Custodian Banks vs. Pension Funds — A Comment on The Ongoing Discussion, And The Most Recent WSJ Article

On May 23, the Wall Street Journal published a front page story: “Inside A Battle Over Forex” by Carrick Mollenkamp and Tom McGinty.

“Bank of New York Mellon Corp. has been fighting accusations that it took advantage of clients while trading currencies,”  it began.  “A Wall Street Journal analysis of more than 9,400 trades the bank processed over the past decade for a large Los Angeles pension fund could provide ammunition to its critics.”

The article advances recent reporting about lawsuits filed by public pension funds against custodian banks, alleging that the banks had fleeced the public funds on fees by filling FX trades at disadvantageous (though arguably legal) prices over many years.   The Journal’s article of May 23 seems to offer proof.   The newspaper filed a freedom of information request with the Los Angeles pension fund for its FX trading records and examined more than 9,000 trades.  Even the bank in question “confirmed the accuracy of the data and said the bank’s employees ‘tend’ to price foreign-exchange trades at one end of each day’s “interbank” trading range…”

Particularly interesting is the bank’s response that clients like the Los Angeles pension fund knew—or should have known—that the bank doesn’t act in their interests when pricing the trades.

There will no doubt be further calls for increased regulation to induce change in FX market practices.  But in my view more powerful and faster remedies are education and the use of available technology to fight imbalances caused by information asymmetry.

Yes, global foreign exchange markets are opaque and difficult to navigate but technology has greatly increased transparency. On our system, pension funds can see their custodian bank’s price feed and those of its competitors, in real time,  on one screen and draw their own conclusions. By bringing to bear all the advantages of modern technology, including access to a shared IT infrastructure, data centers, and support, we have dramatically lowered the cost and barriers of entry for new market entrants to deliver a highly competitive global FX offering. My advice to pension funds is that if your particular provider is not competitive, switch to an institution that is. Multi-venue platforms like Integral’s FX Grid are aggregating and displaying prices across the market from hundreds of sources of global FX liquidity and offer a clear alternative to the single-bank systems like the one on exhibit in your article.

The combination of free historic data and real-time market movements are sufficient to help pension funds become educated and turn themselves into informed market participants. As importantly, a price provider on our platform knows that they are always doing it in competition with others. Thus, competition is built-in. What better way to ensure fair treatment through market self-regulation?

To paraphrase a famous philosopher:  “Fleece me once, shame on you.  Fleece me thousands of times a day, shame on me.”

Here’s a link to the original article.

2011 — The Year of the Platform?

The French web entrepreneur Loïc Le Meur identified “platforms” as one of the key technology trends at the World Economic Forum in Davos in January. American Airlines started to feel its power when combating Orbitz and Expedia.  Apple recognized its value when it created the app store for the iPhone; and is now trying to repeat that success with the Mac store for its computers. Your kids are inhaling the many benefits of a platform through their use of Facebook. When Ford launched its efforts to change how people interact with their cars through SYNC® and MyFord Touch™, Ford is banking on the power of the platform to ensure drivers will enjoy an ongoing flow of updates and added services. To me, it sure looks like everything is becoming a platform.

Why stand-alone applications fall short

Stand-alone applications are a thing of the past. They just cannot compete with the cost effectiveness, flexibility, extensibility, innovation cycle and rapid time-to-market that platforms offer. An application is a closed environment that does whatever its original developers intended it to do, and nothing more. That is not sufficient for the demands of today’s FX markets. Continue reading 2011 — The Year of the Platform?

Aggregation works at any rate (no, really!)

When trading in larger sizes, liquidity takers have come to understand that FX aggregation services have a profound positive impact on the quality of the execution they see. They know the risks involved and want to be sure that they are getting the best deal possible. An FX aggregation and Execution Management System (EMS) understands how to aggregate different streams from liquidity providers who each may have imposed their own trading rules, and still ensures that you’ll get what you clicked on. To that end, an FX aggregator is a trader’s best friend in ensuring competitive bids. It virtually guarantees (pun intended) tight spreads on the top of the book, full fill in the market with little slippage, and even possible price improvements.

While a majority of traders intuitively understand its value when trading $20m,$50m or more, they are sometimes ignore its advantages when trading $500k, $2.5m or $5m. That might be because with large trades, the monetary value often is self-evident vs. with smaller trades, the value is strategic and harder to quantify.

Short-term gain but long-term pain
Long term trading strategy, not short term cost concerns, should be driving your trading system choices. Here is why you shouldn’t trade smaller amounts on a single-bank system, even if it offers tighter rates.

Continue reading Aggregation works at any rate (no, really!)

From Stonehenge to the Asteroid belt or How FX Markets Have Changed

FX markets have come a long way. In the late 1980s and 1990s, the market resembled Stonehenge in that a few silos dominated the landscape. They were, in fact, the market. It was a very static affair with high barriers of entry and almost no difference in what the few banks offered. Today’s market looks more like our solar system’s asteroid belt. There are thousands of market participants that come in all shapes and sizes. They are independent but connected entities. Barriers to entry are low. As a result, the entire market is in a state of flux which fosters innovation. Customers have many choices and competition is strong.

The original banks are still around. I liken them to the planets; a small number of larger entities that still dominate the area around them but exert much less influence on the market at large.  In FX, like in other markets before it, a number of forces came together to affect this change. Continue reading From Stonehenge to the Asteroid belt or How FX Markets Have Changed

The New Meaning of ‘Mine’

Sometimes I get the question how Integral’s products and services fit into all the different FX solutions offered to banks and brokers today.  Let me clarify and explain how what we do is unique, but also uniquely apt to augment the solutions of others.

The largest FX network of its kind in the world…

For starters, Integral helps FX market participants by organizing and automating their FX business.  We provide what we do as a service that is delivered in the cloud.  That means our customers never have to worry about issues that come with buying a software package such as addressing installation problems, building adapters, ensuring connectivity, etc.  We take care of all of that for them. We also offer access to an FX network that we believe is the largest network of its kind in terms of scope of reach. By connecting once to Integral, you gain access to basically every kind of business that is involved in foreign exchange. Integral’s FX Grid is the place to connect with all the different entities (i.e. liquidity providers, prime brokers, banks, brokers, hedge funds, corporates) and venues that comprise today’s FX markets. Once on FX Grid, you’ll find every potential business partner, from retail and institutional brokers, prime brokers, buy-side and sell-side banks, to algorithmic trading firms — on a global scale.

… plays extremely well with others

Integral is a neutral technology provider, not a broker or a bank. This simple statement already gets us a long way to being an acceptable partner for many. However, unlike other technology providers that offer a stand-alone software package or framework to enhance the business fortunes of one customer at the time; from the beginning, we designed our system with the concept in mind of providing a utility-like service that has the potential to serve the entire FX industry.  Every customer benefits from not only our expertise, but also from the network effect that comes from having created a virtual business community. Whether you’re looking to expand your customer base, add to your list of liquidity providers and prime brokers, or want to do what you do more efficiently, FX Grid delivers.

The new meaning of mine

Unlike systems set up by competitors, where participants are forced to adapt their unique business to the cookie cutter approach of their vendor, Integral’s approach is completely different. We believe that OTC market participants have unique business models which require custom configured deployments. By giving users the ability to differentiate themselves while also using a shared service environment empowers them with the best of both worlds: increased flexibility with reduced costs.

Integral’s new advertising campaign

You might have seen our new advertising campaign (Mine) in various trade publications and online.

Mine is a term from the world of FX voice trading. The counterparty that’s saying it indicates that they are willing to buy at the conditions outlined to them.  I propose an extended definition of ‘mine’ to mean; the direct ownership of one’s FX trading and aggregations. It means that the bank or broker has the complete control over their world while still reaping the rewards of using a shared cloud infrastructure. That way, they benefit from all the advantages of this business model with the knowledge that it’s uniquely their liquidity, their customers, their algos, their brand and ultimately their profits.

Integral puts you back in control of your FX business. Who is in control of your FX business?

If you want to discuss this further and happen to be at the Profit&Loss Forex Network show in Chicago, I encourage you to stop by our booth.

Why Single-bank Systems Are Losing Ground

As the operator of FX Grid, a global inter-institutional connectivity and trading network, linking market making banks to FX market participants, we are getting good visibility in how other systems are performing. During the hectic days in May that put strains on everybody’s systems, we know for instance who had outages. (Integral did fine by the way. Read more in our press release and in an earlier blog post.) Single-bank systems were among the ones that suffered the most severe outages. I see this as a clear indicator that their decline is ongoing, despite some marketing hype.

Greenwich Associates already reported in April 2008 that “single-bank systems are failing to keep pace with the growth of multi-dealer platforms.” (E-Forex Comes of Age, Greenwich Associates, e-Forex Magazine, April 2008). In analyzing the results of its 2010 FX survey, Euromoney magazine made several observations that substantiate this claim. Euromoney writes: “The top three banks in the survey accounted for 40.44% of the total market in 2010, compared to 45.99% in 2009.”While Euromoney doesn’t say to where the market shifted, the fact that it continues to move away from the largest financial institutions suggests that single-bank systems are still losing market share. In my opinion, multi-dealer systems have clear advantages and the market seems to agree. Here are the four key arguments that proof my point. Continue reading Why Single-bank Systems Are Losing Ground

Looking Back At May 6th

Last week ended with a bang.

The Wall Street Journal reported on Friday that on Thursday, “At one point, the euro fell 8% against the yen, ending down 5.5%. Given currency traders’ leverage, some may face crushing losses.”

Further: “Despite the euro’s 0.75% gain versus the dollar Friday, it suffered its worst week since the height of the global crisis in October 2008. The common currency was down about 4.4% from last Friday and down about 11% since the end of 2009.”

The New York Times reported that “The major indexes gyrated on Friday before closing down sharply on continued fears that the Greek debt crisis would spread and lingering questions about Thursday’s sudden plunge.”

So, was it a bad trading day all over? Here is a different tune from ForexMagnates, an FX blog that is written by Michael Greenberg: “What follows is Integral press release which states that Integral not only didn’t experience any difficulties but also pretty much enjoyed the day. I don’t yet have the exact details regarding who failed to deliver and who passed this crazy day unscathed but it seems that Integral’s aggregation model is working.”

Continue reading Looking Back At May 6th

‘Just-in-time’ — Just in time for FX Brokers?

How inventory got its bad rap

Traditionally, enterprises viewed inventory as a way for a company to store value, and as a safety feature to ride out market fluctuations. It was perceived to be a good thing. That view has changed dramatically with the advent of information technology that made just-in-time (JIT) delivery possible. As I will explain, reducing inventory also reduces market risk. In FX, just-in-time delivery of currency rates holds the promise for FX brokers to eliminate a major headache that has been a source of major risk taking in the past: Internalization of deal flow. I think JIT will fundamentally improve the risk structure of a broker. Given the reduced risk, brokers will begin to divert their energy to marketing and sales with the eventual goal to lower their prices to the optimal level to maximize market share and overall profits, not marginal profitability.

Why holding inventory equals holding market risk

The simple truth is that inventory is costing you money in more ways than one. Obviously, it is tying up capital because there are costs associated with you acquiring products and holding them. It might be less intuitive that you also just bought yourself market risk, i.e. you are now on the hook for your product to sell as predicted. If it doesn’t, you will have to discount it later just to get rid of it. Because companies know all this, their initial go-to-market price needs to be higher to account for said risk, in addition to covering costs and a profit margin. Continue reading ‘Just-in-time’ — Just in time for FX Brokers?

No Dealing Desk – The Next Blockbuster

“Welcome back Kotter”

We noticed that an old favorite of ours has been getting more and more recognition in discussions about the best way to organize FX markets. I am talking about an organizational element that is sometimes referred to as ‘no dealing desk’, an ‘agency model’ or even’ straight-through-processing’ for retail FX brokers. (This latest descriptor might be the most confusing one, given the meaning STP has in institutional markets.) What is NDD and why does the term bubble to the top in numerous industry conversations these days?

“Take your stinking paws off me, you damn, dirty …”

No-dealing desk describes an order flow where a customer puts in an order with her broker. Instead of the broker touching the order – internalizing it, or filling it in the market on his terms – the order is passed on without interference to a third party that executes it in the market for the best price available at that moment. The beauty of this arrangement is that customers will always get a fair execution. Brokers obtain new leverage to increase their market share because they no longer have to worry about exposure and related capital requirements that limit how fast they can grow. They can really turn on their marketing machine. Last but not least, regulators are at ease because there is less room for a possible conflict of interest between trader and broker/market maker. Also, brokers tend to be more upfront about their pricing models (usually a fee, a spread or a mixture of both). For regulators, such a transparent market is easier to regulate. Continue reading No Dealing Desk – The Next Blockbuster

Taking a Fresh Look at DMA

About five years ago, we took the concept of direct market access (DMA) from the world of equities and introduced it to the world of FX. We did so because we had witnessed its benefits of neutral execution in equity markets and knew it would be advantageous to FX market participants as well. As we had predicted, DMA quickly enjoyed wide market acceptance, in part because it has something to offer for everyone. Integral hasn’t stopped innovating, however. While others still view DMA as just a better technology to achieve connectivity, Integral views it as a philosophy to organize today’s market into one that has less friction, more transparency and lower barrier to entry.

Not all DMAs are created equal

The (wrong) mental model of most DMA providers today is using technology to deliver a connectivity network between buy-side participants, market makers and other liquidity venues. I call this process, providing DMA services at level zero.

Integral has arrived at a much broader understanding of DMA, one that goes far beyond the connectivity level. Our model is a combination of functionality that resides partly in FX Grid®, Integral’s multi-sided trading network, and partly with on demand services that run on top of it. On the level of FX Grid, we added multiple price discovery aggregation mechanisms, credit line management, netting, straight-through-processing for pre and post trade processes, verification of execution with QOS, and most importantly, monitoring services for connectivity and rejection rates. A set of user-controlled algorithms for blending, splitting and spreading liquidity for internal and external users rounds up the service. Continue reading Taking a Fresh Look at DMA