THE CHANGING WORLD OF FX .

Patrick Fleur, head of trading and execution at Dutch fund manager PGGM Investments explains why it has a different spin.

How would you describe the trading environment today?

The current market has been dominated by regulatory changes. One of the biggest challenges is that not all the rules are clear and jurisdictions have different timetables for implementation. For example, we are a pension fund administrator and investment manager that invests on behalf of five Dutch pension funds that are exempt for three years before they have to comply with the central clearing obligations under EMIR (the European Market Infrastructure Regulation).

However, that does not mean we should ignore the changes – eventually we will have to implement them. In fact, we’ve already implemented central clearing and are fully operational, but we’ll not use this route unless the upside of using this outweighs the costs.

What has PGGM been doing to prepare?

We have been leading the charge on transaction cost analysis (TCA) with clients and counterparties. It is well established in the equities market but is still evolving in FX. One of the problems is that although we now have a lot of algos, to a large extent benchmarking is missing, which has meant that TCA within FX is currently very limited. This has made it difficult for the industry to conduct TCA and to correctly assess implementation shortfall going forward. Also, whoever is delivering the algo is also doing the TCA, so it’s not independent. There are different opinions in the industry on what to measure, such as whether it should only be commission and fees and not include the bid offer spread. We believe one of our big differentiators is that we calculate these costs and provide greater transparency to our clients.

How are liquidity levels and volumes shaping the market?

What we are seeing is the fragmentation of the FX market. Total volumes are growing but liquidity is decreasing. At the same time it has become cheaper, due to the increased competition, but if you take a closer look you can see it is also mis-priced. It is unclear where this implementation shortfall is going so I am not sure how sustainable this model is. However, I am optimistic that in five years’ time, FX will become more dominant and get the attention it deserves. One reason is the growing importance of FX as an asset class, with UK hedge fund managers being among the most active participants. At the moment the bulk of activity is still down to hedging but you cannot ignore the changes that are going on.

What impact do you think the current investigations into FX will have on the industry?

At the moment we are seeing people getting fired or suspended, and chat rooms being closed. I think these are short-term reactions but not real solutions. People are innovative and chat rooms were part of the development of the industry. They were used as a communication tool with clients and have proven be a good way to share information. However, there needs to be a universal moral or ethical code instilled. For example, traders need to be authorised by the Financial Conduct Authority and this type of code could be part of the wider remit of the qualification. What is happening now is that we are going back to other venues to exchange information where information is not taped, whereas chat rooms are a much quicker way to get information across and contain an audit trail and compliance monitor.

What other changes do you envision?

I think we will also see changes to the methodology of the WM/Reuters*, which is the most popular and transparent, industry-wide standard used. You can change the time window from 60 seconds to 5 minutes, or even longer. The venues used to calculate the fixings could be optimised to reflect the real price during this timeframe.

How do you see the market developing?

Over the long term, I would actually like to see more multi asset class platforms and not have FX treated differently and as a separate asset class. As I mentioned, it is looked upon as a by-product to hedge currency risk and not for the value it can generate. One reason is that clients have under-invested in the expertise needed to understand FX. For example, at PGGM, we’ve invested in the tools, analytics and have people covering FX, 24/5.

Clients are beginning to rethink their existing models and look beyond the traditional uses. However, TCA and smart order routing are the missing links to complete the circle. Companies also need to invest in better order management systems that have proper pre- and post-trade analytics. FX may be developing along the same lines as equities but they are two different asset classes and you can’t simply cut and paste. The tools need to be developed specifically for FX.

In the short term, I expect to see more electronic platforms, which will create fragmentation and make the decision-making process more difficult. However, over the longer term, more tools will be developed and clients will have a greater choice in how to trade, whether it is by agency, phone, using algos or direct market access across all markets. We have already seen a lot of work going into algos with the hiring of small equity algo teams. For example, we started from scratch, but it takes years to build a database. We currently have 63 live algos that we have tested in every market.

©BestExecution 2014

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