I attended a conference last week held at Bloomberg’s impressive building in the City. The subject was “TCA Best Practice” and the section on FX was very interesting. Bloomberg have a tool which, broadly speaking, allows fund managers to measure “slippage” when benchmark FX orders are executed. It can also measure, for example, how competitive are the various different quotes that a fund manager receives during this process. The information can be sliced and diced every which way and displayed graphically in glorious technicolour. Similar tools exist for Fixed Income and Equity markets. This functionality is very comprehensive, but I think there is more to the problem.
For a domestic fund manager who is buying and selling foreign equities, the overall cost of the transaction is surely not just a few basis points of slippage on the equity transaction added to a pip or two of slippage against an FX benchmark. It seems to me that the equity fund manager has an FX exposure that arises the moment he buys or sells a foreign stock, which could have been many hours before the FX transaction is done. Perhaps the wrong thing is being measured ? Having said that, if your peers are all doing it the same way I don’t suppose there is much incentive to break ranks and do it any differently because fund management is a “relative performance” business.
The debate continues around last look FX pricing and whether the distribution of information is skewed towards the dealers, and away from the customers. Well, yes – it undoubtedly is, and of course that’s the reason the systems are built in that way. I am not saying whether this practice is fair or not, but the contract term “an invitation to treat” is well established in law. It comes from the Latin invitatio ad offerendum and means “inviting an offer. The person (dealer) making that offer does not intend to be bound, as soon as it is accepted. Hence the trade rejections come thick and fast on some systems.
The important part is that users of systems with last look functionality need to know that it is being used, so that the apparent tight spreads and depth of liquidity are not just another mirage in the Foreign Exchange desert.
It seems that the New York State Financial Services Superintendent, Benjamin Lawsky, has cast his net a little wider in the search for what really goes on under the hood of the FX pricing engines at several major banks. He has now issued subpoenas to Credit Suisse, Societe Generale, Goldman Sachs and BNP Paribas. This comes a few months after he had begun investigations at Barclays and Deutsche Bank.
It is one thing to accuse individual traders of colluding in order to “manipulate” the rates around benchmark fixings, but it is a whole new ball game if he suspects that the algorithms in the banks pricing engines may have been written in such as way that could disadvantage customers who are trading on the platform.
When you look at the CV’s of the brilliant minds that some of the major banks have hired to develop their e-trading capabilities, it would be naïve to think that they hadn’t written the alogorithms in favour of their employers. I expect they thought that’s what they were being paid to do !! …………..Time will tell.