so little transparency
Bryan Smith, Integral

"Years ago, I would call FX the black hole of dark pools because there was so little transparency," said Bryan Smith, director of investor sales at Integral.

"Customers had no idea where the price was and banks made their money from clients not knowing where the inside price was. Both the buy and sell side, as well as platforms, need to bring real transparency, which means knowing where and when you've traded, what you are paying your banks for, what you're paying for risk transfer and whether you know what your bank is paying," Smith added.

To look at how costs add up in the execution value chain, clients need to be able to understand every element of the process, an effort that is driven by best execution requirements under Mifid II. This process is, however, hugely complicated as historically banks have been more focused on the revenue side and less concerned about the cost element.

"We have been looking into how the cost builds up," said Tjerk Methorst, a trader and investment manager at PGGM Investments.

"We have the benefit of a multi-asset team and I'm sitting next to equity guys, who are much more advanced in things like venue analysis, what fees you pay for certain venues, what smart order routers (SOR) banks use, those kind of things," he added.

"In FX we would like to look more into this, but the difficulty is that getting the data you can analyse yourself is very difficult and otherwise we have to rely on banks and we've seen that certain SORs are built for certain liquidity pools. But we are looking into support into getting more detailed trade data, more detailed price analysis and where prices came from," he added.

In FX we would like to look more into this, but the difficulty is that getting the data you can analyse yourself is very difficult
Tjerk Methorst, PGGM Investments

While understanding costs is a massive undertaking for banks, for buy-side market participants the challenge is even greater. Different counterparties take different views on a client's credit worthiness and specialise in certain currency pairs, while banks also take into account the overall relationship when providing prices to individual customers.

Stephane Malrait, the global head of e-commerce for financial markets at ING Bank, noted that banks have already started the process of providing clients with detailed price data, as once Mifid II kicks in, banks will be required by law to offer such information to customers on a quarterly basis. And while Mifid II does not cover spot, banks will likely expand their costing exercise to the product as well.

No "official price"

"We are already working on this to provide the data. The problem is there is not an official price in FX as there is in equity markets, so if you trade under the principal model you don't know what the best price is," Malrait noted.

"My price is the ING price, and then what is the agency price, what is the official price for the quantity that you want to do? So it's still very complex to answer these questions. But the industry will have to do it for Mifid and while the process has already started, getting that information together and preparing for this level of transparency is a big change for banks."

Best execution is also about more than just getting the explicitly available price, as clients need to take into account implicit costs as well. Methorst noted that when selecting counterparties, broader relationships also matter.

"I've got a report from my execution venue last year analysing the difference between my best price and my second best price on all my RFQs, and with a notional underlying of around €7–8 billion, the difference between the two was a couple of thousand, or in other words zero. So while we can understand the chase for the best price, it's not always about just that – you also need to look at the relationship with the counterparties," he added.

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