Asset managers are taking foreign exchange (FX) management more seriously. Michel Klein, Director of FX Product at RBC Investor & Treasury Services, shares his top five insights on the shift in FX market dynamics and how managers are responding.
1. As operating costs spiral and best execution rules go into effect, asset managers are now having to confront the indirect costs associated with FX.
Fuelled by volatile market conditions, margin erosion as a result of rising operational costs and the imposition of post-financial crisis regulation, investment firms are increasingly scrutinizing their overheads. FX execution is something that managers are closely examining, especially as many firms are now subject to best execution requirements under MiFID II (Markets in Financial Instruments Directive II).
“Demonstrating best execution is particularly important at the moment given the margin pressures currently facing the funds industry," says Klein. He adds that, while asset managers have traditionally focused on FX spreads, which are easy to quantify, they have not spent much time reviewing the indirect costs associated with FX execution such as settlement, staffing and system maintenance costs.
2. Specialist providers look to assist investment firms with their transaction cost analysis.
The delegation of passive FX management is not a new concept. It has been an ancillary service offered by leading global custodians for many years now but is becoming increasingly bespoke. “FX is currently seen as a specialist and standalone service. Specialist providers offering services such as FX calculations and FX execution can give managers access to oversight dashboards and self-service performance attribution tools, and this is providing enormous benefits to the industry," according to Klein.
Services that can help managers spot and root out hidden costs is key
He adds that, by outsourcing, asset managers will obtain enhanced FX transaction cost analysis—highlighting that such benchmarking tools can enable firms to demonstrate best execution. “Having services that can help managers spot and root out hidden costs in their FX transactions is key,".
3. Best execution disclosure requirements continue to command attention.
Although best execution disclosures are advantageous for end investors, some of the rules do create challenges for fund managers. “In the case of MiFID II, managers must evidence that they have taken all sufficient steps to obtain the best possible FX execution rate for clients. However, this obligation can create complexities and added costs for managers—along with risks, especially if firms fail to comply with all of the reporting requirements. This can lead to regulatory sanctions or fines," says Klein.
4. Consolidation of FX counterparties is likely to accelerate as investment firms look to simplify their FX operating and execution model.
There is an increasing demand for a more seamless and arguably single FX operating
and execution model
While FX counterparty diversification was previously considered vital, there is now a noticeable trend towards service provider consolidation among buy-side institutions. “Historically, market participants appointed multiple FX counterparties as it was seen as an effective way of demonstrating best execution. However, this dynamic is now starting to move in the opposite direction. There is an increasing demand for a more seamless and arguably single FX operating and execution model. Instead of asset owners having multiple segregated accounts at different custodians, they now want a single and seamless FX operating model," says Klein.
5. Digitalization continues to reshape FX execution by offering managers more transparency into the transactional process.
The digitalization of FX workflows and data models has been ongoing for some time now, but it has recently ramped up considerably, and this is something that asset managers are looking to capitalize on. “Today, asset managers are seeking self-service reporting and API (application programming interface) features," says Klein. Just as digitalization swept through the retail banking world, asset managers are increasingly demanding tailored and accessible FX services—delivered through their smart devices. “Managers want dynamic reporting features and APIs so that they can seamlessly consume FX data," he adds.
Asset managers are also seeing the emergence of disruptive technologies such as Blockchain, which may in time facilitate trade settlement more widely in FX markets, according to Klein—a development that could result in operational efficiencies and better transparency.