Back-office bottlenecks hinder foreign-exchange trading
Back-office bottlenecks hinder foreign-exchange trading
The foreign-exchange market's rapid expansion, partially fueled by hedge funds and increased interest in emerging markets, is causing issues with back-office operations. High volumes lead to problems with processing and bottlenecks, which can cost millions of dollars because of the size of the trades.
Foreign exchange volumes create back-office bottlenecks
Melanie Wold
26 Oct 2007
As the foreign exchange market fast approaches $4 trillion (€2.8 trillion) a day in turnover, the focus has shifted from front-office trading to the back office.
Expansion has been partly fueled by greater interest in emerging markets and the involvement of hedge funds and their prime brokers. Processing problems include bottlenecks and errors which, because of the size of trades, can cost millions of dollars.
Operators of foreign exchange trading platforms, including Reuters with its Dealing foreign exchange system, interdealer-broker Icap with the EBS foreign exchange platform, and electronic trading aggregator FXall are moving to straight-through processing to ensure customers can efficiently process volumes.
Icap’s purchase of post-trade processing specialist Traiana takes the UK group into that sector and raises the bar for its competitors in the electronic trading of OTC instruments. But straight-through processing did not equate to post-trade services, said Gil Mandelzis, chief executive of Traiana. Icap previously concentrated on price discovery and trade execution but stopped short of post-trade services.
It instead offered links to vendors of post-trade services, such as Traiana, whose messaging platform offers automated matching, confirmation and netting for foreign exchange.
The combination of Traiana with EBS, the spot foreign exchange trading platform Icap bought from its founding bank consortium last year, gives Icap’s customers the opportunity to improve processing efficiencies, which should enable them to trade more volume, according to Mandelzis.
Traiana’s network connects 10 custodian banks, 17 electronic crossing networks, 20 prime brokers, 40 executing banks and 600 funds. It has 400 bank-to-bank links and 2,500 tri-party links.
Harmony, a matching system, and Netlink, which nets foreign exchange trades before they are settled, sit on top of the network. Mandelzis said Icap would keep the network separate from its brokerage operations to maintain confidentiality.
Trade netting increases the percentage of trades that are settled the same day or the following one and decreases the number of trade tickets that have to be sent to CLS Bank for settlement.
A bank can net its clients’ trades before it sends them to CLS, saving on settlement costs. CLS Bank, a consortium of 69 of the world’s largest banks, was launched in 2002 and has largely removed the risk involved with foreign exchange settlements.
Trade netting is becoming more important because there are more tickets of smaller sizes. Sang Lee, co-founder and managing partner consultancy at Aite Group, said: “The more active trade, driven by algorithms, is producing smaller ticket sizes, which can put pressure on the back office. Netting reduces this.”
FXall offers a netting service on its platform, as does State Street’s FXConnect multi-bank exchange trading network and its ECN Currenex.
Reuters does not offer netting but launched a real-time notification service, Reuters Trade Notification Service, two years ago at the request of interdealer-broker clients that wanted more post-trade automation. The service alleviates the need to enter trades manually and, when the trades are fed into risk and position-keeping systems, it frees risk capital so they may make more trades.
There have been rumblings that netting services may threaten the monopolistic hold CLS Bank has over foreign exchange settlements. If netting were to occur between CLS member banks, rather than between the banks and their customers, it could affect CLS revenues.
Tony White, global co-head of research and development for Wall Street Systems, a treasury, trading and settlement solutions provider, said everyone was talking about services such as Traiana Netlink but was afraid to use them: “Nobody wants to rock the CLS boat.”
Tom Price, an analyst with research firm TowerGroup, said FXMarketSpace, the joint venture between CME and Reuters, was intended to provide netting services to users but backed off under pressure from CLS members – a powerful group of banks that were potential FXMS users.
A spokesman for FXMarketSpace said because it cleared and settled through CLS member CME, netting before sending to CLS was a breach of CLS’ rules. Price said FXMS was waiting for the right moment to try it again.
The spokesman said: “We are speaking with CLS about alternatives to paying gross. FXMarketSpace has the capability to flick a switch and net trades if a resolution can be found.”
CLS is aware of market criticism and of possible threats to its business. Jonathan Butterfield, vice-president of marketing and communications at CLS, said: “We are certainly not complacent and recognize the market is changing. Owned by and operating for our members, they have determined that there is no industry request for a change on netting.”
Icap and Traiana are adamant they are not trying to compete with CLS. Mandelzis said: “We think CLS is providing an important service to the market; it has solved some significant issues and is here to stay.”
Analysts believe the price Icap paid for Traiana was high – $238m in comparison with the $15m in revenues expected this year. But Icap said there was scope for Traiana to go beyond foreign exchange markets into derivatives, fixed income and equities. According to Mandelzis, there was a strategic rationale for buying Traiana but he also said: “We bought the business to make money.”
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