Trading Technology

08:00 AM
Michael Sparkes
Michael Sparkes
Connect Directly

Driving Competitive Advantage Through FX TCA

Accurate TCA for FX trading has proved more challenging than in equities, delaying its progress. But the benefits to trading strategies can't be ignored, and investors are already positioning FX TCA as a critical business function.

"The most valuable commodity I know of is information," to quote Gordon Gekko from the 1987 movie classic Wall Street. This line has never been more significant than in today's data-fuelled financial markets, where detailed analysis of information can provide that all important competitive edge -- both now and in the future. To achieve this, firms are looking toward transaction cost analysis (TCA), which enables them to reduce costs and hone trading strategies.

This isn't new. TCA has been established in equities for many years, and though compliance was initially the main driver, it has increasingly proven to add alpha to the execution process. As a result, it's not surprising that the TCA focus is spreading beyond equities, with foreign exchange (FX) trading coming into the spotlight.

It is not simply a case of applying the equities model to FX, however. The idiosyncrasies and inherently complex structure of currency markets have presented challenges to TCA's progress in FX. Added to this is the fact that FX has often been outsourced to third parties or may be a secondary or subsidiary trade linked to another asset. So not only has accurate TCA for FX trading proved more demanding than in equities, but the impetus also has not been there in the same way.

However, times are changing, and recent events emphasize the need for smarter use of TCA in FX. ITG said in a recent report on tradable data between London and New York before and after the 4:00 p.m. fix, "the costs from the order arrival time until trade execution are on average 17 basis points 20% of the time." This is crucial, because 17 basis points of implementation shortfall for up to 20% of all days can cost asset managers millions of dollars of value lost from their funds. That's not an insignificant amount for any investor.

With greater scrutiny on the role and efficiency of the 4:00 p.m. London fix, the time has come for members of the asset management community to take full advantage of the data available to inform their execution strategies. Forward-thinking investors are already beginning to position FX TCA as a critical business function, enabling better trading outcomes and enhancing performance. Last month's data can be a significant input to this month's decisions on when and how to trade, maximizing the benefit from FX trading. This takes on even more significance when you consider the percentage of the collective pension funds that directly or indirectly participate in the currency markets. Even incremental improvements must be pursued.

To make these improvements, asset managers need to squeeze the very most out of all the information at their disposal. For this to happen, TCA providers need to anticipate what an asset manager might require from their data analysis in the future. A combination of growing regulatory pressure and a need for higher returns is triggering clients to demand even better execution. This will see them asking more testing questions above and beyond the standard analysis.

New technologies are also driving new trading strategies in FX, resulting in a need for further analysis on topics such as algorithm selection and the use of trading venues. Such granular analysis sits alongside the broader questions of investment process, such as the most effective time of day to trade a given currency pair, the optimal frequency of book squaring, or the decision on when to use an electronic crossing network, rather than calling a bank on the phone.

The key to unlocking future success is for the TCA provider to work closely with the asset manager ahead of execution. This enables both the provider and the asset manager to get a better understanding of the investor's objectives and set these against the prevailing market conditions before deciding on its trading strategy. It really is a classic case of using data to support the decision-making process. As we move forward, asset managers who achieve competitive advantage will be the ones that adopt this approach in order to advance their trading strategies in FX, using that "most valuable commodity" -- information -- to answer the increasingly testing questions for tomorrow, not just the ones for today.

Michael Sparkes is a Director in ITG's London office, responsible for business development of Analytical Products in Europe. He has more than 25 years' experience in the investment industry, specializing in international portfolio management, product development and ... View Full Bio
Comment  | 
Print  | 
More Insights
More Commentary
SEC Examinations: What to Expect When the SEC Is on It's Way
Theodore Eichenlaub highlights trends in SEC expectations and how to approach a risk assessment of your compliance program.
The Value of Predictive Analytics in Financial Services
Risk management and customer data are two key areas where data analytics is being applied in financial services.
Moving the Trader Closer to the Investment Process
The sell side can demonstrate more value by applying analytics to pre- and post-trading, and by educating buy-side clients about broker segmentation, trading behavior and algorithm shortcomings, and more.
Wirehouses May See More Independent BDs as Retention Packages Expire
Retention bonuses are expiring, leaving brokerages vulnerable to attrition. Is access to technology making it easier for brokers to go independent?
SCI: A Whale of a Regulation
The SEC's Reg SCI weights in at a whopping 742 pages. Here is what you need to know about the oversized regulation.
Register for Wall Street & Technology Newsletters
White Papers
Current Issue
Wall Street & Technology - Elite 8, October 2014
The in-depth profiles of this year's Elite 8 honorees focus on leadership, talent recruitment, big data, analytics, mobile, and more.
Exclusive: Inside the GETCO Execution Services Trading Floor
Exclusive: Inside the GETCO Execution Services Trading Floor
Advanced Trading takes you on an exclusive tour of the New York trading floor of GETCO Execution Services, the solutions arm of GETCO.