What are the costs associated with opening a North American FX trading desk?
It’s a good question, the baseline costs associated with opening a North American desk, or a desk anywhere, includes hiring two traders minimum. One trader for full-time responsibilities, and a backup for BCP (Business Continuity Planning) purposes or holidays, etc.
Each trader will need a terminal depending on the trading platform being used, which carries a considerable cost. Speaking from the practical side, you could be looking at a high price for office space depending on the region. All of that is the bare minimum set up and the cost of those items are necessary when considering opening a trading desk. However, after the initial setup you are also looking at regular ongoing costs as operations continue.
This is very much an operational challenge. In the current state with T+2 you have 48 hours to execute a security trade, match that trade with brokers, execute the FX and get everything settled. Obviously now it’s a shorter window of time to complete all required steps, and that puts pressure on managers’ operating models.
Even looking across the evolution of FX activity over the years, about 12 years ago the industry was facing issues with transparency and custodial FX programs, which required more oversight for managers and asset owners. This challenge ultimately led to transaction cost analysis (TCA) now being a requirement in FX. Jumping ahead in time, covid-19 was another external factor which put a lot of pressure on asset managers in terms of how and where work was being done.
For a lot of managers, FX can be considered an uncompensated risk since you’re not really being paid to manage the FX. Therefore T+1 is yet another consideration in their overall operating models, especially when it comes to operational foreign exchange.
Have the UK, Europe, and Asia taken diverse approaches to the looming shift to T+1? If so, how so?
In the US, there’s been more interest in automation and outsourced solutions – with the thought of what and how processes can be automated best. This line of thinking has led to an uptick of interest in outsourcing FX. Obviously, the bottom line is ensuring quality execution within any process. For managers in the US it’s about having global capabilities and ensuring that you can execute foreign exchange transactions around the clock, time zones and regions. For some larger managers, it has put the question of increasing global coverage back on the table. Whether it’s outsourcing or active in-house execution, global coverage is critical now more than ever.
With regards to managers in the UK and Europe, it’s a similar story. Some of the larger entities, who have the resources in terms of technology, employees, and budget, decided to open a desk in the US in order to have crucial time zone coverage. However, we’re also seeing interest in outsourcing and automation from asset managers in the 50–100-billion-dollar ranges. These managers are taking a step back to examine their internal focuses and goals and are acknowledging that this kind of activity is not really core to driving performance, but rather operational FX could and should be automated and outsourced to a foreign exchange expert.
In Asia, the focus is a bit different and the theme we’re seeing and hearing about is around pre-funding the FX settlement-related trades. Ultimately, this is due to time zones and Asia having the shortest amount of time with the upcoming move to T+1.
How feasible is outsourcing FX workflow? What should firms bear in mind?
While the outsourced FX space is now very mature, asset managers still need to ensure they have oversight and control embedded in the process. For example, a manager can take the approach of “set it and forget it” whereby they would send copies of equity trades to an outsourced execution desk, have the orders filled, with settlement messages routed to custodians, and a confirm sent back to the client. However, managers may also wish to consider how to maximise netting opportunities to reduce FX exposures and minimise latency (time between security trade execution and FX trade execution), as well as understand the most appropriate time(s) to execute their FX orders, depending on currency pair and market liquidity.
Reporting is critical. Our clients require real-time access to their post-trade data to review that execution expectations and standards are being met. Customisation is also an important factor to consider in any outsourcing model. Many of our clients are utilising our outsourced FX solutions work with custodians and providers who have their own unique set of requirements. Every client’s FX program is different, with their own file translations, custom connectivity or additional reporting requirements in certain emerging/restricted markets. In addition, there are various trade types to account for, such as corporate actions or investor flows, that are different from the traditional security RVP/DVP FX transaction.
And of course, execution quality is essential for both the asset manager and stakeholders. Interactions with market participants have shown that outsourced FX space has now matured to a point where execution quality can be comparable to what a manager might typically achieve with in-house trading via an industry platform. Given that this type of FX activity is operational in nature, it can make a lot of sense for asset managers to consider an outsourced FX provider who can deliver a similar outcome to running your own FX trading desk in-house. Another trend we’ve seen emerge recently are larger managers who have FX capabilities in-house but have supplemented their FX process by leaning on expert outsourced providers for a subset of accounts, trade types, or difficult-to-trade currencies like emerging/restricted markets.
What are the main benefits of doing so?
The outsourced trading space has come a long way in the last several years, where managers can now access FX solutions that combine the operational ease of a custody FX ‘autoFX program paired with the execution quality of managing trading in-house. For this type of activity, whether it is FX related to settling global securities, repatriating corporate actions or investor flows, or even hedging currency exposure within a fund or through hedged share classes, many asset managers view this as operational in nature and potentially risky and costly to manage in-house.
A primary benefit of an outsourced FX model is achieving execution quality that can be on par with running an in-house FX trading desk, while mitigating the associated risk and removing the need to reallocate trading, operations and technology resources. Operational resilience is also an important consideration and potential benefit to be gained by outsourcing operational FX. The key is to optimise your trading and operations strategy to be ready for the future. With changes like the US market moving to T+1 in May 2024, partnering with an outsourced FX provider allows managers to tap into a team of subject matter experts who can build custom workflows to meet ever-changing industry standards. Once we get past the move to T+1 in the US and Canada, the UK and EU moving to T+1, likely in 2027 or 2028, is just around the corner. This will require managers to review their operational FX program once again from a different perspective.
Partnering with the right FX provider can help managers prepare for both the planned industry changes like T+1, as well as the unknown, like regulatory changes and spikes in volatility due to geopolitical or market events.