Matthew Hill is Director of FX Business Development at Markit.
For more than 20 years, technology enhancements and innovation targeting the front office of FX trading operations have not been matched in the back and middle offices. That reality now threatens the growth of the global FX market. The post trade infrastructure in place today was developed when voice business was the dominant approach to trading. With electronic trading replacing voice for the majority of transactions, trade processing must also evolve.
Now is the time to deploy post trade systems that are suited to a market that is continuing to innovate rapidly while also maturing into a lower margin business.
TOO MANY BAND-AIDS
Ironically, FX was one of the first OTC asset classes to pursue widespread trade automation, put in place decades ago with the level of exceptions and STP that was acceptable at the time. The current difficulties in post trade FX could arguably stem from first mover disadvantage: put a system in place that works reasonably well and change becomes very difficult for fear of the unknown. The safety first path is to make minor, incremental changes to an existing process rather than overhauling the entire system.
As a result, market participants have implemented a patchwork of solutions to help them cope with the increasing complexity and fragmentation of the FX market. Operating a series of Band-Aid technologies is unsustainable in the long term and at odds with firms’ priorities to reduce market and operational risk, cut costs and dynamically manage regulatory changes.
FRAMEWORK OF THE SOLUTION
With technology deployments, most banks aim to capture and quantify return on investment without a big bang approach. At a time of rapid technological and structural change, this can present a dilemma.
The industry is moving toward standardised and centralised post trade services in order to support growth and manage risk and regulatory requirements in a more efficient and cost effective manner. For both banks and their clients, a single point of access for matching, confirmation and allocation can greatly reduce operational risk and provide much needed transparency into the overall process.
Matthew Hill, Markit
At the same time, banks view their ability to develop a more efficient post trade offering as a competitive differentiator that will help it attract and retain customers. As a result, the optimal solution would lie somewhere in the middle.
According to the 80/20 rule, market-wide issues can be largely tackled via a collaborative, centralised solution while the remaining 20% of the technology design is left up to individual banks to customise to advance their competitive position.
We also must acknowledge that blockchain could become part of a new post trade paradigm for FX. While parts of the blockchain model remain unproven in capital markets, digitisation of assets and agreements could become another catalyst for the industry to standardise how it processes trade data.
CHANGE: DRIVERS AND CHALLENGES
While regulation has been an important driver of post trade automation across asset classes, customer demand in the FX market for more low touch services is also effecting change in post trade processes. Customers expect more automated, efficient workflow, and banks, as service providers, must keep improving their post trade services. Solution design is critical to avoid higher fixed costs when trade volumes increase.
For both banks and customers, aggressively tackling the issues related to modernising FX post trade processing systems makes sense for multiple reasons:
- Reduce cost basis associated with manual processes and legacy systems
- Reduce error rates and risk
- Improve trading capacity
- Eliminate operational speed bumps that slow the processing of complex trades
- Enable more nimble responses to changing regulation
- Improve client service and differentiate FX services
Most market participants recognise the need to achieve higher degrees of STP, but are wary of potential operational risk and cost. Moreover, the staggering amount of change already inflicted upon banks in the wake of the financial crisis and resulting regulation understandably creates fatigue and inertia. Even firms that want to be proactive in modernising post trade systems face uncertainty from being a first mover onto networks that require industry community to deliver the intended benefits.
CONCLUSION
The benefits offered to the industry by upgrading the post trade environment in FX far outweigh the risk of change. Proprietary work should focus on areas that create direct competitive advantage. New community-based approaches should be adopted for solving industry-wide challenges such as trade confirmation, options exercise management, centralised clearing and regulatory reporting.
Ripping off the Band-Aid in post trade positions would allow firms to focus energy and resources on clients and new revenue sources. The question is who will be first to the opportunity.
