Treasurers have always been at the forefront of looking at risk, in particular the execution risk around foreign exchange (FX). For treasurers, achieving the best price through best execution has a demonstrable impact on the company’s performance – every marginal saving delivers to the bottom line. For this very reason, rather than calling multiple banks to request FX quotes and comply with best practice, corporate treasurers proposed automating these manual processes through electronic trading a decade ago. Treasurers continued to enhance the measures they take to mitigate execution risk and the innovation continues as the markets evolve.
As FX markets have become more transparent and with market data being more readily available, it is now easier than ever before for corporate treasurers to identify whether the best price has been achieved on a currency transaction. Moreover, the emergence of multi-bank FX portals has also done much to improve execution standards in the FX industry. This is evidenced by the significant increase in volumes on multi-dealer platforms. Last year, Greenwich Associates issued a report on the electronic FX market which showed that over 38% of the total market trading volumes were executed via multi-bank platforms; 34% were conducted by phone and fewer than 20% were executed on single dealer platforms.
In a parallel universe, the importance of this issue is currently being highlighted for the buy-side community by an inquiry into whether some US state pension funds have been overcharged by their custodian banks for FX transactions. From some quarters of the FX industry, the biggest surprise surrounding this issue is the fact that the alleged negligence has happened towards institutions such as pension funds, given the online execution methods and execution analysis tools which are available to them. Treasurers have often required complete end-to-end workflow solutions that encompassed all aspects of trading and reporting to meet global compliance standards, such as MiFID and Sarbanes-Oxley, FAS 133 and IAS 39.
The Value of Good Bank Relationships
That is not to say that, in the quest to achieve best execution, online trading platforms have supplanted the need for corporates to nurture bank relationships. For a corporate, a good banking relationship is crucial if it wants to get tighter, faster pricing. In fact, market research has shown that where market participants have traded both on anonymous and relationship-based platforms, both liquidity and pricing proved to be better when dealing on relationship-based platforms as those banks were more willing to execute large trades at tight prices when dealing with known, trusted clients.
To ensure that treasurers are achieving best execution, a best practice policy should be put in place that details in which scenario a trade should be competed for and from how many banks prices should be requested from. Ideally, a corporate should seek a range of prices that ensure there is a sense of where the market is trading at. Typically, this tends to be between two and four prices. That said, there may be times, in order to minimise market impact, when large trades need to be executed quickly, where corporates may decide that the most effective route is to deal with one single counterparty. Provisions for these occasions should be covered by best practice guidelines that respond to specific best execution goals, put the processes in place to achieve them and enable them to be measured. When a corporate needs to ensure that a trade with a single counterparty has been justifiably priced, online trading platforms can provide corporates with reports that benchmark the price achieved against the indicative market rates.
The Search for Best Execution
That said, mitigating execution risk is not just about maximising the chances of achieving the best price. There are other elements to trade execution which a treasurer must be mindful of. These include having an efficient middle office function which will reduce trading and processing costs, as well as the risk of costly errors. Automated FX practices provide treasurers with much more control over their trades and make it easier for them to fulfil compliance standards to hit best practice targets.
Consolidating and netting FX order flow through the optimisation of efficiency is another way that corporate treasurers can maximise best execution. Many large corporates have developed global and regional centres enabling them to centralise and consolidate internal FX flows before netting them and trading the net amount externally. In addition to achieving economies of scale, centralised treasuries provide treasurers with tighter controls over the trading process that further mitigates execution risk. Some sophisticated treasury functions are also beginning to make use of risk mitigation tools that have historically been used by the sell-side such as continuous linked settlement (CLS). CLS provides a real time settlement process with legal finality and enables corporate treasurers to significantly improve their operational control and oversight of their FX settlement. This in turn can assist the best execution process as this added control and visibility over settlement enables corporates to consider working with a greater number of counterparties and therefore leads to benefits such as price improvement.
One of the key safeguards of best execution are execution analysis tools that enable users to analyse trading over time to assess on an ongoing basis the effectiveness of an FX strategy. Solutions such as these involve the analysis of data such as currency pairs traded, trade sizes, times of execution and counterparty performance, after which the vendor relationship managers can highlight to treasury departments how they can improve FX execution performance. If a treasury department can integrate this type of reporting and analytics with the benefits of an electronic FX trading platform, the improvements to execution performance should be significant.
Implementing best practices in the corporate treasury function can go a long way to reducing execution risk and exercising greater control over your operations. Key components of the best practice programme are the use of multi-bank FX portals and the execution analytics that such platforms offer. This must be backed up with good bank relationships, an efficient middle office and a bespoke execution policy. Treasurers who focus on their internal operational processes continue to enhance their execution risk management and move the industry forward.
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