Corporates are still one of the biggest players in the foreign exchange
market, but they are lagging behind their fund management colleagues in plugging
into electronic trading platforms. Many still prefer the human touch, but this
could change as regulatory demands for best execution, control and compliance
force them to search for cheaper and more efficient trading solutions.
According to US-based Greenwich Associates’ annual global FX Research Study,
volumes in electronic trading soared from around $15.7 trillion (£8.9 trillion)
in 2004 to almost $17 trillion in 2005. The majority of the growth was generated
by the overall segment defined as financial institutions, which increased its
annual e-trading volume by about 8%. Corporates represented around 37% of e-FX
volumes and this number rose to 55% for those companies with more than $10bn in
annual FX trading.
The US boasts the highest level of e-FX market penetration, where 54% of
participants said they traded electronically. Europe was not far behind, at 48%.
The rise in electronic trading reflects the overall boom in FX volumes during
the past six years. The Bank for International Settlements 2004 survey of
foreign exchange and derivatives markets revealed that daily trading turnover in
the traditional FX market, which includes spot, forward and swap markets,
reached $1.9 trillion. This was mainly due to an increase in activity by a new
breed of so-called profit seekers, or institutional investors such as hedge
funds, pension funds, insurance companies and mutual funds.
Multinational and large companies have always been active participants,
regularly dipping into the foreign exchange to hedge positions and protect
themselves from unexpected and potentially damaging swings in currencies. It
makes financial sense for them to use an electronic platform to trade,
particularly for the plain vanilla trades.
They have also developed both regional and global treasury centres which
enable them to centralise and consolidate internal FX flows before netting them
and trading the net amount externally. During the past two years, these
heavyweight players have been particularly busy due to cyclical factors such as
a temperamental US dollar, global political uncertainties and booming commodity
prices, particularly in energy.
The companies that seem to be the most reluctant to take the electronic
plunge are the smaller to medium-sized firms, which are infrequent FX traders.
The main reason is that many do not see any compelling reason to change the way
they operate. Many prefer to conduct business over the phone with their banks.
Mark Warms, global head of sales and marketing at FXall, the US-based
electronic trading platform, believes the special relationship companies have
forged with their banks should not be underestimated. “FX is often viewed as
part of the overall relationship companies have with their banks. They may
direct foreign exchange flow towards a particular bank as a reward for the
provision of other services, such as lending.”
Warms’ views are echoed in a separate Greenwich report issued last year,
which noted that credit relationships are paramount in determining which banks
get a company’s share of its foreign exchange and derivatives business. Of the
1,436 FX users canvassed, almost two-thirds said they directed foreign exchange
business to banks that lent them money.
Another area of concern for many companies is the cost of developing the
necessary infrastructure required to connect its foreign exchange trading
processes to an online provider’s systems. David Poole, chief operating office
of ClientKnowledge, a UK-based consultancy, says: “Many of the 4 decisions as to
whether to go online are driven by money. Corporates must ask whether it is
worth making the investment in integrating their treasury management systems.
The multinationals that trade regularly are already online, but I think the next
tier will invest in systems to trade FX online due to tighter regulation and
compliance as well as the drive for best execution.”
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In other words, companies may have to switch part of their foreign exchange
trading online. Corporate governance regulations such as Sarbanes-Oxley and
accounting standard IAS39 are pushing them to adopt a more controlled and
efficient way of doing business. A study by PricewaterhouseCoopers, which
surveyed 180 senior finance executives, along with CFO Research Services and
Virsa Systems, found that 58% viewed improving the monitoring, structure and
vetting of their compliance controls as a priority. Half of the respondents also
planned to vet existing business processes, while 43% wanted to further automate
manual controls, especially for compliance-related reconciliation and security
Tied in with these new regulations is the focus on best execution, which has
become a buzzword in corporate and fund management circles during the past few
years. For the former, the cost savings translate into an enhanced bottom line
performance, while for the latter, it can help improve returns. Although best
execution is hard to define, most corporate treasurers take a holistic view and
factor in pricing as well as the cost of the trade and processing transactions,
not to mention the potential for human error.
“We are seeing an increasing number of companies looking at their control and
compliance systems because of Sarbanes-Oxley and IAS39. One of the big questions
treasurers are asking is ‘How can I make compliance easier?’ What we have
learned is that most companies do not want to change the way they do business.
However, they are beginning to realise that if they automate their manual
processes, they will not only become more efficient, but eliminate the chance of
human error. A trade that would have taken them a day can now be completed
before 9am,” says Warms.
Warms uses confirmation matching, one of the most important controls in the
foreign exchange trade lifecycle, to illustrate his point. He notes that
companies need timely and accurate confirmations in order to properly monitor
foreign exchange activities and their impact. Testing a manual confirmation
matching process is more expensive and time consuming than having a system that
produces automated communications.
For foreign exchange, companies have a choice of either the single electronic
platforms of their banks or multi-dealer platforms, such as FXall, Hotspot FXi,
Electronic Broking Services and Reuters, which launched its service for
corporates last year. It is not enough, however, for these groups to just offer
liquidity and pricing of a wide range of currencies. Today’s systems also need
all the bells and whistles, such as straight- through processing and prime
Warms, for example, does not describe FXall as a trading platform, but as a
workflow trading solution that helps companies streamline and automate what they
already have. “It is not just about getting a trade done, but also looking at
control and compliance, best execution, automating the trading cycle, improving
efficiencies and reducing errors. By tightening controls, reducing risk and
delivering full audit trails for every transaction, electronic platforms like
ours make it easier for companies to comply with industry standards and best
practice guidelines, and to operate more effectively in today’s changing global
Reuters also recently entered the corporate space with its Reuters Trading
for Foreign Exchange service, which it has extended to its treasury and
financial institution customers. The aim is to help them gain access to bank FX
liquidity at competitive transaction rates, while simplifying the trading cycle,
reducing processing costs and eliminating transaction errors. The platform can
also be constructed to enable smaller to mid-tier companies to connect directly
to their banks.
Jas Singh, head of treasury at Reuters, believes it’s important to segment
the client base. “Different companies have different requirements and we are
tailoring the product to their needs. The goal is to help them streamline their
processes in a cost effective and efficient manner. The single-dealer platform
is applicable for both active traders and for those companies that trade less
frequently and want to do it electronically. The single-dealer (Bank platform)
can be configured appropriately to meet the differing needs of the diverse
Xavier Alexandre, head of Europe and Asia at Hotspot FXi, also notes the
increasing importance of offering a variety of value added services. “We are
seeing a huge increase in the number of companies that are interested in trading
FX online. However, it is not enough to just offer different pools of liquidity.
You need to be able to offer best execution, access to prime brokers and
flawless STP (straight through processing). For corporates, the devil is
definitely in the details.”