In FX, clients are looking more like regulators

Broker analytics are all the rage in FX. According to a recent report by Greenwich Associates (The State of Transaction Cost Analysis – 2019), about 60% of FX trading desks have now deployed trade performance analysis tools.

On the surface this is unsurprising. Buyside firms want to make sure they are getting the best prices and service from their liquidity providers (LPs) and are therefore using more transaction cost analysis (TCA) tools to develop a clearer picture of how all their LPs are performing. 

But it has happened without a “regulatory tailwind”, notes Richard Johnson, the report’s author, since spot FX is not explicitly covered by the best execution requirements of Mifid II, the European Union’s Markets in Financial Instruments Directive.

And it’s getting easier for the buyside to assess broker quality. Sophisticated monitoring tools allow end-to-end transaction tracking to be performed in real time and provide a correlation between trade performance and financial outcome.

“With these tools, buyside clients can monitor trade performance and P&L for every transaction, making it far simpler to gain an accurate performance and profitability comparison between the FX brokers with whom they deal,” says Paul Spencer, chief operating officer at Velocimetrics, a trade and payments analytics firm. 

“This detailed evidence provides a compelling reason to switch business to those brokers who provide more efficient market access.”

The trend has been encouraged by the kind of market conditions that make it harder to make money. “With lower levels of volatility and lower leverages available, buyside firms need to increase their profit per trade,” explains Tom Higgins, CEO of Gold-i, a provider of software and services to the broker community. 

“A visualization tool that is easy to use to manage risk exposure, reduce potential losses and increase profits can be invaluable.”

According to the Greenwich report, the benefits that TCA can provide – including cost measurement, trade optimization and best execution compliance – will lead to a steady increase in its use in FX as products mature. But Higgins at Gold-i reckons buyside firms are already spending considerable amounts of time on execution quality, or what he describes as TCA-plus-plus.

“Brokers and liquidity providers are reacting by using this information to improve their execution if they can – or withdraw from that asset class if they cannot,” he adds. “In addition, brokers are investing in their own analytics tools to make sure they stay ahead of the game.”

Increased scrutiny

Even amid heightened levels of scrutiny by clients, it’s not a simple task for brokers to ramp up the spending on analytics. Spencer at Velocimetrics says that with FX brokers already operating on narrow margins, any capital investment needs strong justification.

They have not moved as quickly as their clients in adopting real-time analytics, he says, but this will change as the relationship between trade performance and client retention becomes more apparent. 

Increasing competition for all participants in FX trading has highlighted the need for more detailed real-time analytics as a means of improving margins and profitability.

“While the cost of real-time analytics tools has come down, their sophistication and complexity mean that they will always represent a significant investment,” adds Spencer. “However, market participants who fail to understand their performance bottlenecks will continue to lose market share and will eventually leave the business.”

David Murray, chief business development officer at Corvil, a network data analytics company, notes that another driver of trade performance analysis tools is the expanded use of algo trading and the leveraging of artificial intelligence and machine learning in FX markets. “As execution automation grows, so too must trade performance analysis since mis-steps can have rapid and significant implications,” he says.

Warning signals

A glimpse of those potential implications was provided by a separate report (Customer Retention in the Age of Electronic Trading) published by Greenwich Associates in March, which suggested that the wider use of trade performance analysis tools in other asset classes was eroding client-broker loyalty as buyside clients increasingly sought to reallocate their business based on execution quality.

The firm’s analysis of broker-client equity trading relationships revealed that for the typical buyside client, reallocation of trading volume rose by 50% between 2014 and 2018, with the report observing that this change had coincided with the wider use of trade performance analysis tools.

So far there is no evidence of a comparable reallocation of trade flow by FX clients, but Murray at Corvil says a similar trend is still likely to emerge in FX, where increased competition between dealers is motivating the sellside to further advance its execution capabilities. And with clients already providing their own supervisory squeeze, the asset class is proving that it doesn’t always take a regulator to shake things up.