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March 1, 2014

Once Burned, Twice Shy

Continued adoption of electronic FX trading is increasing demand for performance measurement while providing the necessary execution data to calculate it.

By Rob Daly

Nothing drives the buyside to adopt transaction-cost analysis faster than perceived malfeasance by their sellside brokers and dealers. When Bloomberg published its June 2013 story on the U.K.'s Financial Conduct Authority's investigation into alleged collusion by traders from the largest foreign-exchange dealers to fix the WM/Reuters 4 p.m. benchmark rate, it could have created a spike in interest in FX TCA.

"Since local regulators in Asia, Europe and North America are conducting their own investigations, it has given buyside clients an incentive to analyze how their FX trades are executed. They're questioning whether they received best execution, which could be partially measured by FX TCA," said Howard Tai, a senior analyst at industry research firm Aite Group.

One would assume the buyside would have more FX TCA on their minds due to the current market investigation, said Evangelos Maniatopoulos, head of global Advanced Execution Services' FX trading and FX products at Credit Suisse. "We speak to our customers about TCA on a daily basis, and we can certainly say that there is a significant focus on the topic from the buyside community. Perhaps this is also driven by current market investigations, " Maniatopoulos said.

The initial spike in interest actually first appeared in the second half of 2009, when the California Public Employees' Retirement System and the California State Teachers' Retirement System sued their custodian, State Street, for overcharging the pension funds on standard instruction FX trades. Other custodians like Bank of New York Mellon also found themselves subject to similar suits brought by other pension funds.

"The perceived wisdom was that the foreign-exchange markets were efficient and cheaply priced," explained James McGeehan, co-founder and CEO of FX TCA consultancy FX Transparency. "For most investors, price discovery mechanisms and oversight processes are the case as trades can be done efficiently in the OTC market, but for many after the California litigation came out there was weakness that people had not recognized and not uncovered. It spurred the need to look at currency execution since it trades over-the-counter. Banks and custodians are not acting as fiduciary; they're acting as principal, which makes them economically opposed to their client on every trade."

According to a recent Aite Group white paper written by Tai, "FX Transaction Cost Analysis: The Buy Side Weighs In," the buyside trading desk was the prime consumer of FX TCA. After them, the portfolio managers and the compliance staff were just beginning to delve into best-execution policies.

FX Transparency, which opened its doors in the spring of 2009, has seen interest from every type of buyside market participant, such as pension funds, pension fund clients, asset managers and asset owners, according to McGeehan.

"The adoption of TCA in FX trading, however, is still in the early stages, but we have seen an accelerated uptake since late 2010," says Tai. "The use of TCA in equities has been around for more around two decades, but it really has not been done in earnest until a decade ago, when asset owners began demanding proof of best execution, which drove the asset managers to demand equities TCA offerings from service providers, brokers and others."