e-FOREX magazine January 2011

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e- F O R E X

January 2011

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Issue Forty january 2011

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welcome to

e-FOREX WINTER 2011 Happy New Year!

A

s usual at this time of year we focus on the electronic trading of currency derivatives. In this edition we start by examining various clearing initiatives that are gearing up to provide services for FX OTC instruments. However, the market will probably have to wait until there is much more certainty with respect to the regulatory environment before it can gauge more accurately which clearing providers have built sufficient numbers around their business models to emerge as the winners in the FX space and what impact any significant change in regulations will have on future currency derivative volumes. We also examine the latest developments with electronic FX option trading platforms. For 10 years we’ve been reporting on the automation of FX options. Unlike almost all other sections of our industry which have fully embraced the electronic channel, the growth curve for e-distribution of these instruments has stubbornly lagged behind. However, there is now no doubt that the pace in electronic delivery of derivatives is picking up fast with many new technology solutions being developed to facilitate improved management of FX options trade life-cycles. I believe we can shortly expect to see better integration of option trading platforms with users’ order management systems, coupled with the arrival of a new generation of pricing, analytics and realtime risk management applications, as well as a move towards migrating the next level of exotic options onto e-platforms. Finally, we have put together a comprehensive feature exploring FX on exchanges, with interviews from some of the world’s leading futures and options exchanges to discover what currency products they now offer and how they are developing their technology, connectivity and trading infrastructures. Some of the continued demand for FX on exchanges is undoubtedly related to counterparty risk mitigation and of course many of the leading exchanges are specifically developing products and services to make derivatives more accessible to a wider global audience of currency investors and traders. But growth in FX on exchanges must also have been positively impacted by the new FX OTC rules (capital requirements, leverage etc) which are placing significant pressures on the way that market operates and which may make it less attractive for some players. We hope you enjoy this edition of the magazine. Charles Jago Editor

Susan Rennie

Michael Best

[email protected] Managing Editor

[email protected] Subscriptions Manager

Charles Jago

David Fielder

[email protected] Editor (FX & Derivatives)

[email protected] Features Manager

Charles Harris

Simon Moss

[email protected] Advertising Manager

[email protected] Commercial Manager

Helen Rochford

Felix Shipkevich

[email protected] Production Manager

Contributing writer Regulatory Roundup

ASP Media Ltd Suite 10, 3 Edgar Buildings George Street, Bath, BA1 2FJ United Kingdom Tel: + 44 1208 821 802 (switchboard) Tel: + 44 1208 821 801 (e-Forex sales & editorial) Fax: + 44 1208 821 803

Design and Origination: Phill Zillwood Design Works [email protected] Printed in the UK by Buxton Press e-Forex (ISSN 1472-3875) is published quarterly in January, April, July and October www.e-forex.net

Subscriptions Subscription rates (including postage) UK & Europe: £150 per year Overseas: £175 per year Please call our subscription department for further details:

Subscriptions hotline: +44 (0) 1208 821 801 Although every effort has been made to ensure the accuracy of the information contained in this publication the publishers can accept no liabilities for inaccuracies that may appear. The views expressed in this publication are not necessarily those of the publisher. Please note, the publishers do not endorse or recommend any specific website featured in this magazine. Readers are advised to check carefully that any website offering a specific FX trading product and service complies with all required regulatory conditions and obligations. The entire contents of e-Forex are protected by copyright and all rights are reserved.

January 2011

contents

>>>

FOREWORD Manfred Wiebogen

Frances Maguire

Foreword Derivatives regulation

Leader OTC Clearing landscape

20. Derivatives, riding the next wave of regulation Manfred Wiebogen comments on what impact the planned financial regulations relating to currency derivatives, which are due to enter service by the end 2012, will have on the FX market.

Sang Lee

Nicholas Pratt Marketplace Key trends for e-FX in 2011

22. Overcoming systemic risk: FX adapts to a new competitive OTC clearing landscape With clearing for credit default swaps and interest rate swaps already underway, Frances Maguire investigates what factors will influence the likely providers of clearing services for FX OTC instruments. MARKETPLACE

Roger Aitken

Heather McLean

Cloud Computing Services Impact on e-FX delivery

Regional e-FX Perspective on Brazil

30. Technology and growth: key trends in e-FX for 2011 Nicholas Pratt interviews some of the industry’s leading consultants to try and identify key focus areas that are likely to have a profound effect on the development of the electronic FX marketplace during 2011.

The e-Forex interview

38. Shifting demand for Single-Dealer platforms Sang Lee highlights a major shift

A ACI Advanced Markets AFME AFX Capital Aite Group Alpari Alphastream Aphelion

Tim Maxwell

Traders Workshop Optimising Automated FX

Trading methodologies in Managed FX

Alexandre Vigier and Arnaud Amsellem TraderTalk

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e-FOREX

Companies in this issue

David Rodriguez

B B2RCP Bahrain Financial Exchange Beta Gamma Research Bloomberg Tradebook BM&F Bovespa Boston Technologies C Capital Market Access Partners Celent CIBC Citi Client Knowledge CLS Bank CME Group Credit Suisse Currenex D Deutsche Bank Digitec

page 20 page 18 page 71 page 163 page 38 page 29 page 112 page 15

page 16 page 106 page 92 page 61 page 105 page 145 page 37 page 144 page 31 page 57 page 17 page 14 page 21` page 33 page 6 page 19

page 11 page 133

Divisa Capital Dukascopy E eSignal Exponential-e Eurobase F Fair Trading Technology Financial Software Systems Finatek Firm 58 Fisycs Capital

page 157 page 3

page 43 page 107 page 35

FXall FX Bridge FXCM FXDD FXecosystem FX Street

page 181 page 129 page 143 page 142 page 178 Inside Back Cover page 9 page 125 page 53 page 167 page 18 page 158

G Gold-i Global Trading Analytics Greenwich Associates GSCS

page 134 page 65 page 37 page 63

H Hotspot FX

page 127 page 13

I Integral Development

page 74

FlexTrade

Nicholas Pratt asks why the value proposition of single-dealer platforms continues to strengthen for many trading firms and FX buy-side participants and what key features and functionality they now need to provide.

54. Engaging the market with more intelligent FX orders Nicholas Pratt explores the many ways that the buy-side can work their orders to improve the way they engage with the FX marketplace and how their needs may differ between different client segments.

62. Validation and Compliance: applying new toolsets for more effective TCA in FX

INDUSTRY REPORT Paul and Howard Tolman

FEATURES

44. Single-Dealer platforms: staying ahead in the FX game

LEADER

Industry Report Single-Dealer platforms

occurring in market demand for singledealer platforms driven by various customer segments’ need for asset class diversification and banks seeking to fully support the demands of their customers.

Roger Aitken sets out to discover whether Transaction Cost Analysis can evolve beyond a process useful in compliance and high-level performance assessment into a tool capable of generating actionable analysis for improved FX trading operations..

Intercontinental Exchange

page 26

L LCH Clearnet LiteForex LMAX

page 166 page 23 page 159 page 152

M MCX Stock Exchange MetaQuotes Software Murex

page 104 page 147 Outside Back Cover page 131

N Nadex Nexaweb Technologies Nomura Nordea NYSE Euronext

page 127 page 59 page 7 page 5 page 28

O Oanda Option Computers

page 25 page 89

P Phare Global Markets Philip Futures Portware

page 110 page 149 page 67

MIG Bank

Q QP Capital LLC QSG

page 172 page 64

R Royal Bank of Scotland RTS Group S Singapore Exchange Singapore Mercantile Exchange SmartTrade Technologies Societe Generale Standard Chartered Bank SunGard Superderivatives Sybase T 360T TABB Group Thomson Reuters TMS Brokers TowerGroup Tradency TraderTools TradeStation Securities Tradingscreen Traiana Transaction Network Systems V Vantage FX Velocimetrics

page 47 page 106

page 28 page 103 page 87 page 8 Inside Front Cover page 95 page 120 page 75

page 123 page 34 page 111 page 150 page 36 page 27 page 41 page 113 page 63 page 141 page 85

page 177 page 82

January 2011

contents FOREX TECHNOLOGY

RETAIL e-FX PROVIDER

72. Cloud Computing Services: meeting more than demand spikes in FX

136. Solving the Post Trade puzzle: helping retail FX providers achieve increased operational efficiencies

Roger Aitken investigates how the Cloud Computing model operates and in what ways the pooled resources of an enterprise Cloud design can assist with the delivery of FX trading applications.

82. High volume FX - taking a new approach to performance management Nick Gordon outlines how FX is leading the way in the development of performance analysis technology to facilitate more effective business flow monitoring. THE e-FOREX INTERVIEW

90. The boys are back in town e-Forex talks with Paul and Howard Tolman at Beta-Gamma Research FX ON EXCHANGES Validation and compliance - toolsets for more effective TCA in FX

98. Venues, products and users: momentum builds for FX on Exchanges Frances Maguire looks at the continuing growth in the trading of currency products on exchanges and the services and technology these venues are developing to attract new FX business. REGIONAL E-FX PERSPECTIVE

110. Brazil

High volume FX - a new approach to performance management

Heather McLean examines what factors are driving demand for e-FX in this Latin American powerhouse. FOCUS

Solving the Post Trade puzzle - helping Retail FX providers

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Nicholas Pratt delves into how new post trade FX processing solutions can help reduce some of the draw backs associated with delivering retail FX services and also assist providers to take advantage of new business opportunities.

142. Strategic Insight: Outsourcing & Analytics for more efficient FX brokerage operations Heather McLean casts light on why retail FX providers should consider outsourcing many of their back office functions and in what ways outsourced analytical procedures can be applied to a brokers risk, compliance and trading activities. TRADERS WORKSHOP

164. Coding, backtesting and strategy optimisation techniques for Automated FX David Rodriguez discusses, coding, back-testing and strategy optimisation techniques for Automated FX trading. RETAIL e-FX CLIENT

172. Down to the cogs: getting to grips with trading methodologies in Managed FX Managed FX advisors utilize a variety of different trading methodologies. Tim Maxwell outlines what makes some approaches more successful than others and can therefore serve as a good foundation in an investor’s search for an ideal advisor.

122. Reaching a crossroads: is it time to re-think the management of electronic FX options?

TRADERTALK

With the regulatory spotlight on the OTC market, Frances Maguire explores where we currently stand with the electronic trading of FX options and whether a rethink is needed about how they are traded and processed in the future.

e-Forex talks with Alexandre Vigier and Arnaud Amsellem founding partners of Fisycs Capital, a systematic investment management firm based in Paris.

178. Fisycs Capital – taking emotion out of the trading process

FX excellence in all shapes and sizes At Nordea we deliver flexible trading capabilities by utilising the foremost FX frontend suppliers. We have implemented the Bloomberg FX dealing platform to provide even more dealing channels - meeting the exacting demands of professional traders for pricing, speed and availability. And with our new trading connection between Nordea and the Trezone® system for automating corporate treasury processes, we have eliminated nearly all of the manual work for multinational companies converting decentralised FX exposure reports into centralised FX cover deals.

Visit us at www.nordea.com/e-Markets Nordea’s vision is to be a Great European bank, acknowledged for its people, creating superior value for customers and shareholders. We are making it possible for our customers to reach their goals by providing a wide range of products, services and solutions within banking, asset management and insurance. Nordea has around 10 million customers, approx. 1,400 branch offices and a leading netbanking position with 6,1 million e-customers. The Nordea share is listed on NASDAQ OMX Nordic Exchange in Stockholm, Helsinki and Copenhagen.

NEWS

FXall Trading release 4.0 is launched

F

Xall has announced that FXall Trading release 4.0 brings together key benefits for every client segment across active traders, asset managers, banks and corporate treasurers. The new FXall 4.0 integrates sophisticated functionality and liquidity with Citi’s Phil Weisberg former active trading platform which FXall purchased at the beginning of the year within FXall’s Aggregator. Liquidity has been replicated, along with access to new advanced order types including TWAP, pegging, OCO (One Cancels Other), market and stop loss orders, to give clients a high degree of control over their trading strategies. For real-money and corporate clients who use FXall’s relationship trading capabilities, multiple new workflow features including enhanced role and entity-level controls, have also been released recently to strengthen clients’ risk management and internal compliance. Phil Weisberg, CEO at FXall, said: “Our postacquisition integration has proceeded smoothly, so we now deliver the broadest range of execution strategies - a leading anonymous ECN, advanced order types, ultra low-latency performance and deep liquidity within one comprehensive solution.”

TraderTools unveils FX Liquidity Management component

T

he FX Liquidity Management component monitors and controls inward and outward liquidity flows to make pricing and execution decisions in real time. It features: Back-to-back trading, deciding whether to back-toback or warehouse risk instantaneously. Position management, with a user interface providing a summary view of all current positions updated in real time, changing tick by tick, as the market develops. All available currencies and currency pairs are listed with associated Marked-To-Market statistics. Algorithmic trading, in which custom strategies are created to take advantage of market conditions or to structure trades with specific execution characteristics. Each strategy has access to the current market and executions as they take place and can self-adjust if necessary.

The Position Viewer’s “Account” view shows the current position of currency pairs and trades

FX Bridge launches Multibank FX options liquidity

T

echnology provider FX Bridge is now offering its ProTrader Plus™ platform with live, executable FX spot and options prices streamed by leading global banks. The new FX options liquidity source was rolled out in recent months and is now in full production with select brokers globally. “We are pleased to provide this major liquidity enhancement to the retail FX market,” said Stephen Best, FX Bridge CEO. “Streaming multibank liquidity together with integration with prime brokers is the perfect solution for brokers that want to offer expanded trading and risk management capabilities

6 | january 2011

e-FOREX

of options without running an options risk book.” Pro Trader Plus continues to be available as a singledealer platform enabling brokers to make options markets to clients directly or alongside multibank pricing.

www.nomura.com

Nomura The new force in FX e-trading

The award winning global solution for Foreign Exchange real-time pricing, execution, and analysis. With the focus on the trader, Nomura deploys advanced technology with customizable

The new force in global investment banking

tools and liquidity across majors, emerging markets and non-deliverable currency pairs.

For further information on NomuraLive and the suite of e-commerce products at Nomura, email [email protected]

Nomura is the global marketing name of Nomura Holdings, Inc. (Tokyo) and its direct and indirect subsidiaries worldwide including Nomura Singapore Limited, licensed and regulated by the Monetary Authority of Singapore, Nomura Securities International, Inc (New York), a member of FINRA, NYSE and SIPC and Nomura International plc (London), authorised and regulated by the Financial Services Authority and member of the London Stock Exchange.

NEWS

Nordea expands tradable e-FX products

N

ordea has added more

trading opportunities to its electronic trading platform, e-Markets, in response to new demands for FX functionality. Two new tradable products, uneven FX swaps and forward-forward FX swaps, were previously only available through multibank offerings like FXall. Head of FX, MM and Commodities Trading at Nordea, Kenneth Steengaard, said: “We have recently seen a growing trend amongst our top professional customers of moving to using our proprietary e-Markets platform.

CitiFX launches Liquid Slice algorithm

T

This highly specialised group needs a broader range of electronic offerings and we are committed to meeting these needs and making professional life simpler. The new tradable products in e-Markets keeps abreast of this demand and we are proud to be supporting these features across more than 800 currency pairs.”

he CitiFX Intelligent Orders team has just released the Liquid Slice algorithm. The bank has found that while many of their clients appreciate the quality of passive stealth strategies like Ripple and Silent Partner, there is still demand for vanilla time weighted average price (TWAP) style execution. Liquid Slice provides customers a linear execution within a user defined execution horizon; it enables traders to capture as much bid/offer spread as possible while protecting order information from the market. Recent enhancements to the order management functionality available on the Velocity platform have handed more real-time control to customers over their trades and similar updates completed on the interfaces provided on distribution channels such as Bloomberg are also proving popular.

Societe Generale launches Alpha FX platform

S

ociete Generale has launched Alpha FX, a powerful new single dealer platform providing clients with direct electronic access to FX pricing for spot, forward and non-deliverable FX products.

Alpha FX was developed to provide a more user-friendly interface with customisable features, including research access globally. Accessible via any secure internet connection, Alpha FX clients will benefit from highly competitive pricing and execution, while being supported by a global client service team. The platform is a Rich Internet Application (R.I.A.) built on leading edge Microsoft Silverlight

8 | january 2011

e-FOREX

technology, increasing speed and response times for end users. It also utilises market leading authentication software, allowing clients to navigate with confidence within a highly secure environment.

10 years of investment, innovation novation and independence

n o i l l i b 0 e 0 m u l 1 o $peak daily v r Ove

in s y o l Dep

s y a d

ced n a v d a t Mos

The new

FXall 4.0

s 30+ configuration One platfo rm

bank & E CN pricing

200+

sourc e contin s of u liquid ous ity FXall 4.0 is here. The most advanced ced order types in the business. Single-platform relationship and ECN CN trading. Multiple execution mechanisms. The deepest liquidity. Ult Ultra-low and high fill l llatency t d hi h fill rates. Everything you need to trade your strategy, your style. Plus fast deployment – from “go ahead” to “go live” in days, not months. Take a fresh look at FXall. You’ll see why, since 2001, we’ve been the partner you can’t afford to be without. Contact us at +1.646.268.9900 or [email protected] www.fxall.com

FX trading solutions for Active Traders . Asset Managers . Corporate Treasurers . Banks . Broker-Dealers . Prime Brokers .

NEWS

Two new banks choose D-3

S

wedbank has decided to use the D-3 Pricing System developed by Hamburgbased technology vendor Digitec. The sophisticated and reliable new platform was selected to replace the existing quote infrastructure. The bank went live with both spot and forwards in October 2010. The system provides the Swedbank FX e-commerce infrastructure as well as internal banking systems with streaming rates. Another new Digitec client is Zuercher Kantonalbank (ZKB). The Swiss bank has implemented

Société Générale selects Dealhub

D

D-3 for FX forwards and went live in December. Digitec sees a growing interest of major banks to replace spreadsheet based or inhouse made pricing solutions with the client server architecture of D-3 that ensures high availability combined with low latency.

ealHub has announced that Société Générale Corporate & Investment Banking (SGCIB) has selected DealHub as its e-FX price distribution system. The DealHub Connectivity Manager solution supplied by Option Computers Ltd (OCL) provides a low latency price distribution backbone servicing SGCIB customers across the Bank’s newly launched Alpha FX platform, FIX API and multibank ECNs.

eSignal offers Forex content and free strategies

W

ith 200 global bank and broker contributors and spot rates for more than 100 currencies, as well as precious metals, cross and forward rates, the eSignal data and charting packages are proving ideal for Forex traders. Streaming, real-time quotes and news, Forex Market Depth with the ability to view the best bid / ask by Forex contributor, plus powerful technical analysis and back testing, are now available for the professional, as well as the active trader.

10 | january 2011

e-FOREX

Peter Kriskinans

Tracking contributors’ rates is easy with eSignal’s ability to display GTIS Forex data by contributor. In addition, free Forex strategies are available at: www.esignal.com/ offer/forex.

Peter Kriskinans, Managing Director of OCL commented “We are delighted to have delivered a DealHub solution to manage such a crucial area of the bank’s eCommerce business and provide the backbone for FX price distribution. We are seeing a marked increase in the number of banks and financial institutions wishing to either implement new or replace legacy e-FX trading infrastructures.”

Deutsche Bank db.com/FX

In challenging conditions, it pays to have the right partner in FX. Deutsche Bank delivers globally with market-leading expertise, innovation and insight. With new regulations and economic realities, uncertainty and change are ever-present. You need to be sure of the strength and reliability of your partner. Deutsche Bank – the right choice for all conditions.

World's No.1 FX Bank Euromoney FX Poll 2005 - 2010

This advertisement has been approved and/or communicated by Deutsche Bank AG London. The services described in this advertisement are provided by Deutsche Bank AG or by its subsidiaries and/or affiliates in accordance with appropriate local legislation and regulation. Deutsche Bank AG is authorised under German Banking Law (competent authority: BaFin – Federal Financial Supervising Authority) and regulated by the Financial Services Authority for the conduct of UK business. Securities and investment banking activities in the United States are performed by Deutsche Bank Securities Inc., member NYSE, FINRA and SIPC, and its broker-dealer affiliates. Lending and other commercial banking activities in the United States are performed by Deutsche Bank AG, and its banking affiliates. © Copyright Deutsche Bank 2011.

NEWS

smartTrade Technologies releases StudioAir™

S

martTrade Technologies has announced the release of StudioAir™, an advanced trading front end application and market data visualizer. The product has been built on the Microsoft .NET Framework and Microsoft Silverlight, a powerful development platform for creating engaging, interactive user experiences for Web, desktop and mobile applications when online or offline. StudioAir comes with several features for traders, including Market Data Views, Order Management, and RFQ processes. StudioAir is cross-asset and can be used for any product including FX, rates, equities, futures etc.

StudioAir can be easily customizable by an organization for a quick time-to-market implementation and has been designed for liquidity management. “smartTrade Technologies StudioAir has set new standards for advanced front-end trading applications, allowing our clients to navigate with a high level of security and ease of deployment. StudioAir is highly scalable and works with an organization’s existing technology,” said David Vincent, CTO and co-founder of smartTrade Technologies.

Vantage FX offers free Forex Strategy Builder

V

antage FX Pty Ltd, the Australian regulated margin forex provider, is now offering Forex Strategy Builder, a software for creating, testing and analyzing each client’s own trading strategies. The platform provides an easy way for building forex strategies by combining various technical indicators. Clients don’t have to be experts at writing formulas or have any programming skills. They are then able to test the profitability of their trading strategies and apply them to their live online trading experience. 12 | january 2011

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TMS Brokers plans to be listed

T

he last year for TMS Brokers has been a time of facing challenges and elaborating on the company’s development strategy, states, Mariusz Potaczała, CEO of the company. He says, “Once again our analysts were distinguished for Mariusz Potaczała the accuracy of the major currency pairs’ forecasts . It is worth mentioning that the TMS Brokers is the only Polish financial institution, that FX forecasts are ranked in the FX Week magazine. This year TMS Brokers also launched the new internet trading platform for our clients. The GO4X platform allows clients to invest on the currency and commodities market, as well as in stock indices contracts. As the new product is based on the MetaTrader software, TMS is the first brokerage house on the Polish market, offering two different trading platforms and FX advisory services dedicated to corporate clients.” TMS Brokers has also announced it has plans to be listed on the Warsaw Stock Exchange from January 2011.

Enter the world of

Hotspot FX

You’re invited. Come join the growing and diverse client base that has connected to Knight’s award-winning institutional FX ECN, Hotspot FX. Hotspot FX offers speed, robust technology and complete anonymity. Open the door to experience deep liquidity in over 50 currency pairs and exceptional service and support – now you’ve entered the world of Hotspot FX.

Find out what Knight can do for you To find out: phone Americas + 1.212.209.1420 | Europe +44 (0) 20.7997.7800 | Asia +65.6538.1489 email [email protected] www.knight.com

© January 2011 Knight Capital Group, Inc. All rights reserved. For additional information about Knight Capital Group, Inc. (NYSE Euronext: KCG), please visit: www.knight.com.

NEWS

Capital G Standard Bank collaborates Bank licenses with ClientKnowledge tandard Bank is believed to Spectrum be the first bank in Africa

B

ermuda based Capital G Bank, has licensed the Spectrum Treasury System from Financial Software Systems to manage its foreign exchange, money market and interest rate hedging activities. Capital G Bank is privately held and provides personalized wealth management services for personal banking, business banking and private banking customers. Spectrum is a comprehensive position management system for foreign exchange, money market instruments, fixed income instruments, equities and derivatives. Capital G Bank will use Spectrum to manage its FX trading activity and its Money Market and Repo activity. In addition, Capital G Bank will manage its Forward Rate Agreement and Interest Rate Swap hedging activity in Spectrum. Spectrum will provide Capital G Bank with complete front-office, middle-office and back office functionality, with true straight through processing of Treasury transactions from deal-capture in the front-office to producing general ledger accounting entries in the back-office. Spectrum is built on Microsoft’s .NET platform.

Dukascopy offers Spot Gold

D

ukascopy Bank SA has announced the launch of gold trading starting January 2011. The new instrument will complement the current list of 32 currency pairs on offer today. Trading will be available from Sunday through Friday on a 24H basis and available on all platforms including JForex and iPhone. 14 | january 2011

e-FOREX

S

to implement systematic FX liquidity management. This strategic move has already improved profitability, reduced transaction costs and reduced risk. The bank responded to an industry need for systems that effectively manage client flow by collaborating with ClientKnowledge. The advisory support and expert technical and quant development was undertaken by ClientKnowledge’s Managed Models team. By working in tandem with Standard Bank, connections to feeds and their client flow were established. Richard de Roos, Director and head of Standard Bank foreign exchange, said that: ‘Selecting ClientKnowledge to facilitate

Richard de Roos

this process was an important strategic decision. As experts in the wholesale financial services industry, ClientKnowledge has provided us with unique insight into improving our performance, efficiencies and our profitability.’

Gold-i offers Data Feed from Morningstar

G

old-i has announced it will launch the Gold-i Morningstar Data Feed adapter, enabling Gold-i clients to link the Morningstar Quotes Data Feed directly into MetaTrader. The Morningstar Quotes Data Feed offers MetaTrader clients over 160 different sources of content. Through the Gold-i Morningstar Data Feed, Gold-i clients will have access to exchange indices, futures and single stocks in addition to receiving Morningstar’s FX data. Tom Higgins, CEO of Gold-i commented, “We are delighted to be working with such a well-respected data provider as

Morningstar. Through this enhancement, MetaTrader clients will benefit from having a highquality data feed available that can stream up to 1,000 Tom Higgins symbols into MetaTrader in true real-time, with access to a wealth of content including equities, derivatives, treasury, and fixed-income data.”

Clients using FIX API will also be able to receive streaming prices in the new instrument. With its principle of equal trading rights for all participants, instant

execution on spot trades and its unique transparent ECN pricing model, Dukascopy Bank SA is looking for a strong entry with very competitive spreads.

NEWS

B2 RCP launches FAX2MT

F

X post-trade specialist B2 RCP, working with Neurosoft Ltd, has launched FAX2MT, a service for converting incoming client confirmation Faxes into fully validated SWIFT MT 3xx

Paul Burgess

series messages. Paul Burgess, CEO of B2 RCP, said, “Many of the world’s largest banks already use Neurosoft’s software to convert incoming Fax FX trade confirmations into SWIFT MT3nn series messages. Using our secure, financially regulated messaging hub in Luxembourg we are in the

Luxoft selects SuperDerivatives

S

uperDerivatives, announced that it has been chosen for internal deployment by Luxoft; a provider of advanced application and product development services, to manage the company’s exposure to cross-border currency risk. SD will provide Luxoft with SD-FX, the market’s benchmark solution for currency derivatives. The solution will provide real-time, independent pricing, analytics, post-trade deal management tools, risk and performance reports for the widest range of FX derivatives. “As the FX market continues to unique position of being able to offer this facility as a pay per use service. This means that banks, with fax volumes too low to justify the cost of installing the Neurosoft product in house, can simply send a Fax image or PDF file to the B2 Hub and receive a fully validated SWIFT message in return, significantly increasing their level of STP at a minimal cost.”

AFME establishes FXPB Group

T

he Global FX Division of AFME/SIFMA/ASIFMA has announced that it has formed a new working group to focus specifically on the challenges and issues surrounding Global FX Prime Brokerage and to implement OTC FX Clearing for clients. The participants of the new group, co-chaired by Citibank, Deutsche Bank and JP Morgan, comprise a number of the global Prime Brokerage firms which are already actively involved with the Global FX Division. Commenting on the new group, James Kemp, Managing 16 | january 2011

e-FOREX

Director AFME’s Global FX Division said: “As we build out the Global FX Division, it is becoming clear that there is real benefit in having a coordinated global body to respond to regulation and work to implement best practices and technology solutions for the FX clearing industry. We expect the new FX Prime Brokerage group to look at key issues such as client clearing models, ECN best practice and also to represent end client needs. We anticipate that we will be working closely with regulators and central banks.”

grow more volatile, we searched for a service that would enable us to improve our ability to use derivatives to accurately hedge exposure to fluctuations in foreign currencies,” said Roman Yakushkin, CFO Luxoft.

Panda launches Sync Server

P

anda TS has announced the launch of Panda Sync Server, a product which enables FX brokers to integrate and synchronize MetaTrader 4 with their existing proprietary systems. This eliminates the need to operate two trading environments, reducing cost and complexity. Panda Sync Server offers multi-way synchronization between MT4, other third-party trading platforms, and a broker’s proprietary trading system. Panda Sync Server does not add one more central system, it simply pushes MT4 data to the existing proprietary systems. Brokers can integrate MT4 or other third-party platforms, and deliver immediate value to traders, without affecting their business. Panda Sync Server is most suitable for top-tier FX brokers, which already offer MT4 as an additional trading platform without sacrificing scalability and agility.

Market perception.

Sharp execution.

To be a sophisticated participant in today’s FX market calls for intricate, highly developed solutions that can draw on pervasive market awareness and pinpoint execution. Solutions that can seize on the right opportunities and see them through, time and again. This level of transparency and control can give you a competitive edge to meet your best execution goals. We work tirelessly to help you reach them. As much through technological innovation as through rigorous execution — across frontiers, markets and time zones. That’s why Citi never sleeps. To start to put the best algorithmic execution strategies to work for you today, contact our CitiFX® Intelligent Orders team at [email protected].

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NEWS

FXecosystem introduces Cable 2.0

F

xecosystem has announced the launch of Cable 2.0. The new service provides a number of diverse TransAtlantic link options enabling clients to transact faster than ever before. The service has been designed to reduce latency, risk, cost and slippage whilst increasing bandwidth, flow, customer access, efficiency and price options. Cable 2.0 is fully integrated with the specialised FX Meet Me Room. Cable 2.0 provides users with greater bandwidth, consistent, quantifiable Round Trip Delay (RTD) over a fibre switched network (with a third diverse route coming soon). With current SLA times of 66.35 milliseconds on the primary route and 68.24 milliseconds on the diverse secondary route, no bandwidth restraints and no delta on RTD times, Price Engines

C Jon Vollamaere

and algorithmic strategies can be fine tuned to gain competitive advantage. “Our customers have the choice of selecting the most appropriate connectivity for their individual trading needs. Be that speed, bandwidth, cost, risk or efficiency. Our long and deep understanding of the FX market structure allows us to tailor solutions that bring real competitive advantage, not just an easy alternative” said Jon Vollemaere CoFounder of FXecosystem.

Advanced Markets launches new FX platforms

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dvanced Markets has launched two new FX trading platforms to accompany its widely popular Advanced Trader Pro platform currently used by traders around the world. “With three platform offerings you can choose which system fits your trading needs while still having Direct Market Access to top tier banks.” says CEO Anthony Brocco. The Advanced Trader Platform is a fully scalable GUI margin trading execution platform that is customized for the retail trader. The Advanced Trader platform provides: • Trading from charts • MQ4 scriptwriter • FIX, JAVA and C++ API connections 18 | january 2011

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Credit Suisse launches enhanced FXPB Platform

The Advanced Trader Prime system will fulfill the needs of banks, aggregators and professional traders. Advanced Trader prime provides: • Full available market depth • An Institutional trade blotter • Create pricing and liquidity streams The Advanced Trader and Advanced Trader Prime platforms will be available January 15th.

redit Suisse has announced the launch of its enhanced Foreign Exchange (FX) Prime Brokerage platform, facilitating global clearing and execution solutions to Hedge Funds, Asset Managers and other Financial Institutions. Key features of the enhanced platform include: automated trade capture and clearing functionality, new client reporting, a global service model solely dedicated to FX Prime Brokerage, a new exposure management and margining system, sponsorship to thirdparty electronic platforms and streamlined legal documentation. “We are focused upon providing clients with a market leading FX Prime Brokerage service which is underpinned by strong technology and high quality client service, leveraging the strength of Credit Suisse as a leading Prime Broker” said Paul Houston, Director and Head of FX Prime Brokerage at Credit Suisse.

FOREWORD

Derivatives, riding the next wave of regulation

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major change has taken place in the OTC derivatives market. The Dodd-Frank Bill came into law in July while the European Commission, in a rare synchronization, adopted similar regulations on derivatives in mid September. The financial industry, including ACI international lobbied heavily not to have the USD 53 trillion, FX derivatives market subject to the new regulations because foreign exchange is less complex than other derivatives and did not contribute to the financial crisis. Nonetheless, legislators have been of the opinion that they see no reason why there should be an exemption for the FX market. In the US, the Dodd Frank Act says that OTC FX derivatives will be regulated in the same way as swaps, unless the Treasury secretary, Timothy F. Geithner makes a written determination that they should not. Similarly in Europe, the task of identifying which types of contracts to be subject to a clearing obligation lies with the newly established European Securities Markets Authority. Manfred Wiebogen, President ACI The Financial Markets Association

Markets remain more interesting than ever. With so many evolving issues and more often than not all happening simultaneously, it is hard to keep count and to follow each developments. Yet the landscape, in which we operate and from which we make a living is changing fast. And as Darwin’s saying goes, those most adaptable to change will survive (and thrive).

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The outcome of this decision, will affect a market of FX forwards and swaps, which as shown in the pie chart, has reached USD 42 trillion by June 2010. However, given the political will surrounding the issue, the only reasonable expectation for banks may be to have short term forwards and fx swaps, e.g. of less than 183 days, exempted. The new regulations will come into force by the end of 2012, in line with the G20 commitments.

21% 31% FX Options $11153 Currency Swaps $16347

Forwards & FX Swaps $25625

48%

OTC FX Derivatives (Amounts in USD Billions)

What will change? The major changes for the OTC FX Derivatives market may be grouped in two. Firstly, swaps will have to be traded on a trading platform (Swap Execution Facility - SEFs) and cleared through a Central Counterparty Clearing House (CCP). Secondly, details about each derivative transacted will be reported by SEFs and stored in Global Trade Repositories. This data will be partially made available to the public, whereas regulators will have access to it in real time. Meanwhile, virtually all derivatives including foreign exchange will be considered as swaps. Additionally, exemptions will be narrow and limited to non financial entities hedging commercial risks up to, a yet to be defined ‘clearing threshold’. It is interesting to note that currently, there isn’t a single CCP in the world that clears OTC FX derivatives. However, authorities claim that should no commercial entity takes up this job, regulators do have the tools to make it happen. The pros and cons of the new regime being introduced, together with the envisaged risks attached,

were addressed in a past contribution of mine to this column. At this stage, more importantly, it is to early to comment on how one could start to prepare, for the changes. Clearing will be done through a choice of clearing houses. To mitigate credit risk, end users will be asked to put up an initial and a variation margin. This can easily add up to 5% of notional amount; therefore having a huge impact on the cash flow of the firm. Additionally, it is important to evaluate well one’s trading and workflow. In particular, the review of business processes for confirming, clearing and settlement. Finally, cleared trades will be settled through CLS Bank. This eliminates the most important risk in foreign exchange, which is Settlement Risk. To conclude, the recent financial crisis has only temporarily interrupted the growth of the foreign exchange market. The latest regulations, due to enter service by end 2012 may provide a similar blow to the volumes in FX derivatives. However and beyond any doubt, the FX industry will overcome the new challenges and continue to fulfill the needs and demands of its end users.

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Overcoming systemic risk: FX adapts to a new competitive OTC clearing landscape

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learing has always been considered as the jewel in the crown in the derivatives industry and if credit default swaps (CDS) and interest rate swaps are anything to go by then there is a likely to be a similar number of providers for clearing FX options. Indeed, CDSs and interest rate swaps seem to be a test bed for clearing FX OTC instruments as soon as there is regulatory clarity. OTC FX is considered the last frontier of noncleared asset class business and the debate has been a long running one. What is fanning the flames of the debate now is regulation – the Dodd-Frank act in the US and the regulation coming out of the European Commission – and that FX will be cleared. There is still uncertainty. Most accept that FX options will be cleared, but the final treatment of forwards and swaps, and the exact definition of a Swap Execution Facility (SEF), are still to be hammered out.

Frances Maguire

With clearing for credit default swaps and interest rate swaps already underway, Frances Maguire explores what factors will influence the likely providers of clearing services for FX OTC instruments.

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Shape of rules and regulations There are some strong clues in the Dodd-Frank act, however, as to the likely final shape and form of the rules and regulations. In essence, SEFs must be a many-to-many execution platform, which is also a self-regulating entity that polices for trade practice violations and manipulation, offers impartial access and extensive pre-trade and post-trade transparency. Combine this with the mandated link between clearing and SEF execution and you have what looks remarkably like a futures exchange.

>>> At present, the market is waiting for the US Treasury department to respond to the letter they recently received from the Association of Financial Markets in Europe (AFME), the trade body representing the FX market, regarding swaps and forwards. The US Treasury has until 15 July 2012 to exempt them – the rules do not have to be written until then – and it is expected that the CFTC will begin to publish draft rules shortly, as there are 243 to be written from Dodd-Frank act alone. In the EU, Patrick Pearson, head of financial market infrastructure at the European Commission’s DG Market, has stated that the EU will follow the US on swaps and forwards, and look to harmonise policy where there are mutual areas of uncertainty. ESMA, the body that will write the rules based upon-EMIR, which needs to gain approval of 27 Member States and the EU Commission, has until June 2012. Gavin Wells, consultant at LCH.Clearnet, says: “Whilst the market hopes to gain greater clarity soon, the formal dates for the rules to be written, based upon respective Regulations, are July 2011 and June 2012.” He adds that building capability to clear certain types of OTC products still depends very much upon the demand. “We would certainly look at clearing FX swaps if that was what our members wanted. We seek to provide the service that the market wants and build things in conjunction with our members. Clearly what our members are currently focused is what is clearly going to be mandated – and that is FX options,” says Wells. LCH.Clearnet has been clearing OTC swaps since 1999, clearing some 40 per cent of the global interest rate swaps market and in 2009 it became the first clearing house to launch interest rate swap clearing for the buy-side. SwapClear service is extending the range of currencies cleared from 14 to 20. From the first quarter of 2011, interest rate swaps (IRS) denominated in HUF, CZK, KRW, MXN, BRL and SGD will be clearable.

FX Options Clearing for FX options will go live in the second half of 2011. It will be a standalone service, which will clear European vanilla options. Initially the service will clear nine currency pairs out to two years. The number of currency pairs and maturity dates will be increased in subsequent phases.

Gavin Wells

“We would certainly look at clearing FX swaps if that was what our members wanted.” Wells said: “We are consulting and designing the service with a broad group of our members and we have spoken to both buy and sell-side. If clearing of FX options is mandated at the end of 2011, then all market participants will have to consider where they can clear, from day one.” CLS settles all physical settlement in foreign exchange and for FX options, the exercise of the option. Wells adds that whilst there are market participants that want to clear FX derivatives in general, across swaps, forwards and options, because of the benefit of mitigating counterparty risk, which they saw demonstrated after the Lehman’s default, in the increased spreads of the market, LCH.Clearnet’s focus remains on FX options. There is no discussion about clearing cash products, or spot FX. With around 75 per cent of the FX market transactions settled through CLS, settlement risk in the spot market is already largely mitigated, with little need to mitigate counterparty credit risk for the one or two day duration of spot contracts. Furthermore, the use of collateral across different assets is a service offered by LCH.Clearnet – i.e. you have excess collateral posted against your repos, and january 2011

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need more collateral for your interest rate swaps – the collateral is moved from one to the other. Some market participants have suggested that the next step is cross asset correlation. In this instance, risk is managed across assets using correlation measures / studies. However this is currently felt by many to provide an unacceptable level of concentration of risk and as such is not offered.

Other clearing initiatives On 18 October 2010, CME Group went successfully live with clearing for OTC interest rate swaps in dollar denominated products. An integral part of CME Group’s FX clearing, will be CME ClearPort, a series of flexible clearing services for OTC products across asset-classes. These trades are sent to CME Clearing from multiple front ends, whether from brokers or direct from clients that have hooked up to the APIs for direct market access. Derek Sammann

Since its acquisition of the New York Mercantile Exchange (Nymex) in 2008 (ClearPort was founded by Nymex in 2002) CME Group has used CME ClearPort for capturing OTC transactions in energy and commodities. The recent market and regulatory focus on CDSs and interest rate swaps has meant that CME Group has focused on this launch first, and now that this is live. Derek Sammann, Managing Director for FX and interest rate products at CME Group, says the exchange will now look at FX OTC with a view to launching in 2011. CME Group proposes to offer a post-execution clearing service to facilitate the clearing of any OTC FX position with maturities of up to five years. The product coverage will include FX spot, forwards, swaps, non-deliverable forwards and options. This post-trading clearing service, delivered through CME ClearPort, will be platform agnostic and integrate with existing foreign exchange market infrastructure. Given the scale and scope of interest rate products at CME Group, the interest rate business accounts for about 35-40% of the company’s volume, it was made a priority. Additional interest rate swap products will follow. According to Sammann, the exchange will initially focus on clearing spot, swaps, forwards, NDF and vanilla options. “FX is a little bit different than interest rate swaps. Interest rate swaps were clearly 24 | january 2011

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“It doesn’t make sense just to bring the capacity for clearing to one product. A customer that is trading forwards, is most likely also trading swaps, and probably options and spot FX as well.” mandated to be cleared after a certain date, generally believed to be July 2011.

FX Swaps Sammann says the CME Group continues to work on developing a clearing solution for FX swaps, and expects to launch an FX clearing solution in 2011. “We are trying to provide the best mechanism for the market to adopt, based on customer demand, which will entice players to use the service because it’s good for their business but many customers are waiting to see what the regulation will be with regards to mandated clearing, and what the scale of that mandate will be. We are talking to a broad range of buy-side and sell-side market participants and gathering their feedback to help us bring to market an FX OTC clearing solution.” According to Sammann, CME Group is in a unique position to other potential players in the FX clearing business because it already has a strong and growing global franchise in FX listed futures and options. “The FX OTC clearing solution will leverage the liquidity of our listed products and also extend the benefits of the central counterparty clearing mechanism.”

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LEADER

He adds because customers do not yet know what products they must clear in FX, CME Group is focusing on bringing the whole suite of FX products to market. “It doesn’t make sense just to bring the capacity for clearing to one product. A customer that is trading forwards, is most likely also trading swaps, and probably options and spot FX as well. If customers want to maximise the benefits and efficiencies from clearing we need to provide a service that covers the entire range of products within the asset class.”

Currency Futures Intercontinental Exchange (ICE) has offered the US Dollar index and currency futures pairs since 2007, when it acquired the New York Board of Trade. ICE Clear US currently clears 51 currency pairs and around 97 per cent of FX contracts cleared were executed OTC. Ray McKenzie, VP, sales, at ICE Futures, says that currency pairs are mostly traded bi-laterally, off-exchange, as Exchange for Physicals (EFPs). The currency pairs cleared by ICE are futures contracts, not OTC products. They are EFPs, which are better suited to the more illiquid currency pairs. This means the currency future is traded bi-laterally against an OTC trade. A spot trade is done versus a futures trade and then the spot trade is offset through the EFP on ICE. McKenzie says: “The difference between the ICE FX futures and competing currency futures is that they are quoted exactly like a spot product: they are not inverted. Most are $100,000 denomination. They are exactly like the OTC product, except that they are futures, with a future value date.” With the 2008 establishment of ICE Clear Europe, ICE is already well established in OTC clearing of energy products, and recently successfully launched clearing for credit default swaps (CDS), clearing $14 trillion in gross notional value of CDS transaction to date, and taking a substantial market share of CDS clearing. ICE Trust began clearing CDSs in North America in March 2009, and in Europe ICE Clear Europe launched CDS clearing in July 2009. 26 | january 2011

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The ICE OTC clearing service is also executionvenue agnostic and integrates with existing market infrastructure. More recently, ICE has extended its options’ technology, including user defined spreads and requests for quotes. McKenzie adds that ICE’s business model is geared towards offering clearing of products the way the customer wants to clear them, whether they are screen-traded and cleared through ICE or executed elsewhere. On the energy side, ICE Clear Europe clears futures and OTC swaps. In addition to futures traded on ICE Futures U.S., ICE Clear U.S. clears some agricultural swaps. He says: “Our vision is to clear as many asset classes as we can, based on customer demand. Currently we do not offer any cleared FX OTC products, but we are definitely looking at this space very carefully, and what we are hearing from the market place is that certain products, such as FX options, are very likely to be required to be cleared on-exchange.”

Increasing Volumes Volume in the ICE US Dollar Index, ICE’s fastest growing currency futures product, is up 400% to date. Many traders are starting to trade dollar index futures as an alternative to trading six separate currency pairs. The ICE US Dollar Index gives traders a pure dollar play against a basket of six currencies in a single trade. This U.S. Dollar Index is very liquid and is traded electronically. “We’re seeing a big demand to trade currencies in this fashion. It’s coming from both current members doing more business and additional numbers of proprietary traders, FCMs and retail traders from the equities markets. Institutional players also like the dollar because it is an established benchmark and replaces the need to trade forwards on six different currencies, using up credit lines, to cover risk in six currencies against the dollar,” says McKenzie. He goes on, “There are really two components of liquidity: there is how much is shown on the screen and how much is actually traded. In the dollar index there is tremendous liquidity: it is usually a half-tick

LEADER

2010 it led the way with the launch of a clearing service for OTC financial derivatives, again starting with clearing interest rate swaps, with nine bank clearing members. Muthukrishnan Ramaswami, president of SGX, says: “The launch of our new clearing service is a significant milestone for the financial services industry in Singapore. A first of its kind in Asia, the service provides clearing members, access to SGX’s central counterparty clearing service, reducing counterparty risk and enabling growth in OTC derivatives activities.”

Ray McKenzie

“Currently we do not offer any cleared FX OTC products, but we are definitely looking at this space very carefully, and what we are hearing from the market place is that certain products, such as FX options, are very likely to be required to be cleared on-exchange.” market most of the day. The volume of transactions doesn’t reflect exactly the amount of liquidity available. I think this is true of all products on listed exchanges. The OTC market in FX has got about 600 billion a day in spot turnover. This is the reason there has not been more trading on the futures in FX, as the OTC spot market is tremendously liquid.”

SGX AsiaClear offers clearing under Singapore Exchange Derivatives Clearing, the SGX clearing house for derivatives. Together with its clearing members SGX-DC performs the central counterparty clearing role, managing risk using its daily mark-tomarket and margining system. It is expected that SGX AsiaClear will begin clearing Asian FX forwards, currently traded in the OTC market, and non-deliverable swaps (NDFs) in the first quarter of 2011.

The race is on The race is on, in Europe, US and Asia, to see who will be the first to market with clearing for FX products, potentially a much bigger market than CDSs and interest rate swaps. It still remains to be seen whether other players join the fray with clearing for FX, but it is highly likely once there is regulatory certainty, given the size of the market. Any new competition is most likely to come from other derivatives exchanges.

And ICE is ready for such growth. McKenzie says its matching engine is one of the fastest futures platforms, with trades in micro-seconds in terms of processing speed. ICE also offers co-location, and is building out more capabilities to clear business in new asset classes in the future.

One likely contender is NYSE Euronext, which is currently building two new clearing houses, in London and Paris, due to go live in 2012. The move follows the creation of NYSE Liffe Clearing in 2009, which saw the exchange take clearing out of the LCH. Clearnet in-house. The two new clearing houses are being built to clear its exchange-traded products London will clear listed interest rate, commodities and FX products and Paris will clear equities and equities derivatives products – but NYSE Euronext also intends to extend clearing to the OTC markets.

OTC clearing in Asia Although it was not the first to offer OTC clearing, the Singapore Exchange (SGX) has become one of the principal exponents of OTC clearing in Asia. The exchange launched SGX AsiaClear in May 2006 to clear oil swaps and freight forwards and in November

Others are very likely to follow, as well as the number of different FX products cleared by these players, once established, is likely to grow, not only because clearing for OTC is a natural evolution of exchange-traded clearers, but also because FX represents for many exchanges, a wholly new asset class.

He believes the more transparent the FX market becomes, the more cleared products offered, the greater the growth. “I think volumes could double in the next three years as the market becomes more transparent.”

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Technology and growth: key trends in e-FX for 2011 As a new year begins, thoughts inevitably turn to what the next 12 months will bring in terms of new developments, old practices, areas of growth and markets under threat. In this article Nicholas Pratt interviews some of the industry’s leading consultants to try and identify key focus areas that are likely to have a profound effect on the development of the electronic FX marketplace during 2011. Some of these address age-old issues that are common to every asset class, although with clearly different properties and stresses. Other developments are unique to the FX world and reflect the very distinct path that electronic foreign exchange is forging for itself.

Algorithmic FX trading Algorithmic FX trading is a growing area but, according to Sang Lee, consultant at Aite Group, much of the development in 2011 is likely to centre on the attitude to and adoption of algos rather than the technical minutiae. “In terms of execution algorithms, I expect to see banks more engaged in providing algorithms for their clients. FX is still lagging behind other asset classes. Those FX traders that have been using algos for some time have by now developed their own but banks are seeing more interest from the more traditional FX clients who are happy to take the algos offered by their banking partners. “For corporates, FX is more of a by-product of their cross-border transactions. They trade less but at specific times and up to now they have been willing to pay a few extra pips to get their trades done. But as the FX market becomes more competitive they are looking to be more efficient in their trading and are looking at algorithms but have no desire to develop their own.” 30 | january 2011

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The algos that banks are offering to the traditional fund managers are first generation algorithms employing basic strategies like time-slicing rather than the more sophisticated investment algorithms. “The FX market is highly liquid and in the most prevalent currencies traders have always questioned whether there is any need for algorithms but this attitude is changing. They are becoming more aware of the quality of their execution. Previously they could afford to pay a few extra pips on their trades but market conditions are tougher. And there are also new entrants into the FX market that are more comfortable using algorithms. It is essentially a question of education.”

Aggregation and liquidity management Aggregation and liquidity management are very popular topics in the trading world but the terms can take on very different meanings in different asset classes. For FX aggregation means putting all liquidity sources in one view, be that physical (via a single screen) or machine (through an API). The popularity of aggregation is partly because FX is an asset class that is global and universal in terms of currency pairs but also available from multiple sources so traders want to see liquidity in the best possible format. But, says David Poole, chief operating officer and principal at Client Knowledge, a UK-based research, analysis and advisory firm for the wholesale financial services industry, aggregation brings up a number of questions technology-wise.”In the old days you could get prices from one source such as EBS but now the same prices are available from multiple sources. Before, when people talked about aggregation, they often referred to the interbank market but it is now trickling down to the smaller, regional banks because the technology is becoming cheaper and more standardised. So there are essentially three reasons – there are multiple pools of liquidity, the technology

>>> order to accurately price this liquidity, they have to have aggregation technology.”

Real-time risk management Risk management has become an area of greater focus across the capital markets and among all of its participants - from regulators to end investors to banks and brokers, so it is no surprise to see that real-time risk management solutions are much sought after in the FX market and look set to be an important development in 2011.

Sang Lee

“The FX market is highly liquid and in the most prevalent currencies traders have always questioned whether there is any need for algorithms but this attitude is changing. They are becoming more aware of the quality of their execution.” is cheaper and the initial inertia of the market to embrace aggregation is being overcome. But aggregation is only part of the technology for an effective liquidity management approach, says Poole. “As well as aggregating technology, you need to have real-time positioning, market data and P&L. you need CEP, underlying algos to help you manage the order and decide whether to be passive or aggressive. It opens up a huge number of variables but these have to be brought together in real-time and electronically.” When it comes to making specific purchasing decisions, it is dependant on the extent of the technology revamp that firms are willing to undergo, says Poole. “What do you want to achieve and how long will it take to do it? To make that choice, you have to analyse the benefit and not everyone is doing this because it is a necessity for some firms. If you’re going to do this, you need to have this technology. Margins are under pressure and spreads are coming down. The regulatory environment is changing and market participants will need to have more pre-trade transparency for audit purposes. Even at the top tier of banks there is a constant reappraising of technology, there are key liquidity providers (single banks) and in

“Risk management demands are going up among participants in the FX market,” says Sreekrishna Sankar, analyst at Celent. “This is having implications on the development of risk solutions.” One of these implications relates to the demand for real-time risk management services and tools. In such a liquid market as FX where there are so many transactions, the data demands for any real-time risk management tool are enormous and this is increasing the need for high-end data servers on the hardware side and, on the software side, creating yet another reason for the greater adoption of complex event processing (CEP) - a technology specially designed to cope with data“As well as aggregating technology, you need to have realtime positioning, market data and P&L. you need CEP, underlying algos to help you manage the order and decide whether to be passive or aggressive.”

David Poole

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intensive tasks that need to be carried out at high speed or in real-time. Another trend that Sreekrishna has seen is that corporates and other less intensive users of FX are adopting sophisticated risk management solutions as compared to the ad-hoc approaches of previous years. “Non-financial firms are responsible for 13% of market volumes and consequently this might be a big opportunity for risk and portfolio management firms in 2011 to sell their services to a whole new segment of the market,” says Sreekrishna.

Online currency derivative trading FX forwards have been around for years on the interbank market and most ECNs support them. It is the same with swaps. In terms of these being traded electronically, 2011 may see a marked increase, says Aite Group’s Lee. “Electronic trading has typically concentrated on the more standardised products - it is harder to automate complexity. “When you talk about e-FX, it tends to focus on the spot market but if you look at the latest BIS figures, the swap market is huge and as it becomes more standardised, it will make increasing sense to put these derivatives on an electronic platform to make execution more efficient and to reduce risk, particularly as the volume of trading goes up.” But there are limitations to any possible growth in electronic currency derivatives, says Lee. “The FX market is bilateral in nature and trades are done on an OTC basis. Regulation in the last year has centred on trying to reduce the number of OTC trades and to encourage central counterparties but for whatever reason, the FX market has been largely off the table and I can’t see it becoming more exchange-based.”

FX market data delivery Sreekrishna Sankar says that data and analytics have been identified by his firm as key areas of growth for 2011. “The trading volumes are growing and the provision of market data has become extremely important in FX, especially with the need for real-time risk management on the rise.” Not only will data and analytics offerings grow in number, they will grow in terms of their sophistication, says Sreekrishna. Data management is often the area that gets the most attention but, says Sreekrishna, this is just one side of the data market. “Data analysis and usage of artificial 32 | january 2011

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Sreekrishna Sankar

“Data analysis and usage of artificial intelligence-related techniques in order to handle the data in a timely manner will emerge as significant trends in 2011.” intelligence-related techniques in order to handle the data in a timely manner will emerge as significant trends in 2011. I also think that with the need for basic analytics also increasing, there is some chance that hosted data and analytics service in the same vein of what 1010 data provides for ABS may become more widely sought after.” What is more likely to occur though, says Sreekrishnar, is a progression from basic data services to more complex analytics offerings. “We feel that the trend will be for a move from simple data provision and primitive analytics to more sophisticated analytics.” In this progression, the aforementioned CEP will once more play a pivotal role. “CEP adoption is now moving beyond the top banks and the high frequency traders and is being seen in tier two banks and even tier three banks. These banks are looking at Portware or Streambase or similar providers to provide them with CEP frameworks.”

Low latency trade execution Seeking the lowest latency when executing has been a popular and much publicised pursuit in the equities world over the last few years. And while removing latency is an important objective in any asset class, it is less readily associated with the FX market. However,

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>>> “There is a lot that the FX world can teach in terms of rationalising the application processing chain, reducing the amount of time it takes to generate a quote, risk management protocols, messaging middleware and all the various ways that exist to remove bottlenecks that build up within the four walls of a trading firm. I also see a more constructive approach to building infrastructure in tandem with the application developers so the two teams are working closer together to ensure a holistic approach to addressing the latency challenge.”

Will Rhode

“I also see a more constructive approach to building infrastructure in tandem with the application developers so the two teams are working closer together to ensure a holistic approach to addressing the latency challenge.” according to Will Rhode, analyst with advisory firm Tabb Group, there are lessons that the equity market can learn from the way the FX market has sought to address the issue of low latency. “Low latency has to be looked at in a holistic way so not just the execution itself but also the application processing and the network,” says Rhode. “Whereas the equities world has focused very heavily on execution, this is not the case in the FX world. In FX there is not a localised market and there are no execution venues in the same way there are in the equities world, so the greater challenge in reducing latency is on the network side and the easiest problem to solve is on the application processing side.” Consequently, FX firms have been very innovative in ensuring that their quotes are streamed as quickly as possible in order to generate market share as opposed to ensuring as fast a path to and back from the execution venue – which has been the main focus of equity trading firms. In 2011, says Rhode, we can expect to see a crossfertilisation of these opposing strategies and a sharing of ideas between FX firms and equity traders. 34 | january 2011

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The equities world has hitherto hogged the headlines when it comes to reducing latency but this could change in 2011 suggests Rhode. “Banks in the FX world have done a pretty good job in terms of garnering market share through an efficient Quote streaming capability and FX is a complex asset class in this respect. All quotes are contingent on credit and the process of margining and there are several applications involved. So the FX market has had to be ahead of the curve.” The low latency challenge could also see increased involvement from hedge funds, says Rhode. The high frequency trading firms have invested heavily in reducing the latency in their own application processes, largely because they have little or no control over the latency of the trading networks and pipes that they use. And in these times of reduced investor redemptions, a number of sell-side banks are investing capital in these hedge funds in return for their expertise on reducing latency.

New technologies in FX It is difficult to overestimate the role that technology has played in the growth of the electronic FX market, particularly the development of web-based technologies. More recently the technology world has given us cloud computing – an evolved version of the hosted solution where software and hardware services can be stored, accessed and maintained in secure online environments. And while cloud computing may be more widely used in the FX market in the future, much of the focus for 2011 will be on the use of another relatively new technology – complex event processing (CEP). CEP has been used in other asset classes, particularly equities, but is particularly useful in FX and is becoming a standard feature on FX trading desks, says Stephen Bruel, a research director in the securities and investments practice of US-based consultancy

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into the CEP market, however for the established providers there is likely to be a big increase in demand. There is a clear speed component to CEP and every market, not just FX, is moving faster all the time.” The drivers are evident on the pre-trade side, in execution and on the post-trade side, says Bruel. “On pre-trade, CEP allows for dynamic pricing which is a risk reduction tool. On execution, CEP enables you to source quotes very quickly and to gain a competitive advantage. And on the post-trade side, CEP enables you to have better monitoring of your trades. So CEP is changing how traders view all of these areas. This is the big trend that we will see in 2011- the diversity of use for CEP. It was previously thought of as an algorithmic tool for execution but we are seeing new uses beyond simply a decision tool.”

Stephen Bruel

“On pre-trade, CEP allows for dynamic pricing which is a risk reduction tool. On execution, CEP enables you to source quotes very quickly and to gain a competitive advantage. And on the post-trade side, CEP enables you to have better monitoring of your trades.” TowerGroup. “FX lends itself very readily to CEP because of the large amount of liquidity, streaming quotes and the issues around counterparty risk arising from the lack of central counterparties. So CEP is a logical choice. “In the FX space, people are starting to look at how CEP can be used to generate alpha. FX has often been considered as a commodity asset class that is used on the back-end of an equity trade but the pure FX dealers have always seen the potential in FX for generating alpha and now other FX participants are starting to look at it differently. So the technology is allowing more sophisticated FX trading and the participants are themselves becoming more sophisticated in their outlook and strategy.” Sybase, Aleri, Progress Apama and Streambase are the main providers in the CEP market and although other technology firms are looking to break into this lucrative area, Bruel expects the existing providers to dominate. “It is not an easy technology to replicate so it is not likely that we will see too many new entrants 36 | january 2011

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Retail FX The retail FX market has grown enormously in recent years, due in part to the increasing availability of electronic, web-based trading. However, there are signs that the relentless acceleration of growth is beginning to slow, says David Poole of Client Knowledge, and this is leading the various platform providers in this space to search for new ways to expand. “The retail FX platforms are looking to get volume from outside of the retail market. They have a sophisticated and innovative pricing technology but there is a feeling that under the traditional business model, the accelerated growth of the last few years is slowing and they need to look for new sources of volume. For example, it takes 1,000s of retail clients to equal the volume of a large institutional client and also there are regulatory changes such as the increased margining requirements in the US retail market, so it is less certain that future growth can come from the pure retail space.” There is some overlap between retail FX and wealth management and this is where many banks are looking for new business, says Poole. “Retail banking is all about building a clientbase and acquiring clients is an expensive business so if it is possible to extract more business from existing clients, then this is an attractive option. Another possible avenue for growth is to integrate the FX business with other asset classes, such as equities or fixed income and enshrine it as part of a cross-asset class offering for retail clients.”

Regulation There are always two aspects to regulation – the first is from a market point of view and concerns purely

Technology and growth: key trends in e-FX for 2011

the economic impact of trading; the second aspect involves the political element of regulation. To some extent regulation represents an opportunity for politicians to be seen to be doing something about the more topical aspects of the financial markets. In this regard derivatives are at the top of the pile. The FX market, however, has largely escaped the political side of regulation, says Peter D’Amario, managing director of the European division of FX consultant Greenwich Associates. “The FX market should absolutely be treated more lightly because it is large and transparent and this renders it exceedingly difficult for market participants to get away with anything. This does not mean the FX market is immune to politically motivated regulation, either directly or indirectly, says D’Amario. “There is a danger that over-regulation in other areas could have a negative impact on the FX market by making it harder to trade and by creating more instability.” “There is a danger that over-regulation in other areas could have a negative impact on the FX market by making it harder to trade and by creating more instability.”

For electronic FX though, regulation could have a very positive impact in terms of encouraging greater adoption. “The electronic FX market represents the ultimate in transparency. Many client users of FX have to prove that they executed at the best possible price and electronic trading produces a ready-made audit trail. So it helps to keep traders on the straight and narrow. “Consequently if 2011 produces the glut of regulations that many people are expecting, even if most of them concentrate on derivatives and equities rather than FX, providers of electronic trading services and tools could be one of the few beneficiaries of closer regulatory scrutiny and greater demand for transparency.”

Emerging and frontier markets It is always somewhat challenging to make definitive statements on the emerging markets and it is no different with electronic FX, says Peter D’Amario of Greenwich Associates. “The use of e-FX outside of the major markets is still in its infancy. As recently as three years ago, there was hardly any use of e-FX but logic suggests that it will take off at some point and we are seeing some evidence of this. For example, by the end of 2009, 46% of all large FX traders in Asia were using e-FX, up from 42% the previous year which is a meaningful increase. However, there is a bias in Asia between the highly developed markets such as Australia, Japan, Singapore and Hong Kong and the less developing countries such as Taiwan and South Korea where there is less use of e-FX. Generally though the picture is one of steady growth, says D’Amario. “We are seeing the developing markets adopting e-FX at a similar rate to what we witnessed with the developed market five years ago. This is often the case with the emerging markets and technology – that it lies five years behind the major markets – but there are other factors to consider.

Peter D’Amario

“The sophistication of users in these markets is sometimes a hurdle as is the quality of infrastructure. Even the most advanced trading firms still need broadband speeds and virtual private networks if they are to adopt electronic trading. In many parts of Eastern Europe and Latin America, the telecoms systems are nothing to write home about but we are seeing developments in these areas and eventually all of these hurdles will be overcome.” january 2011

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Shifting demand for Single-Dealer Platforms Similar to the listed markets, the OTC market has also undergone fundamental changes over the last decade. Much of those changes have been around increased pressure on improving market transparency and price discovery mechanism as well as on minimizing overall risk. A core driver of these changes has been adoption of electronic trading in pockets of the OTC market. While most of the OTC market remains a manual market driven by bilateral relationships, non-standardized contracts and trading details, a growing percentage of the more liquid part of the OTC market has fully embraced electronic trading.

Sang Lee is Managing Partner of the Aite Group

Having access to hard-to-get information and supporting a minimal level of market transparency has traditionally been a highly profitable combination for major dealers in the over-the-counter (OTC) market. While the listed equity and derivatives markets may garner much of the public’s attention, the real money has always been in the OTC market, where global banks and dealers can use various levels of risk to create lucrative markets with fat profit margins. Unlike in the listed markets, where agency-based trading has become the norm for most banks, the OTC market is driven by principal trading, in which major banks leverage their balance sheets to take risk positions against a diverse group of client segments. In exchange for taking the risk, however, participating dealing banks expect much higher profit potential.

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Significant adoption of electronic trading has taken place over the last decade, especially in the FX and fixed income markets. Both markets feature a vibrant inter-dealer market and a rapidly growing client-todealer market. While both markets have experienced robust growth in multi-dealer platforms in order to handle customer interactions, the FX market has experienced active adoption of single-dealer platforms until recently. There seems, however, to be a major shift occurring in market demand for single-dealer platforms beyond the FX market, driven by various customer segments’ need for asset class diversifications and the need for banks to fully support the demands of their customers. This article examines burgeoning single-dealer platforms with a focus on the FX market and highlights strengths and weaknesses of single-dealer platforms.

>>> Market overview The constant push and pull between voice and electronic trading continues across all asset classes. In the OTC market, where the profit margin per transaction happens to be much higher than in the exchange-traded market, the implementation of a socalled “hybrid” approach has been widely accepted for many years. In markets where products have become commoditized with high levels of liquidity and lower profit margins per trade, electronic trading has been fully embraced by even the dealers themselves. Those markets with complex deal structures and relatively low levels of liquidity, on the other hand, remain heavily voice and manually driven. Figure 1: Electronic vs. Voice

As the OTC market continues to evolve and change, so does the typical trading profile of specific products, leading to customer adoption of the hybrid approach to accommodate both electronic and voice trading. Within the OTC electronic trading market, customers have three options: • Multi-dealer platforms (MDPs): Very popular with certain cash fixed income products (e.g., U.S. treasuries) and FX, multi-bank platforms help customers gain access to multiple liquidity sources using a single point of access. While most of these multi-bank platforms started with a basic RFQ (request for quote) price discovery mechanism, more liquid markets, such as FX spot, real-time, and executable streaming prices, have been implemented to mimic what one could expect from equities alternative trading venues. • Single-dealer platforms (SDPs): Single-dealer platforms are owned and operated by a single bank and provide not only execution services related to multiple asset classes, but also posttrade support, research, market data, and access to multiple asset classes. • Inter-dealer platforms (IDPs): Inter-dealer platforms have also opened up to the customer market in recent years, but only for those actively trading firms that function more like a dealer than like a liquidity-taking customer. Traditionally speaking, inter-dealer platforms cater to dealers only; that said, we have seen customers enter the market in certain products such as FX and liquid cash fixed income. The single-dealer platform is clearly not the only way for customers to gain access to liquidity and

Source: Aite Group

other bank-provided products and services. In fact, single-dealer platforms represent a very small percentage of client-to-bank interactions in certain products. Starting with FX and cash fixed income, however, the single-dealer platform is growing and threatens to become one of the dominant methods of communication for customers. As OTC trading volume continues to grow and electronic trading becomes more commonplace among less liquid products, adoption of single-dealer platforms is expected to grow even more. In addition, the increasing sophistication of large banks’ ability to segment their customer base has led to further development of single-dealer platform capabilities.

Evolution Customers have many different options when it comes to interacting with their banks. More traditional methods of communication include phone conversations and in-person meetings. Electronic communication can also take many different forms, including e-mails, instant messaging, multi-dealer platforms, and single-dealer platforms. Within this context, single-dealer platforms are natural extensions of a bank’s communication with customers and prospects, and those banks that have invested heavily into their single-dealer offerings have benefitted greatly in recent years in terms of customer retention and revenue generation. Key components From a technology perspective, many different components make up a robust single-dealer platform. A self-sustaining single-dealer platform is composed of connectivity to customers and third-party venues, market data distribution system, pricing engine, credit/margin platform, risk management application, january 2011

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and other middle- and back-office applications to both serve customers and manage the banks’ risk portfolio. The heart of the platform is the pricing engine, which needs to be flexible enough to manage and distribute varied rates depending on customer tier and execution venues. Connectivity to customers and third-party execution venues are also important, as is the ability to formulate a comprehensive, aggregated, real-time picture of the global FX market. One major issue with single-dealer platforms is that they were typically developed to serve a single asset class. As a result, it is common to find multiple platforms that banks currently maintain to support their customers across multiple asset classes. While most banks have developed a single customer interface on top of the multiple platforms that they currently manage, it is not uncommon to find the interface to have inconsistencies across different business units as well as require multiple sign-ons.

Disparity across asset classes Despite growing adoption of single-dealer platforms in the OTC market, a substantial disparity exists across asset classes. The FX market represents a clear success story with a significant level of adoption, currently estimated at 36% of the client-to-dealer market. In comparison, multi-dealer platforms have lost market share over the last few years. As banks continue to refine their internalization capabilities, overall growth of single-dealer platforms is expected to continue at the expense of traditional venues (e.g., EBS and Reuters) and voice business. Leading singledealer platforms in FX would include major FX banks such as Deutsche Bank (Autobahn FX) and Barclays Capital (BARX FX).

>>>

• The diversity and complex nature of products within the fixed income market; • Lack of liquidity in most fixed income products; • Continued dominance of voice trading; and • Strong adoption of multi-dealer platforms, such as Tradeweb and MarketAxess. Despite the existing obstacles to adoption, banks have become more active in recent years in building up their fixed income single-dealer platform capabilities to move beyond research and analytics to include transaction capabilities. The focus is especially prominent in the rates market.

Benefits of single-dealer platforms The launch of multi-dealer platforms made sense for the OTC market for many reasons. First, instead of calling four to five dealers for prices using an RFQ mechanism offered by multi-dealer platforms, customers were able to gain access to multiple live prices via a single connection.Secondly, pitting dealers against other dealers for customer business also gave multi-dealer platforms the positive effect of putting downward pressure on pricing. Finally, by comparing multiple quotes at once, multi-dealer platforms also provided customers a complete audit trail of data that can be used to justify best execution. On the negative side, multi-dealer platforms are typically single asset class-centric, meaning that customers would need to access many multi-dealer platforms in order to trade various asset classes on multi-dealer platforms. In addition, depth of liquidity and competitive pricing are big question marks, especially in venues with low levels of liquidity. Still, multi-dealer platforms have played an important role as one of the essential distribution channels for banks over the last 10 years. Single-dealer platforms too have become a vital part of the overall electronic distribution strategy of banks seeking to reach and build relationships with customers. For banks, the following facets of single-dealer platforms highlight the importance of operating them:

Figure 2: SDP Adoption in FX Source: Banks, Multi-dealer platforms, Aite Group

On the other hand, single-dealer adoption in fixed income has until recently struggled for various reasons: 40 | january 2011

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• A single point of interaction with clients: Probably the most important facet is the fact that single-dealer platforms enable banks to communicate directly with clients (if done correctly, that is, through a single interface across all of their major business units). While multi-dealer platforms continue to be an

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important channel for customer interaction for individual banks, a robust singledealer platform can minimize the potential disintermediation that can occur between the bank and its customer. Deepening relationship with clients: By capturing and analyzing the way customers interact within the single-dealer platforms, banks can develop a full profile of their customers and help deepen their relationships. Internaleffi ciency: By creating a truly integrated single-dealer platform with single sign-on capabilities that provide access to all of their major business units, banks can capture internal efficiency and fully leverage the internal IT assets they have developed. Speed to market: Single-dealer platforms can help banks quickly launch new products and services for customers. Relying on third-party venues such as multi-dealer platforms can run into the third-party venues’ own development queue, which may not coincide with an individual bank’s customer demands. Increased ability to customize: Single-dealer platforms can also help banks customize services and products for different types of customers. For example, for price dissemination, banks can choose to provide the RFQ mechanism for its corporate customers or streaming real-time live pricing for more actively trading customers.

For customers, single-dealer platforms provide the following advantages: • Deeper pools of liquidity: Most customers will find that going directly to the source of liquidity via single-dealer platforms will lead to deeper pools of liquidity as banks will have more flexibility in terms of showing different levels of price. • Single point of access to multiple asset classes: Customers can potentially have a single point of access to liquidity of multiple asset classes instead of relying on multiple platforms. • Access to value-added non-execution services: Customers can gain access to vital nonexecution services, such as research, analytics, and cross-margin services, by leveraging singledealer platforms. • Improved customer service: If executed properly, customers can expect enhanced

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customer service via a single-dealer platform; banks will have a better understanding of an individual customer’s basic requirements based on information captured through past interactions. A single-dealer platform allows banks to respond much more quickly and with customized services to ensure the needs of customers are met in a timely manner.

Conclusion As OTC markets continue to grow and present customers with increasing complexity, banks have relied on developing multiple distribution channels to ensure that a wide variety of customers can efficiently access different products and services. Single-dealer platforms are a crucial component of this multi-pronged approach, along with multi-dealer platforms and more traditional methods such as phone and in-person meetings. As one of the banks interviewed for this report intimated, banks would need to adopt smoke signals if customers wanted to communicate through them. While obviously made in jest, the statement emphasizes the importance that banks develop and maintain customer relationships through many different means. Single-dealer platforms have come a long way since their inception, typically starting as an informational platform. In the FX market, single-dealer platforms have become the most dominant form of transactional channel. While still lagging behind, single-dealer adoption in the fixed income market is gradually gaining traction. Aite Group expects that IT spending in single-dealer platforms at the end of 2010 will be US$1.5 billion. As regulatory

Figure 3: Estimated IT Spending on SDPs Source: Aite Group

changes push the OTC market toward more structure and enhanced transparency, the role of single-dealer platforms will no doubt increase, ensuring that banks can continue to develop and maintain long-term relationships with customers in an increasingly volatile and uncertain marketplace.

FEATURE

Single-dealer platforms: staying ahead in the FX game numerous factors driving clients to single-dealer FX platforms. “Firstly there is the speed and reliability of execution which are more critical factors than price in a liquid market like FX. Then there is the ability to execute more complex trades and the ability to set up multi-leg trades. Integration of research and technical analysis is also more easily supported through a singledealer platform – this includes both the contribution of a trade idea and also the analysis to support when exactly a pre-determined trade should be executed to maximise profit and minimise market impact. And single-dealer platforms are rapidly catching up with or even overtaking multi-dealer platforms in terms of post-trade processing, allocations and straightthrough-processing.”

By Nicholas Pratt

The electronic FX market started to develop back in 2000 with the launch of a number of multidealer trading platforms or portals that exploited the development of online and web technology to enable traders to see multiple prices on one screen and to execute on these prices electronically. At the same time as contributing to these multi-dealer portals, banks were also busy developing their own single dealer electronic platforms. Nicholas Pratt examines why the value proposition of these single-dealer platforms continues to strengthen for many trading firms and FX buy-side participants.

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en years after the arrival of electronic FX, banks are continuing to invest in their singledealer platforms which have been enjoying a resurgence of late. According to Paul Caplin, chief executive of Caplin Systems, a provider of e-commerce technology for use in single-dealer platforms, there are 44 | january 2011

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Unsurprisingly it was the established FX banks that first realised the potential of single-dealer platforms and built powerful engines that have done very well. However, says Caplin, as client delivery of trading services has become more important and as the technology in this area has improved, it has given new entrants an opportunity to challenge the established banks. “It is entirely possible for a relative newcomer with a reasonable budget and a clear focus to produce a very compelling offering.”

Focus on client service Although it takes time to build market-share, Caplin says that the renewed focus on client service that is evident across the capital markets does present an opportunity for ambitious firms to establish a roster of new customers. “And in the FX world there has been rapid growth in the number of users, particularly in retail FX trading, and they are the ones demanding a greater level of service and functionality.” In order to meet these demands, a single-dealer platform provider will have to invest enough time and resources in taking its offering to the next level, which means ensuring that it can be tailored to meet the specific preferences of different customers, says Caplin.

>>> “On the retail side we are seeing a demand for more research-driven FX which starts with a number of trading ideas and then allows the client to pick one from the screen, read the relevant research notes, perform technical analysis, engage in on-screen and real-time dialogue with an advisor and then automatically populate a trade ticket.” Alternatively a single-dealer platform may also have to cater for the contrasting corporate customer who has a series of payments that have to be made and is looking for a series of currency hedges and an efficient way to process these trades. “These are two different trading objectives but they can be serviced through the same system,” says Caplin. “This has been made possible by improvements in front-end technology and a rapid development environment that can produce a different look and feel for two different users of the same system.”

User experience Caplin refers to the emergence of user experience (UX) design, which is helping front-end users to have a more involved role in the development of user interfaces. “It used to be that the user interface was designed by programmers, which was perhaps why they tended not to look very nice. And banks used to think that users didn’t care what their interface looked like but all the recent research indicates that they do. So now we are seeing not just graphic designers joining the development teams but also UX designers who are able to analyse users’ behaviour.” The design element could be particularly important for the next area of development for single-dealer platforms that Caplin foresees – mobile platforms. “We have seen some iPhone applications in the FX area but what the banks are very serious about is the iPad and other similar devices. They see these as must-have platforms. It is not so much about the ability to execute on these devices but using them as a way of staying in touch with the market and being able to keep an eye on positions and breaking news at all times.” For some, the recent success of single-dealer platforms is down to market conditions. For january 2011

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client’s desktop so they can build in client-specific logic that ensures they get a lower rejection rate and more targeted pricing.”

Benefits The most important benefit of a single-dealer platform, says Geaney, is the enhanced relationship. “Up until a few years ago there were several banks that did not have a viable, single-dealer platform to offer their customers. But now we have seen a lot of banks come out with new and improved offerings and new ideas and there is no better way to have constant contact with your bank than trading on their singledealer platform.”

Paul Caplin

“It is entirely possible for a relative newcomer with a reasonable budget and a clear focus to produce a very compelling offering.” example, the credit crisis created an opportunity for banks to promote their single dealer FX trading platforms and when credit was very constrained, banks could exercise more influence over where their clients chose to access liquidity and direct them to their own single-dealer platforms, says Justin Geaney, who works in the e-commerce foreign exchange team at Citigroup Global Markets. “The single-bank platforms offer a number of savings that are not available in the multi-dealer platform environment. For example, there are no brokerage fees with a single-dealer platform or additional fees that are charged to the bank, and many banks then build this into the price they show their clients.” Additionally, banks can generally cover flow on their own single-dealer platforms much better than on any other channel. “It is their technology, they know how it behaves and they understand the algorithms working in the background used to hedge transactions. There is also less latency because there are fewer hops. And the banks own the applications that sit on the 46 | january 2011

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These improvements have focused on areas such as speed of execution, says Geaney, which has been driven by two factors. “Firstly you have more players in the market so your platform’s performance is being benchmarked against more venues than before. More importantly though is that firms became more sensitive to the efficiency of the post-trade process because the of credit crisis. If there were any delays in updating a client’s credit status, positioning or risk metrics this would be a big issue. So banks have spent a lot of money on improving the straight-throughprocessing in this area.” Direct connectivity to single-dealer platforms has also improved says Geaney. “Everybody these days has FIX but the way that we provide liquidity over FIX has certainly improved. Previously banks would provide single tiers of their order book, then this became selected tiers and now a few banks, Citi included, can offer clients a much more flexible FIX solution and they can send in requests for a set of dynamic tiers of an order book. Liquidity can fluctuate between tiers and clients can get a real-time and transparent picture. The demand for real-time risk metrics and posttrade analysis tools has been driven by a decreased risk appetite among clients, says Geaney, particularly within banks. “Previously it used to be much easier and much simpler to provide clients with a line of credit. Most banks would have a single, flat margining rate across all of their currency buckets. But the world is now much more sensitive to credit provision and it has become a more complex world and harder for clients to calculate their margin rate.” He goes on, “Some banks are still not able to provide their clients with a constantly updated calculation

FEATURE

of their margin rates and their positions and clients are increasingly sensitive about this. Regulations are not yet calling for this information to be made available in real-time but it is something that could happen and this is putting added pressure on the banks to improve in their provision of real-time risk metrics and positioning information.”

Tailored offerings Another advantage that single-dealer platforms hold over their multi-dealer counterparts is the ability to tailor their offerings to match different client segments. “If a client is trading on a multi-bank portal they get what they are given,” says Geaney. “At Citi we are pretty good at knowing whether a client’s demands are viable and also whether these demands may be useful for other clients or other client segments because it makes sense to incorporate these new services across the organisation whenever possible.” Geaney points to the example of uploading client orders. “We can do this on a specific basis but because we have a global client-base we can usually find synergies where it makes more sense to create a series of templates that will work with multiple order books and not just single clients but also gives the clients a more tailored service than a simple one-sizefits-all approach.” Despite the clear advantages that single-dealer platforms potentially offer banks, there is a significant investment required if they are to remain competitive in an increasingly crowded market, or if they are to try and dislodge any of the established incumbents in the market. “In terms of our FX technology budget, our single-dealer platform would be in the top level of investment,” says Geaney. “We have been in the market with Velocity for just over 2 years, but our behind-the-scenes pricing technology has been around significantly longer. Our overall client solution is very mature but we are constantly tweaking it in line with new client needs, and we are now ready to take that next big step. A lot of our competitors are bringing out new systems but it is always a balance of the time to market and the quality of system. We are seeing other banks bringing out an 48 | january 2011

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Single-dealer platforms: staying ahead in the FX game

interim solution that is more or less off-the-shelf but we know from experience that it takes three to four years to develop a fully functional, high quality system.” There is also, of course, the fact that the FX market is known for the strong and loyal relationships between buy-side firms and their FX banking partners with which many firms will conduct almost all of their FX business. So what is to say that these same firms will not similarly direct all of their electronic FX business the same way, regardless of the quality of the bank’s single-dealer platform? “The decision will never be based on the system alone and where you have two systems that are very similar, then the relationship will be a factor,” says Geaney. “But you have to look behind the system and a lot of the success is down to the quality of the sales people and the ability to get in front of clients.” “Some banks are still not able to provide their clients with a constantly updated calculation of their margin rates and their positions and clients are increasingly sensitive about this.”

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Changing client requirements Clients’ requirements are constantly changing and the key for any bank with a single-dealer platform is to invest in the right technology to keep up with these changing requirements, says Mark Burroughs, executive director, FX e-commerce sales at Nomura. “Clients still value relationships and single-dealer platforms can deliver the bespoke offerings that so many firms are looking for. I don’t think a one-size-fits-all approach works in today’s market. We are seeing increasing requirements for pre-trade, trade and post-trade workflows to be integrated with research, live market commentary and, above all, consistent pricing.” There are more multi-participant platforms that are catering for the growing number of non-bank entities in the FX market, and, says Burroughs, one would expect some clients with lower requirements to move to these platforms. “But we continue to see volumes on single-dealer platforms grow rapidly as clients are seeking stability and consistency in the current market conditions and turning to the single-dealer platforms to find this.” As for whether the single-dealer platforms have had to undergo a step change in the speed and transaction processing capabilities that are on offer in order to compete with the multi-dealer platforms, Burroughs says that Nomura’s platform has always sought to be strong in this area. “Speed, reliability and the ability to process transactions efficiently are all things that our clients expect from day one.” That said, there are probably some banks that have been using older technology for some time or have been white-labelling platforms and technology from more commoditised sources, says Burroughs, and have had to revamp this in order to protect their franchise. “I think in the last couple of years these banks have had to improve things because clients’ expectations have risen and there is increasing competition in this space.” Clearly the benefit of multi-dealer platforms is that trading firms are able to see multiple bank prices on one screen and without having to support a range of single-dealer platforms. But for those firms that favour single-dealer platforms, are they relying on just one bank’s platform or using a number of different bank offerings?

Justin Geaney

“We do not see many clients these days with multiple single-dealer platforms on their desktop and trying to january 2011

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juggle them all” says Burroughs. “Many of these type of firms have moved to aggregation services. But we like to think that our clients like the functionality and performance of our platform and value their relationship with the bank and are rewarding us by putting most of their business through our single-dealer platform.”

More flexible connectivity Single-dealer platform providers are also having to invest on meeting the demands for more flexible and direct connectivity options to their platforms. “There are a whole host of different protocols out there for both liquidity provider platforms and liquidity takers and we need to be able to connect to them all very quickly. There are also a number of clients that have developed their own internal trading systems with their own protocols and specifications so the technology team spends a lot of time developing the best way to connect to and work with these systems,” says Burroughs. The development of the FIX protocol is making this connectivity an easier thing to achieve, however, a lot of the internal systems used by trading firms are based on internally developed algorithms that exhibit precious little standardisation or flexibility creating farmore work for the single-dealer platforms. However as standard protocols such as FIX become more ubiquitous and as trading firms realise the benefit of standardisation and the economic merits of a streamlined operational set-up, connectivity is likely to become less of an issue in the long-term. A lot of effort has also been made by single-dealer platform providers to improve client access to real-time risk metrics and non-generic trade information, says Burroughs. “There is a lot that goes into building the relationship with clients, such as providing them with access to research and trading ideas. With a single-dealer platform this information can be provided in real time which is something that clients value and helps to attract more trading volume on the single-dealer platforms.” A lot of clients already have the real-time risk metrics built into their own trading platforms. But pre and post-trade analysis tools that

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attractive to clients,” says Burroughs. We can also expect to see more integration between the execution applications of single-dealer platforms and the payment and cash management systems of clients, says Burroughs. “There is definitely room for more efficient work-flows in that area. There is a growing demand from money managers for aggregation and execution tools provided directly by their order and execution management systems and banks are continuing to offer more in the pre and post-trade space with analysis and reporting so it is becoming more compelling for money managers to look for direct execution from these type of venues because these tools are not available from multidealer venues.”

Levels of investment

enable them to look at how they trade with a bank is something that clients are increasingly interested in and something that single-dealer platforms should be looking to provide, says Burroughs.

Keeping pace with all of these developments necessitates a significant level of investment and raises a question about how many banks are able to maintain the commitment needed to remain competitive in the single-dealer platform space. “At Nomura we have around the clock client coverage combined with continuous information flow and the technology needed to do that involves substantial investment. Competing on price alone is no longer an option and everyone in the top tier has similar G10 currency coverage. So we think the key to success is the provision of advanced risk management and pricing models. We have seen a lot of banks move into the single-dealer platform space and have attracted significant flow but I think any bank that does not invest in their pricing infrastructure and risk management will struggle to monetize any flow that they manage to capture,” says Burroughs.

Single-dealer platforms also have to cater for the varied client-base that many of them attract. Much of this tailoring takes place on the front-end and fortunately technology known as rich internet applications (RIA) are enabling banks like Nomura to address these concerns. “We use Microsoft Silverlight which allows us to deliver flexible and tailored solutions direct to the clients’ desktop via the internet. It all runs on a web browser and is very easy for us to deploy. At Nomura we are very lean and nimble and able to build bespoke solutions which is a very strong focus for us. On the technology and financial engineering side we are developing core components to help us build a variety of cross-asset class trading systems and services that take very little time to get to market and are very

Furthermore, Burroughs also believes that the need to provide strong pricing infrastructure and powerfully performing algorithms creates a possible advantage for a relative newcomer such as Nomura against the established FX banks that have been working with a single-dealer platform for many years. “We have made a firm commitment to develop our e-commerce offerings. Eighteen months ago, Nomura effectively started from scratch in FX e-Commerce and for six months during the infrastructure build out and whilst client’s were being on boarded, we had an opportunity to re-write all of our price models and risk management algorithms. This time has been extremely valuable and allowed us to grow our distribution channels quickly and immediately monetise that flow.”

Mark Burroughs

“Clients still value relationships and single-dealer platforms can deliver the bespoke offerings that so many firms are looking for.”

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Engaging the market with more intelligent FX orders Order management has become an important area of focus for buy-side firms and, consequently, an area that any bank offering an FX trading platform is keen to develop. Nicholas Pratt examines the many ways that the buyside can work their orders to improve the way they engage with the FX marketplace and how their needs may differ between different client segments – from the more casually trading corporates simply looking to hedge an exposure to the high frequency and high intensity FX traders looking to generate alpha.

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he availability of order management algorithms has been hugely beneficial to buy-side firms in enabling them to minimise market impact and to achieve better execution results. And banks have been investing significantly to ensure that their e-commerce platforms can meet the new demands of the buy-side for more sophisticated order management and to keep pace with the accelerated evolution of the electronic FX marketplace.

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Engaging the marketplace There are essentially two ways for buy-side firms to electronically engage the marketplace, says Yaacov Heidingsfeld, founder and chief executive of US-based TraderTools which provides trading services to sell-side banks in the FX market. They could decide that they want to show a complete order to a particular vendor or they could decide that they would prefer to work that order within their own technology and only send it for execution once specific execution conditions have been met. “If you have a sophisticated order management system, which many more buy-side firms have now either created or purchased, you do not have to show your entire order to a particular market participant,” says Heidingsfeld. “You can instead work the order internally by taking streaming executable prices into your system and only send an execution request to specific market

>>> participants when pre-determined market conditions are reached.” The order management requirements will vary between different market participants. “At one end, the average corporate trading FX will be more business-sensitive rather than specifically executionsensitive. Of course everyone wants the best price but a corporate may have a different approach to price discovery and the number of counterparties they go to in order to source that best price. At the other end of the buy-side spectrum lies the alpha-seeking hedge funds that are only interested in one simple question – did the order execute or not?” Given that there is such a wide spectrum of buy-side clients, can a sell-side bank reasonably expect to be able to offer order management services to suit both the corporates and the alpha-seeking hedge funds? “If you’re on the sell-side, it is important that you have the ability to accept as many different order types as possible and this requires banks to have the right technology,” says Heidingsfeld. “However, very few sell-side banks have the breadth, flexibility and sophistication of offering needed to be able to service all aspects of the marketplace, except for the handful of banks that occupy the higher echelons of the industry. For many other sell-side banks, they have made a conscious decision to serve one specific segment within the market.”

Use of algorithms Algorithms are being more commonly adopted among the buy-side says Heidingsfeld. “It is a developing trend, although it is still a far cry from being the standard practice. We are getting lots more inbound calls from buy-side firms – particularly hedge funds and alpha players that are looking to become marketmakers – wanting to incorporate algorithms into their order management systems. So although it is not the market standard practice, I expect the adoption of algorithms and related technology such as complex event processing to increase during 2011.” So is it simply a matter of time before algorithms and CEP do indeed become the standard market practice and are adopted by all participants or will the technology always remain unsuitable for some? “The technology will be more prevalent than ever but the market will continue to splinter,” says Heidingsfeld. “The corporates that are more servicefocused than price-focused and the hedge funds taking a long term position are not going to need a high level of sophistication. But any firm looking to do high frequency trading or advanced market making will need to be using this technology if they are to beat the competition.” In terms of future development Heidingsfeld expects to concentrate on providing greater

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of the cross have matched and then only execute or cross the trade when both sides are suitably priced.” Above all Heidingsfeld sees the market evolving rather than changing. “I think the market will continue to grow at pace through the improvement of existing technology. Speed to execution will continue to fall, availability will increase and additional order types will be made available electronically.”

Yaacov Heidingsfeld

“If you’re on the sell-side, it is important that you have the ability to accept as many different order types as possible and this requires banks to have the right technology,” functionality for his existing client-base as opposed to rolling out the same technology to a greater range of clients and a larger number of first-time users. “We have had to extend our API to meet the growing demands of our customers (the sell-side banks) who are in turn looking to provide more functionality to their buy-side clients.” The aftermath of the financial crisis has led to a slight readjustment in the marketplace in the last 18 months. “Customers are returning to smaller banks, their more traditional counterparties, due to the lack of availability of free prime broking and similar mirage-like promotional offers from the top banks. The challenge for the smaller banks is to provide these returning clients with same level of functionality they enjoyed when working with the big banks,” says Heidingsfeld. This functionality includes offering a greater range of order types and also the ability to offer certainty of execution as the order types become ever more complex,” says Heidingsfeld. “For example, banks must be able to provide their clients with the ability to engage in a sophisticated synthetic cross but also offer them a facility whereby they can be sure that both legs 56 | january 2011

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Changing client demands Many of Heidingsfeld’ sentiments are shared by the numerous sell-side banks that have spent time and money investing in their FX trading platforms and have noticed the changing behaviour and demands of clients over the last decade, particularly when it comes to the management of their orders. “Every single client trades for different reasons and depending on the scale of the assets they manage has to execute in a range of styles of pairs,” says James Dalton, director of FX algorithmic execution at Citi. “There is no onesize-fits-all answer to the best way to trade orders. We like to work with clients to find out what is driving their execution and offer them the appropriate range of execution services. For some clients, leaving an order with the desk is the right thing to do and for others, putting an order on an electronic platform is more appropriate. And for others, the best option is to use execution algorithms. It all depends on the market conditions, the currency pairs and the trading objectives of the client.” It is a far cry from the days when the only FX execution many buy-side firms were engaged in was on the back of equities or fixed income trades or an overlay account. But there is now a range from macro models to systematic currency portfolios that have emerged, all with their own execution timeframes and objectives. Furthermore, Dalton says that recent research carried out by Citi as part of its latest development efforts suggest that individual clients and not just client segments are looking to mix up their order types based on the market conditions. “They are looking for logic that allows them to automatically switch to an electronic execution or even an algorithmic execution in more extreme conditions.” If a bank is looking to improve the way they execute orders, they need to look at the flow they generate and consider the platform they are using, says Dalton, and this is leading many banks to turn to the single dealer platforms. “If you are using a multi-dealer platform,

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it can be hard to turn away from that. But there is nothing to say that you should not have a number of other platforms available to you both for contingency reasons and for the greater availability of execution services that are available on single dealer platforms. It is also easier to maintain banking relationships through single dealer platforms.” There has been a fairly significant rise in the buyside’s adoption of order management algorithms, says Dalton. “It took a while to educate the buy-side in terms of what an algorithm could do for them and what was available but I very rarely have to have those conversations with clients. If they are not already using them, they are about to.” Consequently much of Citi’s focus for 2011 will be on marketing the core algorithms to a wider range of clients. “Distributing algorithms en masse is not necessarily the right approach because they are not for everyone but it is certainly true that there is a much bigger buy-side market out there now.”

Smart order routing Buy-side FX firms are also showing much greater interest in smart order routing technology, says Dalton, however they need to be discerning when considering investing and appreciate the fact that some smart order routers are simply smarter than others. “There are a lot of companies out there selling smart order routing platforms that often offer nothing more than the ability to find the best price at a given time. There are others that will go stage further and look at the total execution costs but this is just the first building block to developing an execution capability. “If you are dealing in the interbank market, you need to know who else is participating in the trade and be able to grade them in terms of their toxicity. There may be some gaming or flashing going on and maybe the supposed ‘best price’ is not always the best price. So you should be able to grade the execution venues in terms of how they’re run, the type of participants on them and the rules that are in place to protect the underlying client.” In many ways the banks need to educate their clients as to how best to use the SORs and to prevent any unintentionally toxic flow, says Dalton. “Smart order routing is definitely here to stay in FX and I can foresee a lot more investment in routing technology and anti-gaming logic – all of which is very mature in the equities market – in the FX market over the next 12 to 18 months.” 58 | january 2011

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James Dalton

“If you are dealing in the interbank market, you need to know who else is participating in the trade and be able to grade them in terms of their toxicity.”

Differentiation Nomura International is another bank making a significant investment in its FX dealing platform and according to Jeff Leal, head of FX e-trading at Nomura, there is an increasing interest from clients looking to execute their orders differently. “One way to do this is by using algorithms to work orders. This has the advantage of giving clients different ways of participating in the market and we have a suite of algorithms that are designed to reduce the cost of participating and to reduce market impact.” he says. The algorithms you offer clients may differ, says Leal. “For example, you are likely to offer some degree of direct market access to short-term focused clients that are looking for alpha whereas others which are more interested in transparency and reducing their market impact you may offer more passive algorithms. Essentially it comes down to the risk profile of each customer and it is our job to give them enough tools to perform the pre and post-trade analysis that helps them to decide which strategy best suits their objectives.” He goes on, “As the FX market becomes increasingly fragmented, the liquidity available becomes much more critical and you have to keep up with these changes and

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algorithms to see which ones best suit their workflow and to have more choice when it comes to working their orders.” There is a lot of focus on being able to access liquidity effectively. It is not just about connecting to as many liquidity sources as possible but also about how you treat that liquidity and how efficiently you access it, says Leal.

Future development and demand Given the fast pace of the developing electronic FX market, can we expect the demand for order management and execution algorithms to continue to grow or are we rapidly approaching the point at which development and demand cannot be reasonably expected to increase much more? Jeff Leal

“..you are likely to offer some degree of direct market access to short-term focused clients that are looking for alpha whereas others which are more interested in transparency and reducing their market impact you may offer more passive algorithms…” be able to offer clients good access to liquidity. We have many years of experience in smart order routing so we feel that gives us an advantage over our peers but the changing landscape requires constant development and investment to ensure that you have a consistent service to offer your clients. In the long term I think strategies that incorporate more predictive algorithms for marketmaking and execution will become more of a focus. A lot of clients like the ability to back-test their algorithms and see how they have performed historically and to be able compare different

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“It is possible that the uncertainty around regulation and the use of central clearing in the FX market could mean that execution algorithms become less differentiating as trading would take place on fewer venues with deeper liquidity and offering more consistent execution. But in the short-term we are seeing greater demand for more configurable algorithms that are transparent to clients and these are the type of products that we will continue to develop”, says Leal who stresses that it is important for any bank looking to be successful in this space to stay flexible and to keep pace with the rapidly developing world of electronic FX, be that the ability to accommodate new liquidity venues, to match the changing market conditions and to meet client’s demands. “At the moment we are still seeing a lot of clients interested in advanced order functionality and better execution and I think this trend will continue to drive the main players in the market to continue to develop more efficient and smarter algorithms,” he concludes.

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Validation and Compliance: applying new toolsets for more effective TCA in FX

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he need for greater insight and transparency in FX trade costs is naturally evolving and spreading out to hundreds of FX trading firms. And, firms who lay claim to offer cutting-edge execution on foreign exchange products are utilising the results of TCA as something of an extra marketing tool - in addition to internal performance evaluation purposes to identify areas for basis point improvement on portfolios. The recent high profile $200m litigation case involving CalPERS (California Public Employees’ Retirement System) has also brought into some sharp relief issues facing some asset management companies, particularly those managing institutional assets of large U.S. pension plans. Clearly, they need to look carefully today at how they execute FX trades.

By Roger Aitken By Roger Aitken

Transaction Cost Analysis (TCA) has been embraced by the equities world for nearly twenty years, with the majority of buy-side trading firms expending considerable resources measuring just how well they executed on their share trades. Despite some reservations over whether TCA can evolve beyond a process useful in compliance and high-level performance assessment and into a tool capable of generating actionable and real-time analysis, few can ignore its benefits. While TCA has been fairly invasive across the equities space, demand for similar services is also picking up in the foreign exchange markets as many asset managers may have underestimated the impact of FX trade execution on investment returns, particularly with respect to secondary FX trades associated with underlying securities (equities, derivatives, etc.)

“It’s fair to say that many managers did not regard how they executed their FX trades as being of any great material importance to their investment returns,” says Robert Kay, former CEO of GSCS and Head of Analytics, TradingScreen Inc., a provider or multibroker and multi-asset class execution management systems (EMS) to the Buy Side. These managers tended to focus on where it was administratively easier to execute, which typically was with the custodian bank, possibly with an executing broker, or they would do it with a third party vendor. However, it was not something that they necessarily would lay claim to paying a lot of attention to. Kay adds: “What they are now doing is paying a lot more attention to that. And, one of the things they are making sure they are doing is ensuring that they are indeed executing at an appropriately competitive rate on those FX trades.”

Application of TCA elsewhere Highlighting the current state of play and application of TCA in the equities space, a report from Greenwich Associates published in November 2010, interviewed january 2011

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TCA services in the FX space as a natural response to an increasingly electronic and technology-driven FX marketplace. Similar to how many of the tools for equities execution have become more automated and in many cases ‘black box’, developments such as broker-facilitated ECNs and FX execution algorithms have followed suit in the FX space.” QSG provides tick-based execution quality reports and research interface tools to buy-side institutions in the equities market. And, because of this more granular view they consider themselves to be servicing some of the most sophisticated trading desks willing to outsource their trading research to a third party vendor. He adds: “In the FX space, many buy-side trading desks are still more concerned about finding a tool that can affirm their execution relative to a mandate rather than pro-actively seeking out ways to increase alpha and decrease trading costs. However, given the growth of FX execution algorithms we expect firms to demand a way to track the performance of these algorithms.” Alex Hagmeyer “We view the current uptake for TCA services in the FX space as a natural response to an increasingly electronic and technology-driven FX marketplace.”

114 large stock trading institutions in Europe and the U.S. about their use of TCA. This found that threequarters of the institutions canvassed use TCA as part of their investment processes for equities. However, just one-in-five institutions pointed out that the “accuracy, richness and depth of their core trading data is consistently adequate” and 45% of the institutions said assigning the correct benchmark for each trade is “either problematic or extremely problematic” in their TCA process. While the study results suggest institutions’ relatively high levels of satisfaction are related mainly to the use of TCA as a tool for compliance and some general tracking of overall trading desk performance, disappointment was expressed about the inability of TCA systems to generate analysis that provides opportunities for institutions to improve overall performance by wringing new efficiencies out of the trading process. Alex Hagmeyer, Head of Trading Research, Quantitative Services Group (QSG), commenting on the present demand for TCA services in the FX versus equities, says: “We view the current uptake for 64 | january 2011

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QSG’s work in the equities space involves examining globally the price impact of each individual fill that hits the tape or a dark book for their clients. Currently they provide algorithm performance tracking tools that help the buy-side determine which algorithm is best suited for certain order characteristics and market conditions. As the growth of electronic execution tools continues to increase in the FX space, Hagmeyer says they expect to see a “parallel interest” for buy-side trading desks in proactively managing costs in the FX market. “However, in order for firms to properly measure and therefore manage execution costs, there needs to be an increase in the generation, preservation and normalisation of post-trade data across execution providers and OMS systems,” he stresses.

Taking greater control over order flow With buy-side firms and particularly larger asset managers, increasingly focused on the quality of their FX execution, Harrell Smith, Head of Product Strategy, Portware, says: “Managing one’s FX risk is no longer looked upon as a necessary - and expensive - cost of doing business that should be rolled up into a firm’s custody services. As a result, firms are taking greater control over their order flow.” He adds: “As they do, these firms require more sophisticated analytical tools that will help them

Validation and Compliance: applying new toolsets for more effective TCA in FX

analyse the performance of their trading and order routing strategies, as well as the performance of their brokers.” And, this where TCA can help FX trading firms optimise trading performance and validate the impact of their strategies. FX traders can use various execution alternatives differently depending upon their objectives for a particular deal. Jim Kwiatkowski, Head of Sales, Americas, FXall, says: “Clients may choose to undertake a deal for a large amount with a bank, use a multi-bank portal to select the best price available from several banks, or they may opt to use an algorithm such as TWAP (Trade Weighted Average Price - i.e. average price of contracts over a specified time) to break that large deal into smaller pieces.” FXall, for example, has developed a decision support tool called Execution Quality Analytics (EQA), which helps clients to understand if the results from these selections are consistent with their objectives. Kwiatkowski explains: “EQA also enables clients to

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see when they are paying a premium to trade at a particular time of day or in a certain size, so they can decide if waiting or breaking the trade up may help them to achieve a better result.”

What gets measured gets managed “TCA reports are used to measure the overall effectiveness of a trading strategy or venue and allow the user to change or tweak those strategies if TCA results are deemed inefficient,” says David Hintz, Senior Vice President at Global Trading Analytics (GTA), a web-based trading cost analysis consulting firm based in New Jersey. GTA trademarked the phrase ‘What gets measured gets managed’, which is really what every TCA program is designed to do. In terms of the ways in which the use of transaction cost research may determine the routing decisions of FX buy-side firms seeking best execution, Hintz says: “TCA reports can be used as an effective tool to rank bank or execution venue performance.” Hintz adds: “Several of our clients use our metrics as a report card and even put certain venues in the ‘penalty box’ if they under-perform. The drill down capability of TCA reporting allows the user to look at the cost profiles of multiple venues side by side to determine which group is most efficient at executing a particular currency pair.” The firm offers a ‘custom’ analysis based on each client’s unique trading profile, which is held up as being “sophisticated, intuitive and offering greater ease of use.” Portware’s Smith notes here: “Asset managers have many more routing and execution tools at their disposal than they did in the past. Not only can users of advanced multi-broker trading systems direct order flow to the most appropriate liquidity source or sources, they can leverage variety of trading tools that will optimise how they interact with those liquidity providers.” For instance, an asset manager utilising a system like Portware can select from a variety of out-of-thebox strategies that seek to execute large orders by leveraging multiple sources of liquidity simultaneously.

Harrell Smith “Managing one’s FX risk is no longer looked upon as a necessary - and expensive - cost of doing business that should be rolled up into a firm’s custody services.”

“Alternatively, a trader might want to execute versus one or two particular liquidity providers using RFQ or RFS functionality,” says Smith. “Or, they might want to send a single order to a bank’s algorithmic strategy. In short, these platforms offer a great deal of flexibility with respect to both execution venues and trading strategies, which is helping drive adoption rates across the asset management community.” january 2011

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He adds: “As such all of these analyses can help a firm decide where, and how, to route a particular order.” TradingScreen’s Kay says: “There’s no doubt that TCA has had and will continue to have an effect on where orders are routed to by market participants. Having said that, TCA is only one factor among a number of factors, which determine the broker you send an order to. Research is also a factor, as are commission levels and obviously the quality of execution that market participants people bear in mind.” And, over time, Kay contends that within FX trading “will become one factor in assessing where to place your business.” He adds: “What portfolio managers are looking at is how they performed relative to the rest of the market at the time when trades were placed, not just relative to the three or so dealers that they asked for executable FX quotes from. And, what TCA can help them understand is when situations arise where the quotes they are getting are not coming from competitive counterparties.”

David Hintz “TCA reports can be used as an effective tool to rank bank or execution venue performance.”

Greater need for analytics However, with greater choice comes greater need for analytics that can assist traders to select the most appropriate trading method or venue. “TCA can give firms greater visibility into their trading performance, as well as the performance of their liquidity providers,” adds Smith. For example, users of Portware FX’s TCA product, FXLM, can benchmark their strategy’s performance, and the performance of their liquidity providers, against any number of absolute or calculated data points. Smith says that FXLM allows users “to gauge slippage by comparing executions to Weighted Average Price (WAP) arrival time calculations; compare trading strategy results to single broker RFQ prices; view a breakdown of liquidity found at each trading destination for each order; and, analyse the performance of liquidity providers, either on a real-time basis or via comprehensive month end reporting.” 66 | january 2011

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This involves two to three steps, including possible slippage up to the point a trade is made, what happens at the point you trade, and even what happens after a trader has left the market and stopped trading. This third element applies basically to high frequency and high value FX activity (e.g. hedging activity). Known as reversion benchmarks, they might typically be 15 seconds to 30 second snapshots after the trades were executed. Or, depending on the currency and amount it might be 1 to 5 minute spectrum.

Gaining insights from the latest tools FXall’s Kwiatkowski notes: “We help our buy-side clients look at their overall execution quality through our EQA reporting tool, which evaluates their trading across several key metrics.” In particular, he says, EQA assists clients to understand how size of trade, time of day and counterparty can affect execution results for each particular currency pair. “By reviewing these results compared to execution objectives, routing rules decisions can be adjusted based upon recent results,” he says. “Our clients can use this insight to help them determine how best to trade - whether they need to use different types of execution strategies (either an anonymous algorithm or a trusted relationship), or make changes to their overall workflow (e.g. trading in different sizes or at different times of day to optimise

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their spreads) and to maximise their use of the counterparties they have relationships with.” Clients, he asserts, “will certainly choose trading platforms that offer these multiple ways to access the market and sophisticated analytics so they can regularly monitor their trading.” Turning to the functionality that the latest TCA toolsets provide, FXall’s Kwiatkowski says: “Our EQA report analyses clients’ trading across multiple criteria, which help determine execution quality. We evaluate the distribution of trades by currency pair, size, time of day and counter-party, in addition to the impact on savings and spreads.”

John Halligan, President, GTA, says: “In most cases the benchmark options depend on the availability of time stamps in the client’s transaction file and the type of firm or strategy we are measuring. GTA feels the most effective way to look at TCA in any asset class is to take a macro approach.” This approach is distanced from using TCA for specific micro and real-time evaluation purposes. Clients typically ask for quarterly or monthly reporting, which he says is still a “very effective” way for identifying trends or outliers. Traders might make a bad trade, but one bad trade will not tell the whole story. He adds: “One of the issues traders face with real-time TCA is making knee jerk reactions to the data and overall quality of the data itself prior to being scrubbed or checked for accuracy.” QSG has recently launched a ‘tick-based’ TCA engine in the FX space similar to its tick-based reports for the equities. “While we have seen a growing interest in execution quality, it has been more reactive in nature,” notes Hagmeyer.

Monthly reports provide benchmark market data from FXall’s trading platform with respect to response time, average spreads, market highs, lows and medians, in order for clients to analyse their trading against the market.

Measuring FX transaction costs There can be a number of methods for measuring FX transaction costs. One is the time of execution method that involves comparing the execution (exchange) rate to the mid-point of the bid and offer rates available in the market at the time of the deal. Another method is the day’s average rate method. This latter method compares the execution rate to the average of the high and low exchange rates for the trade date. But slippage can also occur between the point of the investment decision and when execution is made. GTA takes a custom approach when analysing a firm’s FX transaction costs based off their unique trading profile. The firm employs a number of different static (arrival price, close, implementation shortfall) and dynamic (TWAP, VWAP, Average) benchmarks in their reporting. 68 | january 2011

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Robert Kay “What portfolio managers are looking at is how they performed relative to the rest of the market at the time when trades were placed, not just relative to the three or so dealers that they asked for executable FX quotes from.”

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QSG’s SYNC FX Analysis product is a ‘tick-based’ TCA engine that takes the timestamp of each deal as a parameter and finds the midrate of the market in a given currency pair at the time of the deal to the millisecond, allowing for a granular perspective of execution quality. “Additional benchmarks are provided such as timeweighted average midrate and rate distribution decile, in which the client can understand where their rates executed fall relative to all rates executed on the day over time.” These services from QSG are currently offered on a T+1 basis. Hagmeyer explains that: “In the SYNC FX Analysis research interface, execution quality data can be grouped by trade date, week, month, counterparty, given currency, the side of the given currency and any custom flags the client can provide in the data.” Currently, QSG is developing a proprietary measurement by which several deals with potentially different counter parties can be wrapped up into an order and the ‘cumulative rate impact’ of the order can be understood transparently. Says Hagmeyer: “The SYNC report generation capacity for FX Analysis is similar to that for SYNC Equities Analysis, in which the user can create an unlimited set of custom-defined reports that show outlying deals on a daily basis, trends in execution quality by counterparty on a weekly, monthly or quarterly basis, or even this data grouped across custom flags (i.e. account, execution algorithm, etc).” Hagmeyer says it is important to note that at this time QSG works with the client to “normalise” much of the post-trade data that comes back to them from each individual counterparty or OMS. “As with any project involving execution data, the quality of the analysis is only as good as the quality of the data, and QSG urges order and execution management systems (EMS’s) to pioneer the boundaries in data quality retention and normalisation,” says Hagmeyer. As the demand for more transparent data continues to emerge from the buys-side, QSG expects this process to become easier and more seamless over time, he contends.

Wider perspectives Now that TCA has moved beyond equities, vendors like GTA and others are certainly seeing more cross-asset

Jim Kwiatkowski “By fairly evaluating execution quality over a large number of trades utilising ECN’s, algorithms and bank relationships, clients will be better able to value the benefit, which they receive from their bank relationships in achieving their execution goals.”

or multi-asset class TCA. GTA’s Halligan says: “For example, if the FX trade was performed simply to settle a global equity transaction, we view both events as a single transaction with a single cost or benefit. Improved data in FX and fixed income has allowed for more accurate reporting in over-the-counter (OTC) markets.” TradingScreen’s Kay says: “Our transaction cost data offers benchmarks, parameters and filters across all brokers to a common standard and measurement methodology. And, if clients want that data provided to their preferred consultants outside TradingScreen, we will accommodate that too.” The advice offered under TradingScreen’s consulting service is broker neutral and is claimed to leverage one of the largest trade databases in the world. The approach allows clients to be able to incorporate external data, methodologies and output data to third parties. “Just as clients have preferred brokers, they may have preferred consultants or be interested in proprietary tools offered by others,” says Kay. january 2011

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For TCA to be meaningful, Portware’s Smith says firms’ FX trading systems must be able to record or calculate any kind of market data or related event in real-time and tag orders accordingly. “As a result, you really need to have a system that is built around an event-based technology architecture,” he says. Noting that FX TCA is an incredibly “data intensive process”, GTA’s Hintz says: “New technologies have allowed for better data transmission, data warehousing and faster retrieval of that information. We developed the first web-based reporting so clients can access their reports 24-7 worldwide. Also, more groups are trading over FIX connections or through ECN’s and away from the traditional trading desks.” TradingScreen’s Kay says: “What we see happening is a progressive increase in the level of FX trading process. Now I think the next phase - once you begin to do the analysis [on electronic trading] - may well be incorporating in real-time more information about market-related events that are going on at or around the time your order is in the market.” But he adds: “I can envisage that over a period of time those sorts of things will develop and happen. However, I would say that at the moment they’re not yet a major factor.”

Competitive advantages Looking at how TCA tools can help high frequency and alpha seeking FX trading firms to achieve competitive advantages, firms who engage in alpha generating strategies are certainly interested in execution quality, but not perhaps in the same way that traditional asset managers are. “A proprietary trader who engages in directional or relative value strategies is primarily concerned about the strategy’s performance as whole, but not where a particular order was ultimately filled,” notes Portware’s Smith. “Traditional asset managers on the other hand seek to execute a pre-defined order as efficiently as possible, and as such are more concerned about how their performance relative to specific data points or benchmarks.” According to Smith, this is not to say that proprietary trading firms are not concerned with execution quality. “They are,” he says. “But rather this constituency focuses on different types of analyses.” 70 | january 2011

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John Halligan “One of the issues traders face with real-time TCA is making knee jerk reactions to the data and overall quality of the data itself prior to being scrubbed or checked for accuracy.”

GTA’s Hintz says: “One of the ‘lost benefits’ of TCA is how effective the reports can be used as a marketing tool. Clients with above average results can use the reports to effectively market their algorithms or trading strategies. The TCA reports can also be used to make sure strategies or algos are working correctly and tweak the process if it is not.” In relation to how the application of TCA in other asset classes may be mirrored in FX, GTA’s Halligan says there are certain basic methodological principles in TCA that apply to all asset classes. “The use of average price benchmarking, peer or universe comparisons and market condition assessments are the most common,” he notes. However, one should be “careful” when it comes to looking at peer group analysis, according to TradingScreen’s Kay. He says: “The thing about peer group analysis - even in equity TCA - is essentially the problem of normalising your data set. So, when you look at how well did a portfolio manager/trader perform against benchmark and how well did other

market participants perform, it’s very difficult to get a properly normalised transaction sample.” “So, the danger with peer group analysis,” he adds. “Is that you might well say that counterparty ‘X’ is doing a better job for me than the universe and therefore you’re pleased with their performance. But the problem with this is that it may not be a meaningful or fair comparison - if you giving your counterparty relative easy FX trades as opposed to another party who executes more involved trades.” And, finding that ‘normalised’ peer group can be quite difficult, even taking into account as many factors as possible. As Kay puts it, if one compares a plethora of factors it can be akin to looking at “a mixed bag of fruit” and making “apples to oranges” comparisons.

Looking to the future As to what the future holds for TCA in FX and how it may affect the value proposition of individual FX sell-side institutions, GTA’s Halligan says: “One thing for certain is there will only be more scrutiny from regulators and clients when it comes to best execution. So, FX TCA is here to stay.” He adds: “We feel the overall quality of market data will improve making real-time and pre-trade TCA more effective. Sell-side shops that are able to adapt and prove superior execution quality amongst their peers are bound to increase market share.” FXall’s Kwiatkowski believes that execution quality analysis will become a “requirement for most clients” as a best practice to demonstrate that they are measuring their trading results and using that information to refine their trading process in order to achieve improved results. He says: “By fairly evaluating execution quality over a large number of trades utilising ECN’s, algorithms and bank relationships, clients will be better able to value the benefit, which they receive from their bank relationships in achieving their execution goals. Certain banks may be superior counterparties for particular currencies or sizes, and breaking large deals up to smaller pieces may or may not benefit each client equally.”

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Cloud Computing Services: meeting more than demand spikes in FX Whilst it may still be early days in the evolution and adoption of Cloud Computing technology by financial services firms and other institutions, the hype surrounding it may in five years time have dissipated to such an extent that market participants and end users regard Cloud technology as the norm. Roger Aitken investigates how the Cloud Computing model operates and in what ways the pooled resources of an enterprise Cloud design can assist with the delivery of FX trading applications.

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any organisations today appear stuck with legacy applications that are handcuffing them from investing in new technologies and applications to deliver competitive advantage, reduce costs and increase revenues. The scenario might be akin to a crash on the highway waiting to happen, which can only be avoided by investing in modernising applications and retiring older IT systems. Highlighting the nature of problem, recent analysis undertaken by Forrester Research of 562 companies in North America and Europe has revealed that 55% of current IT budgets are dedicated to propping up systems and business processes that are between 10 to 20 years old. Clearly, this is a huge maintenance burden, which is where Cloud infrastructures can play a pivotal role going forward.

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Change is obviously hard for many organisations, and many reasons are cited for why firms delay IT modernisation. However, as a Gartner paper warned (‘Signs Indicate a Train Wreck is Coming Unless You Modernize IT’), an impending IT disaster might well be inevitable unless applications are overhauled. Consequently CIOs have been advised to “fund an IT modernisation/application overhaul program.”

Definitions “Cloud computing as a term is very broad and means different things to different people,” notes Rob Gagne, V-P of Engineering, Nexaweb Technologies in based in Burlington, Massachusetts, and the architect of the firm’s FX Accelerator product. He adds: “From a purely technical viewpoint, whether it is a private Cloud or public Cloud, what Cloud Computing in general allows one to do is leverage virtualisation technology, as well as some things that have been on top of virtualisation technology to run machines independent of hardware.” In terms of definitions, Wikipedia refers to Cloud Computing as: “Describing a new supplement, consumption, and delivery model for IT services based on the Internet, and it typically involves over-theInternet provision of dynamically scalable and often virtualised resources. Frequently this takes the form of web-based tools or applications that users can access and use through a web browser as if it were a program installed locally on their own computer.”

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A recent Cisco white paper on Cloud Computing stated: “Cloud computing is often viewed as a revolutionary, disruptive innovation. However, considering the use of grids and the notion of IT utility, it is clearly a natural evolution of the digital supply chain.” The concepts of Cloud Computing, which include networked infrastructure resources, available for a price and accessible over a standard interface, are fairly similar to preceding ones, with the main differentiator being that these resources are now supplied from outside the enterprise firewall. As a result the Cloud operating environment is more reliable, agile and efficient. Being abstracted, it can evolve as new technologies emerge. Nexaweb, which has helped over 200 customers transform growth-limiting legacy applications into modern web-based Cloud Computing solutions that are securely accessible to anyone from anywhere at any time and help fuel expansion, views Cloud Computing as a “continuum of leverage, opportunity and benefit.” Clients that Nexaweb work with are not using services from the likes of Amazon, but what they are doing is using additional technology in order to create new nodes. This means that they do not have to buy new computers, but just add new nodes as required.

Well suited to FX Harpal Sandhu, CEO, Integral Development Corp., which develops and operates FX Grid, a global Multisided Trading Facility (MTF) connecting active market participants with all major sources of FX liquidity, contends that while Cloud Computing has a lot to offer in any environment, it is especially “well suited” for FX markets. And, there are good reasons for this. “FX trading at the outset is an expensive proposition due to the OTC nature of the market and there is no ‘one-size-fits-all’ solution,” Sandhu says. “So, in order to be an active market participant, one needs to provide both sides of the technology, the functionality an exchange would provide in equities, and the functionality of a broker or bank connecting with this exchange.” 74 | january 2011

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On top that there is the sheer volume and volatility in the FX marketplace, which puts enormous strains on the underlying IT infrastructure. And, on a very basic level, Cloud Computing allows for a dramatically reduced cost structure because of the use of a shared IT infrastructure, shared support, and the standardisation that comes with it. “Once in place, a Cloud-based FX trading application offers the added advantage to be very scalable,” he adds. “Last but not least, Cloud Computing allows for active market participants to only incur trading expenses when actually trading.”

Private versus Public Clouds Generally speaking, there are three primary services that are provided by the Cloud infrastructure, though each are interrelated. In terms of the enterprise Cloud design, the basic Cloud is comprised of pooled resources (compute, network, and disk) that are dynamically provisioned to meet the demands requested of it. Real-time and on-demand virtualisation technologies are used heavily for rapid deployment of resources to meet the demand. At one end of the spectrum are Private Clouds enabled by virtualisation technologies such as Xen and VMware. Many organisations are opting for this approach to simply move applications to a more efficient IT infrastructure. Private Clouds dynamically provision computing resources on demand (by utilizing idle CPUs in the datacentre) to handle peak usage or to guarantee continuity of service in the case of server failures. Public Cloud is enabled by vendors such as Amazon and Rackspace, all of which offer solutions that leverage their back-office infrastructure for storage and run-time.

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Service (PaaS) solutions which offer customised APIs and built-in libraries for quickly building tailored applications running on a public Cloud infrastructure. Then there is Software as a Service (SaaS) solutions, offering turn-key web-based applications on demand and finally there is Infrastructure as a Service (IaaS) applications. “Software as a Service (SaaS) is a pay-as-you option go without any up front investment,” says Gagne. “Platform as a Service (PaaS) is also pay-as-you-go, where the upfront investment that one needs to make is your own software development effort, since the provider does not offer you with the full solution. You need to build on top of that.” He adds: “What virtualisation allows you to do is to move things around over the course of a day or a week, so that your idle time is significantly far lower and therefore you can do more with less hardware.” In effect, it lowers the initial investment and allows firms to leverage it flexibly and efficiently.

Rob Gagne

“The main benefits these institutions are going to realise, is firstly leveraging the private Cloud and using that as a way of making better use of computing resources and providing more flexibility around peak times/peak usage and being able to react quickly to requiring more capacity.”

Sandhu notes: “IaaS (Infrastructure as a Service) is offered by us because FX Grid is constantly integrating with new providers and venues and all of that integration is offered to customers on a provisioning basis at no additional cost.”

“Public Cloud is pay-as-you-go, but you do have to manage it yourself,” explains Nexaweb’s Gagne. “So, you’re getting the virtual equivalent of a datacentre, without having to pay for a datacentre. However, one still requires IT admin staff and the type of people that would run the datacentre for you. You just don’t need to make that upfront investment in the data centre.”

He adds: “PaaS (Platform as a Service) is offered when we [Integral] allow certain clients to develop their own algorithmic trading models and run them within the FX Grid (the Cloud). We also offer SaaS services for people who use the best execution facility we provide as a set of business services. They might use those for themselves or they might provision them for their clients’ usage.”

While with private Cloud an upfront investment is required, users do need to buy the hardware (although it allows hardware to be used much more efficiently). Dedicated or shared CPU and storage resources are hosted, operated and secured remotely. They are provisioned on-demand typically for a monthly usage fee that depends on the type of hardware provisioned and the usage level (e.g. bandwidth or CPU consumption). Companies utilising public Clouds do give up some control and flexibility (as they do not control the computing resources directly). That said, firms gain economic and speed advantages by not having to incur additional in-house data center overheads.

Improving operational capabilities Commenting on the benefits and the ways the pooled resources of an enterprise Cloud design can assist with the delivery of FX trading applications, Nexaweb’s Gagne says: “The main benefits these institutions are going to realise, is firstly leveraging the private Cloud and using that as a way of making better use of computing resources and providing more flexibility around peak times/peak usage and being able to react quickly to requiring more capacity.”

Service models At one end of the service spectrum is Platform as a 76 | january 2011

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And, Cloud technology can certainly help avoid downtime. “One can literally take a running instance of your application and move it from one computer to the other using Cloud technology and not have to worry about losing downtime,” he says.

Cloud Computing Services: meeting more than demand spikes in FX

Essentially the same sort of technology that Amazon provides can be used and run in your own data centre. “And, that’s what a majority of banking customers are doing today,” says Gagne. “They are utilising that technology but not taking that additional step of selecting Amazon as a hosting provider. They are still keeping it within their own datacentre, but leveraging all the same type of technology.” Stuart Grant, Sybase, EMEA Business Development Manager, Financial Services, who labels Cloud Computing as being akin to “wolf in sheep’s clothing” says: “It’s starting to get into a cycle where the Cloud Computing capabilities could help organisations bring their front, middle and back office functions far more closely together than they ever have in the past, whilst at the same time improving the operational capabilities of the trading desks.” He adds: “In this way these organisations can reduce the risk element by being able to monitor mark to market missions, maximising the profitability and running their algorithms right next to the trading activities.” Integral is certainly pushing the envelope of the benefits of Cloud services to its FX customers. According to Sandhu the provider “is unique in the degree to which brokers can take these Cloud services and build their own private exchanges on top of it.” Integral offers brokers the ability to define liquidity streams, business processes and risk management preferences on a customer-by-customer level.

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Cloud Computing provides it is perfectly in line with our strategy in that we’re now able to provide organisations with ‘One version of the Truth’ that enables them to act on that data in real time, regardless of whether or not that piece of data has just occurred, is static reference data or it was created 10 years ago.” As a leading provider of software in that respect, Sybase also has the mobile capability as well “to mobilise that information out to handheld devices”. And, they are one of the few organisations that have those core components lined up for enterprise-class scale. The most important business drivers for utilising Cloud Computing solutions in FX trading are according to Integral’s Sandhu “the ability to increase revenue and improve risk management practices”, whilst at the same time benefit from a dramatically reduced cost structure. He adds: “Cloud computing allows companies to capitalize on revenue opportunities by quickly launching and expanding their private band FX “It’s starting to get into a cycle where the Cloud Computing capabilities could help organisations bring their front, middle and back office functions far more closely together than they ever have in the past, whilst at the same time improving the operational capabilities of the trading desks.”

A broker, for example, can fine-tune his offering so that a customer might receive a tight spread on one currency pair, but less tight ones on others. Sandhu claims: “This is truly a break from the traditional view of Cloud Computing that is focused on connectivity and delivering the same Cloud-based application to all users.” Integral also allows a user to customise and extend the functionality of FX Inside Professional with ease by providing an industry-standard Integrated Development Environment (IDE). Users can write their own programs (“Add-Ins”) in any Microsoft compatible programming language.

Data management and analytics From Sybase’s perspective, Grant says the vendor is coming at matters from the data management and analytics side of things and for the past decade has been focussing on “improving an organisation’s ability to report and perform on-demand analysis on any kind of data.” Stuart Grant

He adds: “When one looks at the opportunities that january 2011

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trading system, with no up-front cost. They can improve their risk management procedures by exactly defining the market risk one wishes to retain, on a customer by customer level or basis.” All this can be done on a dramatically reduced cost structure by taking advantage of a shared infrastructure with Cloud Computing solutions, paid for as you go. “Among the most important advantages is that time to trade is reduced to weeks - from months or even years,” says Sandhu. “So, instead of spending time and money on re-inventing the wheel, a broker can take advantage of top-tier liquidity and industry-leading technology developed by a third-party technology provider.”

Reducing complexity Sybase’s Grant notes: “The real opportunity for Cloud Computing is actually to improve the transparency of what is going on in many of these financial organisations by reducing a much of the complexity that has been in place. For example, we speak to a number of organisations who have the same data replicated 50, 100, or even 150 times in different offices around the world.” So, not only should it benefit instititions’ fundamental and underlying business, but it could go some way to appease regulators’ concerns in terms of risk - credit risk, liquidity risk and counterparty risk.

Benefits to FX firms In term of the benefits that banks, FX brokers and trading firms are likely to see by utilising Cloud Computing solutions, in addition to things like optimised trader desktop environments, improved risk management, speedier disaster recovery, and more flexible control over non-strategic administration and data management applications, Integral’s Sandhu regards the main benefit is really in increased flexibility. As he frames it: “Fundamentally, it’s about how a broker is able to automate exactly the way they are doing business today without having to make any compromises. Cloud computing allows brokers to organize and automate their existing business exactly the way they have it.” Tim Haman, CEO, Fair Trading Technologies (FTT), which is based in the UK and has a development office in Sweden, says: “I believe that any financial institution, brokerage or bank that would like to go into Cloud Computing really needs to have their 78 | january 2011

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Harpal Sandhu

“Cloud computing allows companies to capitalize on revenue opportunities by quickly launching and expanding their private band FX trading system, with no up-front cost. They can improve their risk management procedures by exactly defining the market risk one wishes to retain, on a customer by customer level or basis.” own private Cloud. Inside this private Cloud one can enable a public area where the traders and users can have their own servers and their own Window 7 workstations and trading terminals, which will then be remote controlled from wherever their client is.” FTT, developer of the T3 Execution bridge, uses Cloud Computing in its retail FX trading applications. Haman says: “Everybody in the FX market is talking about the spread. The spread is a big marketing tool in terms of say a 1 or 0.5 pip spread. However, that is completely unimportant to the trader because it does not matter what type of spread they have. What matters is the latency when placing an FX order to reduce the slippage as much as possible.” When FTT decided to use Cloud Computing technology they opted to use a VMware solution. “We have a rack of physical servers in Zurich and they are combined in one physical machine in a cluster. And, this high physical machine is divided into a number or virtual machines,” says Haman. The MT server, bridge and MT demo machine resides in this Cloud of virtual machines. The transfer

Cloud Computing Services: meeting more than demand spikes in FX

time between the servers is in microseconds, rather than milliseconds. Offering a VPS solution (virtual private server), which your clients can connect to, it effectively means a latency saving for end users of between 0.5 and 1 second, Haman claims. This means if a trader puts in an order for a million in some currency pair and they save a second, it translates to a saving of a $100 as the pip value is perhaps $100 for that second. Haman says: “So, we’re minimising the slippage in the order and saving money for the clients as well as making money on the volumes that the clients trading.” As to whether the benefits of Cloud technology development outweigh the costs, Haman says: “The benefits are really the costs, the time savings and also a huge benefit of improved security because in the Cloud everything is redundant.” He adds: “One is not depending on an Internet supplier or a single computer. If something crashes, which computers tend to do from time to time, you’re instantly backed up with a secondary resource to our [FTT] private Cloud in Zurich. Thus, if any one or two of our three ISPs encounter a problem and the Internet goes down, clients still have a third way to remain operational. That means significant uptime. It can never be 100%, but close to 99.9%.” “I believe that any financial institution, brokerage or bank that would like to go into Cloud Computing really needs to have their own private Cloud.”

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There are also issues around improved risk management and security through having access to Cloud technology. If, for example, a trader places an order and they would like to get out of it, then were they to experience a problem with the Internet, pulling out might not be possible. “In a Cloud environment one has more security and greater redundancy, which will enable a trader to actually get out of the order,” Haman says.

Deploying Cloud solutions In terms of the building blocks required to deploy a Cloud Computing solution and what issues are involved in migrating legacy FX trading infrastructures to the Cloud, Sandhu says: “The foundation for us is a low latency FX Grid to make OTC trading possible. Then, one requires flexible best execution services to be deployed for an institution or the client of that institution.” He further explains: “The service provider must be able to just configure the system to the client’s satisfaction, i.e. turn on/off that other venue for price discovery, turn on/off that other venue for execution, report to that other CCP when the trade is done, add the trading costs to the spread before the trade is done, and charge a separate commission to my traders, etc.” “Finally, robust and complete monitoring services are needed. So, to ascertain what happened, what is supposed to happen, and what did not actually happen.” Cloud operators range from technology providers to (larger) banks and brokers. But this is not unlike the choices trading firms have had previously. “It should not come as a surprise that the logic is the same,” points out Sandhu. “Should a trading firm really go with a larger entity and risk all the inherent conflicts of interests? Or, would it not make more sense to partner with a neutral technology provider?” On the levels of investment which are required to take advantage of Cloud Computing and what factors will influence this, Sandhu states: “Cloud computing requires little of the upfront capital and IT investments that are standard in the software-and-install-businessmodel,” says Sandhu. “The additional benefit of the Cloud Computing business model is that it offers the utmost elasticity to align business resources with business demands, even as they change frequently.”

Tim Haman

David Gershon, CEO of SuperDerivatives, which operates an electronic FX options platform based on january 2011

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Cloud Computing, says that the firm has been using Cloud technology and Cloud farms for over two years now, having switched over from around 400 old servers and a cost running to several million dollars. Everyday the firm makes millions of calculations - not just for trading - but for everything else the firm does. Clients can undertake real-time risk management, which is heavily dependent on Cloud technology. SuperDerivatives has several Cloud farms whereby all their Clouds are connected. Gershon in London, says: “In my opinion there are certainly enough vendors in the market that can provide appropriate software. And, of course all the big companies like HP, IBM and Cisco provide excellent hardware for Cloud. The provider we selected gave us extremely robust tools to manage the site in remotely.” In terms of those costs, Gershon says: “It really depends. Firstly, of all it depends on the size of your organisation and how global you are. Secondly, it depends on how much of your hardware can be used for the Cloud or how much you need to trash.”

Competitive advantages Commenting on some of the competitive advantages that could be derived for either institutional and retail FX providers from Cloud technology, FTT’s Haman says: “First of all there is improved security since you do not have to manage a number of physical machines. One manages a number of virtual machines in the same management interface, thereby improving your security.” As well as being able to easily keep track of who is permitted and who is not allowed to use the trading systems, it also improves uptime since everything is fully redundant. He adds: “In the scenario where you have 10 physical servers and these are enabling 50 virtual machines. 80 | january 2011

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And, if you have a critical virtual machine, you can easily have a copy of that virtual machine. Then, if something adverse happens it will switch over to the next machine in seconds. Therefore, a very increased uptime can be experienced because of the redundancy.” One can also achieve a significantly faster execution of orders, which saves many milliseconds since virtual machines share the same CPU and memory resources, with travel time between the virtual machines being extremely short. And, as Haman says it saves a huge amount of money by not having as many physical servers as before. He explains: “When you’re using Cloud technology you’re really utilising maybe five virtual machines that are sharing these physical servers. You are getting a 1 to 5 ratio, and if you have 50 servers running as an FX broker, you can reduce that to 10 servers.” According to Haman just one installed standard server that runs for 24 hours a day for a full year (c.8,600hrs), would potentially consume c.£1,000 (c.$1,500) in electricity alone. So, if one is able to reduce 50 machines to 10 machines, it’s a massive saving in energy and makes it possible for brokers and banks to “market their green credentials.” SuperDerivatives’ Gershon adds a cautionary note on the utilisation of Cloud services in FX, saying: “We also have to distinguish between where we are now and where we can be in the future. Let’s talk about algorithmic FX trading, rather than discussing FX options where even more calculations are required.” He says: “If a market participant wants to apply an algorithm that uses correlation between currencies and other assets, which takes data and based on this makes trading decisions, then Cloud is the right solution

Cloud Computing Services: meeting more than demand spikes in FX

and they don’t want to suffer from latency, then Cloud is the correct solution and is very necessary.” For retail FX, Gershon does not fully believe Cloud is so critical since the spreads “are wide enough” and so for this constituency they may not be “sensitive enough”. In relation to what impact there might be to the future delivery and the evolution of FX algorithms from Cloud Computing, Integral’s Sandhu believes that it will “dramatically” lower costs. “That in turn will allow for more innovations in the markets, as more solution providers will find it economical to join in,” he says. “Markets will be more connected and will provide increased transparency; pre- and post-trade, and at the moment of trade. More participants will use a PaaS to develop the innovative algorithms at considerably less costs. And, as markets change they will change the algorithms.”

David Gershon

“If people want to trade a large number of varied options and they don’t wish to suffer from latency, then Cloud is the correct solution, which has become very necessary.” because it will enable them to perform enormous numbers of calculations continually. It is essential to be as fast as possible and maximise performance to avoid extra latency.”

Impact on Algorithmic FX trading For algorithmic trading Gershon asserts that Cloud Computing can be useful, but only for those extremely sophisticated market participants with a heavy need for calculations. “I’m not talking about simple algorithms, but rather the more complex algorithms that undertake huge numbers of calculations,” says Gershon. “It is difficult to know what each of your clients will do and how it will be spread out. By deploying Cloud you make sure that everyone gets the best performance possible.” Gershon states: “I don’t think there is a critical need for Cloud Computing in spot FX right now, but I envisage this will change in the future. However, it is definitely a good fit for option trading as it can assist trading platform providers with the calculations. If people want to trade a large number of varied options

Turning to the prospects for the development of more effective Service Level Agreements (SLA’s) with respect to Cloud Computing. Gershon says: “Once you outsource Cloud Computing you’ll likely to get better and better SLAs. At the moment I think the average is not good enough (c.90%). But once the SLAs from the various providers improve there will be no reason why not to use them. The Cloud basically ensures latency and performance 99.99% all the time.”

Looking to the future As to what the role Cloud Computing is likely to have in the FX space in the future, Nexaweb’s Gagne says: “Certainly more and more companies will make use of it. It’ll go from being a bit of a vague hype that it’s right now with some very real benefits underneath it, to something that people don’t even talk as much about because everyone is using it.” He adds “It will be rather like the way the web-based applications were five or six years ago. Everyone will be using it and nobody will be thinking about it anymore in the same way it’s being considered right now as the next big thing.” And, he says that across SaaS, Paas, IaaS and the Public/Private Cloud continuum, everyone will eventually migrate to one of those. “One won’t find people doing things the old fashioned way of setting up a server and running an application off of it. More banks will look at how they can make use of SaaS, so that they can stop essentially having to decide whether to undertake software development themselves or let someone else do it.” january 2011

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High volume FX taking a new approach to performance management Would you drive a Formula 1 car around a race track at 240 mph without any instrumentation? “Without instrumentation we can’t run a Formula 1 car at maximum speed. It is a highly tuned piece of engineering that needs monitoring on a real-time basis”. So says Andy Stevenson, Team Manager of Force India, the Formula 1 racing team based at Silverstone. The same can be said for modern low latency FX trading systems today. With the Formula 1 car, there is an entity that can be managed within its own closed environment, except for external factors such as the other cars on the track and the track itself. This is exactly the same for FX Businesses competing against other businesses with their own environments reliant upon exchanges and price data to drive the profitability of the business. 82 | january 2011

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FX business flow instrumentation Like Formula 1, the drive for real-time latency monitoring is coming directly from the technical teams as they are being put under intense pressure by the business to sort it out. The FX Business sees a P&L issue and assumes that a technology problem is the root cause. With the advent of real-time latency monitoring it allows the business and technology to track the behaviour of individual event histories and to find the causes of a P&L problem. In short it is the explanatory power that is the initial benefit to an organisation. Once you have this capability then other benefits can be achieved. Anyone who has sat on the support desk of an FX trading environment can see that there is a vast array of computing technology being utilised to monitor and report on systems. Can there be a new way of monitoring these complex rapidly changing architectures without impacting the highly sensitive low latency business flows? Is there a need for a new way of monitoring these systems? What has been available until recently has been two generations of technology monitoring. The first generation was built around hardware and operating system capability which measured the utilisation of individual components within boxes such as memory and CPU usages. Then in the last five years we have seen the advent of a second generation of products and approaches that started to take some of the business logic out of the price, quote and trade data to understand the individual flows, the routes they take and the time they take, normally at best a few minutes after the flow events. These are typically focussed on the network traffic or the intra-application performance testing environment. These first two generations have focussed on the root cause technology space – is the machine working at 99.9% efficiency, where are the bottlenecks inside my application and so on.

Nick Gordon is a director of Velocimetrics

Co-location and highly specified hardware and network provision are available to the FX purchaser today – millisecond response times, microsecond latencies, and sometimes even nano second targets can be offered. But, as in the Formula 1 scenario, are we keeping instrumentation pace with the underlying technology? january 2011

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“The heterogeneous approach to the collecting of the data with the time stamp – to microsecond accuracy, allows the analysis engine to correlate within individual different business flows.”

The new generation of tools is looking at the problem from the business perspective, where the focus is on understanding the trade flows as they pass across different systems. The instrumentation of the business flows is done by tracking the messages, abstracting a mixture of business and technical data to provide realtime feedback. These tools enable the business to track back quickly from a loss-making trade to re-assemble all the price and quote inputs. Post-trade analysis can even be performed algorithmically providing a live feedback loop into the quoting engines. The FX business has a number of crucial business questions. In a low latency world it wants to know how long it is taking for particular market data to reach their pricing engines, how quickly they are generating quotes, and how quickly the clients are trading against those prices. They would like to have alerts that can tell them when individual prices are stale or old. They want to see whether the price to quote or trade are taking longer than expected. They are asking whether they can feed live latency data into their algorithms to drive more aggressive margins. They want to know when their trading systems are likely to fail so that corrective action can be taken in time. Today most of the analysis of this is being done forensically by analysing log files and then ascribing business information to those flows, all after the fact. This type of analysis can sometimes take days to identify the individual price data feeds that were impacting quote and trade engines. We are in the middle of a 84 | january 2011

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micro-second battle for margin and we take days to carry out an investigation! Like the Formula 1 scenario, this is just not sustainable.

The new instrumentation world New instrumentation techniques allow individual FX trade flows to be monitored across networks, inside applications, and then correlated into a coherent view of the whole trade cycle, all close to real-time. The real-time element allows alerts and live latency data by hop, or venue or end-to-end to be directed into the trading desks and operational support desks. The principle of this flow approach allows these new technologies to look at the FX trading environment from a business perspective. Data is collected through a series of probes or agents unobtrusively– the sole aim being to gather data from a passing message or transaction off the network or from within processes within an application, take a time stamp and pass it back to the analysis centre. The heterogeneous approach to the collecting of the data with the time stamp – to microsecond accuracy,

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allows the analysis engine to correlate within and across different business flows. For example a Market Data Flow may be measured from the point that it was initiated by the Price supplier all the way through the feed handler into the pricing or quote engine. The quote flow may be correlated from the quote engine to the client gateway. The analysis engine then has the capability to correlate multiple different flows and then associate the links across these flows thereby conjoining the individual item flows across the whole of the FX business transaction lifecycle, even into the hedging and settlement processes. To do this requires powerful tools and processing capability that until recently hasn’t been easily available. With the power comes the ability to start providing real-time latency data by individual item and item hop.

Technical hurdles There are some technical hurdles to overcome, for instance the system clocks need to be synchronised, the probes mustn’t add to the latency, the volume of data that can be generated can be immense, there are correlation strategies across the flows to be built and maintained, but these hurdles are now surmountable. Experience is showing that using these light touch systems FX trading architectures can be instrumented and then benchmarked within a matter of days. Where technical teams were in the dark in relation to when, where and why latency was being experienced, the principle problem is now being solved. The latency is now measured consistently, accurately and down to the business data, quote, request for quote and transaction flows and into the individual event histories. 86 | january 2011

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With the complete instrumentation of the business flows other more dynamic benefits can be realised. The advantage of the spanning of both software and network/hardware is that there are multiple options for the probes to be put in place. The probes can be turned on and off dynamically so that additional data may be gathered only when latency in a particular segment of the business flow needs to be analysed in more depth and then the probes switched off. The probes themselves don’t need to know where the other probes are. They only need to be put in the places that are to be monitored. Once enabled, as messages pass the probe, data is serviced back to the Analysis Centre. This dynamic probe capability can also be used to control the data volumes and processing demand that the monitoring environment might be creating. The data is immediate and once gathered is available for manipulation through a number of alerts, aggregator and historical and charting engines that you would expect. There are some interesting spin-offs from this data collection. There is a new set of business flow data that can be analysed in real-time and then stored into appropriate historic databases for further analysis. The collection of the flow data allows the interpolation of both business and technical data, so allowing alerts to be created if particular simple business rules are broken, for example a customer using your FX flow business is constantly hitting the quote at the extreme end of the quote validity window.

Pro-active management Now Flow businesses can see where particular customers are interacting with their systems in

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real-time and monitor the individual customer flows across their infrastructure. This allows proactive management of those flows - where they are interrupted alerts can be raised and solutions put in place, where claims are made about the efficacy of the FX service being provided a detailed report of each and every transaction can be provided, including when and which prices drove the trade, which quotes were driven from which prices and at what time. All this is at the FX business finger tips. The development teams, through the use of strategically or tactically placed probes, are now able to model the impact of different scenarios across new releases of the architecture within the “safety” of the development environment. One global FX organisation has created a business flow performance SLA as part of the acceptance criteria for the roll-out of Flow business systems. Once the probes have been embedded in the development environment, they can then be switched on or off as required in the production environment. As FX businesses are discovering this capability so the opportunity to utilise this new set of temporal real-time data to optimise FX Trading is being explored. It is early days yet, but gradually more FX driven organisations are demanding this type of instrumentation. This new approach does beg the question – we have managed to survive so far and we are profitable, why should we spend even more money on latency instrumentation? Indeed discussing this recently with an Algorithmic Trading Institution CEO, he stated, “I have spent a fortune on hardware, software and people – and it doesn’t seem to be stopping, and my people are telling me that I will have to invest more if I want to stay in this pace race!” As organisations are spending millions of dollars improving their FX businesses, this is exactly the time to invest in appropriate business flow instrumentation and analysis. How else are you going to benchmark the performance of your low latency FX systems 88 | january 2011

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except through the analysis of the business flows across each and every element? Indeed, can you afford not to? Could this be viewed as “yet another layer” of monitoring, adding more expense and time being taken up by operational staff? An organisation will still need all its first and second generation technology monitoring environments to determine the root cause of issues. A key element of this performance management is the need to link into these low level tools to help determine the technology or programming issues. Crucially with this extra layer the business can now see immediately where the latency for their business flows is occurring and target the most appropriate resources, sometime even before the latency causes significant pain. No more committees of representatives from networking, operations and development denying that they are the cause of the problem!

Conclusion The business case justification for this new performance management approach has to be carefully thought through. Time needs to be spent in the proving of the approach within the target technical environment. Impact analysis of the probes has to be undertaken and staff have to be brought on board and be comfortable with this new way of monitoring. Once the monitoring systems are in place, the data gathering is immediate, so the data has to be managed. These systems do not replace your tick data base, but can feed it with some temporal data points. There is a new set of temporal business flow data, and large amounts of it, and that need to be stored. There are sets of real-time reports that the business will want – new graphs to display latency across both business and infrastructure. FX is leading the way in developing this technology as the benefits can be large and immediate, and crucial as business latency drives down business performance. The new third generation of monitoring environments is emerging and with it come exciting new challenges to deliver effective FX business flow monitoring. The biggest impact of this new technology will be on the FX bottom line.

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e-FOREX : INTERVIEW

The boys are back in town e-Forex talks with Paul and Howard Tolman at Beta-Gamma Research

Beta-Gamma Research is an algorithmically focused software house based in London with an office in Australia. The principal role of the company is to provide software solutions which enable banks and financial institutions to enhance their profitability, efficiency and risk management. Dr Paul C. Tolman, the founder, has a PhD in Mathematical Physics from Cambridge University and is former Head of Quantitative Trading at Royal Bank of Scotland Financial Markets. He is an expert in concurrent programming and applied Bayesian statistics. Paul’s uncle, Howard M. Tolman, is CEO at Beta-Gamma Research and has extensive experience in banking and in particular FX IT.

Howard, algorithmic trading continues to gain in popularity within FX. What sort of firms are approaching you for help with deploying Algo trading techniques and what types of tools and strategies are they looking for? HT: Before answering this I would like to mention why BetaGamma was formed. Our founder Paul Tolman took the view that there were a large number of institutions that could benefit from using algorithmic based trading technologies but could not justify the expense associated with it. We identified our principal market as being banks in the second tier and below, however we have attracted interest from Hedge funds, wholesale and retail distribution platforms as well as banks. It’s fair to say that the principal interest in the banking market at this time is for infrastructure which is why we developed the Aggregation tool. Until a bank has reasonable rate management in place they cannot really reap the benefits which our flow and risk management tools can offer. It’s important to stress that we are firstly a product based company. We are not generally in the business of writing custom made algorithms. Paul Tolman

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>>> Trigger Trader is the core algorithmic trading system provided by Beta-Gamma. In what ways do the execution algorithms and trading tools provided by this solution provide competitive advantages?

has the capability of raising profitability while at the same time reducing risk. Of course the user has to arrange the workflow in such a way that the flow can be managed efficiently in the first place. That is not always the case.

HT: Trigger Trader is the product name we use for a collection of algorithms which manage risk and flow and as such it is a reactive tool. Our first bank deployment is a black box solution but there is absolutely no reason why the trading strategy algorithms could not be rolled out on any aggregation platform including our own. In this way we are providing dealing room automation which reduces direct costs. But the principal advantage is that the flow management algorithms can make money for the user. Efficient flow management

Howard Tolman

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Do you believe we are moving away from a pure “black-box” approach to algorithmic FX trading towards a more transparent environment where algorithmic toolkits developed by providers like Beta Gamma are more easily accessible? HT: Frankly yes. Of course we are always going to see black box stuff developed and deployed. After all people are still trying to break the Bank in Monte Carlo. Dr. Paul is quite capable of writing proprietary trading algorithms which may well make a lot of money but if we wanted to do that we should start our own hedge fund and put our money where our mouth is. Having said that, this is something which we may well do in the future. I can’t speak for the whole market but Beta-Gamma’s design philosophy is to build a huge amount of client configurability into the core applications and to then make it easy for business users to react to market or internal circumstances instantaneously. What we cannot do is predict the unpredictable. Events like 9/11 do happen and if you are the wrong side of a risk position at that point, well you can’t beat bad luck. We provide a myriad of configurable parameters within the trading toolkit which are accessible in real-time and can provide a whole series of different outcomes depending on appetite in different areas.

What factors are important in helping trading firms decide whether it is better to deploy off-the-shelf or customised FX algorithms? HT: At the end of the day it comes down to what you want to achieve. Cost is also an important factor. If you want your own team of quants then be prepared to pay a lot of money for it. They don’t come cheaply and are not always good. Likewise if you want a customised Algo developed by a vendor for prop trading then be prepared to shell out as you’ll have to pay up front even if it doesn’t work in the end. As I said earlier it comes down to what is actually required. There is a huge difference between wanting to manage an existing situation more efficiently and profitably and starting from scratch. Give some rigorous intellectual analysis of what you have and what you want to achieve. If you conclude that your current set up is leaving money on the table then work out what the solution might be. My preference would be to buy an off the shelf solution with high levels of flexibility, but I would say that wouldn’t I.

Do you see any particular risks associated with customising algorithms and does customisation make attempts at benchmarking Algos much more difficult? PT: When the algorithms are our own, configurable parameters are always checked to be in safe ranges. Further a number of in-built risk controls limit the positions taken and the number of trades placed by any Algo. We also provide the option for our customers to automatically measure the performance of execution Algos by benchmarking them, for example against the expected fill rate of classic smart order routing execution. We also provide a full simulation of the aggregated market, ensuring that the behaviour of Algos in volatile or wide markets can be tested before they are sent live.

What steps do you recommend that clients should take to measure the success of a specific algorithm or combination of Algos? HT: It might sound like I am being flippant but the key to being able to measure the effectiveness or otherwise of any algorithm or combination of algorithms is proper management of the underlying data and frankly not every trading house has this capability. I do not want to go into too much detail as this is an obvious requirement but suffice to say that proper analysis of performance can only take place if 92 | january 2011

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The boys are back in town

all of the components of why trades were executed are capable of being collected properly and this includes, in the flow management sense, the data coming from the underlying client trades or other flows. The design of Beta-Gamma’s applications allows a comprehensive calculation of performance against specific benchmarks which are subject to configuration by the client. This is to my mind a very important part of the proper management of FX positions. It is obviously important to measure the profitability of electronic distribution channels by client but not everyone has this capability. Once again I think it is down to the client being rigorous in determining what they need in the way of reporting and ensuring that they have the methodologies to deal with it. Fortunately for us BetaGamma’s applications have this capability built in.

>>>

In what ways can we expect to see algorithms becoming more “intelligent” and flexible with respect to their order management and strategy execution capabilities? PT: Modern manual traders, whether clearing or prop, are used to working with the machines. We feel a key element of flexibility is to allow the traders to control the Algos and not vice versa. We try to get away from the closed “black box” mentality of execution strategies and instead provide a framework in which traders, provided with at least a qualitative understanding of what an Algo does, can configure and customize it to perform different roles depending for example on the currency pair or the context in which the algorithm is being used. Essentially this allows human intelligence to be overlaid on the application technology.

The Beta-Gamma Research offering currently consists of four products, all designed in different ways to work together in creating a more efficient and profitable execution and Algorithmic trading environment: FX Aggregator: which can sit alongside other aggregators has a client or browser based front end. FX Aggregator gives access to depth of market, which can be viewed via a bar chart instantly showing who and how deep the market is in realtime. FX Aggregator features various execution principles, including the ability to trade passively as well as actively, and can take into account differences between trading venues. The system shows rates very clearly, by displaying the main last digits of a currency in a far larger font than the first two, making it easier to really see the rate quickly by just glancing at the screen. Colour coded “Power Dealing Buttons” make one click execution easy. The aggregator can connect directly to banks and or liquidity providers or to to an existing aggregation system on the organization’s intranet. Trigger Trader: is a modular algorithmic trading system and can be “optionally integrated” into FX Aggregator according to Dr Paul Tolman. Features include market access, order placement and management, position and risk management, execution algorithms and performance reporting. FX Blotter: provides real-time open position information, mark-to-market (by currency pair and by product) as well as session profit & loss and a fills table, which can be sorted and filtered. It is available

as a stand-alone module or as part of FX Aggregator. In addition to the above several add-ons are available to FX Blotter: These deal with Profitability Analysis, Order Management and Risk Management. The Risk Management module uses Beta-Gamma’s proprietary Bayesian short term model of variancecovariance to provide the ability to calculate real-time value-at-risk (VaR) over any time frame, and can provides automatic calculation of optimal hedging trades. FX Toolkit: is an earlier product from the BetaGamma stable aimed mainly at quantitative market analysis at daily frequency. Some of the models and methods are however used in Beta-Gamma’s high frequency products. Quantitative models include Model View which compares different portfolio models, Bayesian covariance – an advanced model of volatilities and correlation model and Bayesian gambler - which provides an objective view of the optimal portion of the available capital to “bet”, given current market conditions. Other models include Market Coherence Index - designed to produce strong signals ahead of major market events, an advanced Stop-loss calculator, FX Backtester and Signal-Stabilisation – which uses an application of Bayesian control theory designed to stop the common problem of model “whiplash” with minimal impact on profitability.

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>>> Beta-Gamma recently launched FX Aggregator. What is this aggregation engine designed to do and what benefits does it provide?

Do you believe there will be more demand for specific FX algorithms as high frequency and systematic model driven trading spreads into emerging markets and is applied to less commoditised currency products and more complex order types? HT: I would have thought that this was more or less inevitable. The FX market has always been extremely innovative.While some things have not moved as fast as they might have done the improvement in the quality of the technical components which drive electronic FX execution in recent years has been impressive. In fact is already happening. I was speaking to a day trader the other day who trades in only one exotic currency pair and makes a nice living on the proceeds. FX will surely follow along the same path as equities did. If anything, technology is moving faster than ever and this is going to create opportunities for those people who are smart enough to handle it and espouse the necessary advances quickly enough. One of the drawbacks of fast moving technology is that shelf lives of particular strategies or technologies are getting shorter and shorter. Take ultra high frequency latency arbitrage as an example. It is not that the advantages go away completely but as time goes on the bottom line suffers as technology expense rises inexorably and profitability is eroded through competition 94 | january 2011

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HT: Although we have just launched this application we have been using the aggregation capacity within a black box trade out system for the best part of two years. I probably made a mistake in positioning the trading strategy algorithms ahead of the aggregation capability. We launched the Trigger Trader flow management product in February 2010 and while it created a great deal of interest it became obvious within a few months that the market was very heavily focusing on trading infrastructure. As such we put the cart a little a little way ahead of the horse. FX Aggregation is the science of pulling together all of the component FX data feeds and execution channels in order to maximise opportunity and ensure the best possible rates of execution. The strength of individual applications from different vendors of course varies however some of the technology is already outdated. We are very proud of our Aggregator. It’s design, thanks to Paul who is the ex Head of Quant trading at RBS Markets, is state of the art, written end-to-end in C++, and it is extremely fast and has the significant advantage of being designed for use by professional traders using easy to use tools that allow them to manage trading algorithms in real-time. It assists traders in their job, making them more productive and more profitable.

In what ways are traders able to configure the builtin execution algorithms within FX Aggregator? HT: We provide a simple algorithmic input GUI which the trader can use to install de install and amend trading algorithm parameters in real time. These algorithms can then be attached to Power Trading buttons under the control of the Trader. Of course a huge amount of the day to day work of a dealing room can be handled electronically but the market is also heavily influenced by events happening

e-FOREX : INTERVIEW

in the real world. Our applications allow traders to take account of these occurrences. Traders can also enter a series of what ifs to customise their trading activity to deal with any eventuality.

What connectivity and installation issues need to be addressed for implementing an FX Aggregation framework like yours? HT: Here again we differ from a lot of companies. Our applications ultimately replicate what individuals could do if they had the knowledge and capability and there were enough of them. In fact most applications do just this. Well you don’t plug a trader in when he arrives at his desk in the morning and we feel that deep integration is a two edged sword. Most companies have pretty sophisticated back office trade capture and management systems. This inevitably leads to duplications. The stuff that must be handled really quickly i.e. getting the orders in the market and filled will work better the more it is left alone and is not relying on other integrated applications which might slow it down. So we have designed our software so that in most cases a minimum of integration is required: opening a port in the firewall for the market venue connections and setting up a dealing account in the back office systems . Obviously this cannot always be the case but certainly within banks deep internal integration massively increases not just start up but also ongoing costs, generally speaking slows things down operationally and thanks to human resource limitations complicates and spins projects out far more than absolutely necessary. In an ideal situation a Beta-Gamma FX Aggregator deployment takes a matter of days.

Do you think there are any significant knowledge transfer lessons that FX can learn from the continuing development of algorithms in other markets? HT: Undoubtedly. However where we are presently is in the information gathering phase. I think it is true to say that the principal characteristic of those people who develop trading strategies within a specific asset class should be a deep knowledge of that asset class. While there are no doubt common characteristics within asset classes specifying them is a real intellectual exercise. 96 | january 2011

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Do you see the evolution of more advanced FX trading strategies impacting on the future development and implementation of FX algorithms? HT: Yes the two are interlinked. But FX algorithms are not new. I had some discussions around automated execution over the Cognotec platform based on historic analysis of market data in the mid 1990’s. The guys concerned were very bright and had access to an array of Crays at the ZIT. It didn’t come to anything but there was activity in the space even back then. Where it eventually leads to I don’t know but FX is not a totally predictable market whatever anyone says. It needs real people with real brains and emotions. Right now we are trying to help those people improve their performance.

Looking ahead where will leading technology providers, like Beta-Gamma be looking to extend the functionality of algorithmic FX trading toolkits to take strategy execution to new levels? PT: Beta-Gamma is active in quantitative research in areas such as risk and directional forecasting. We employ this research both to developing new and enhancing our existing execution strategies, and in providing quantitative tools as plug-ins to our applications. Our work on simple multi-language APIs is intended to allow clients to easily integrate their own algorithmic strategies into our applications. In addition, we are researching user-interface enhancements to allow manual traders to more easily exploit the opportunities in the aggregated market.

FX ON EXCHANGES

Venues, products and users: momentum builds for FX on Exchanges While there has been much focus on the regulatory pressure to push FX towards regulated exchanges to mitigate central counterparty risk and eradicate highly leveraged unprotected trading in the retail market, exchanges around the world are also benefiting from the natural evolution and growth of the FX market. The increasing size of that market, along with the development of different instruments and products to cater for its various segments, have both contributed to the evolution of trading FX on exchanges that were originally built around equities and interest rate derivatives. As demand for exchange-traded FX is set to grow Frances Maguire looks at the products and technology that the leading exchanges are developing to attract new FX business.

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arlier this year, the triennial Bank for International Settlements (BIS) survey reported that foreign exchange has surpassed daily volumes of $4 trillion. From April 2007 to April 2010 the market grew by 20 per cent. According to Derek Sammann, managing director for FX and interest rate products at CME Group, volumes traded in CME’s FX products grew by 94 per cent in the same three year period. Additionally, this year, the CME Group saw a 50 per cent increase in its FX business, compared to a growth of 16 per cent on EBS Sammann attributes this growth directly to counterparty risk mitigation. The BIS figures show CME Group’s FX options business growing 226 per cent whereas the OTC FX options market shrunk by 2 per cent during the same April 2007-2010 time period. “If you just look at the quantitative data, relative to any other benchmark, it tells a story of the continued out performance of CME’s FX listed futures and options business and of a broader and a deeper adoption of listed FX trading on-exchange,” he says. Currently CME Group’s FX complex offers futures on 52 different currency pairs and options on 31 currency pairs. Sammann says growth in the exchange-traded FX landscape is significantly outpacing the growth of the OTC market. “This is not to say that there is a market shift, on a zero-sum game basis and that exchange volume is growing because OTC markets are shrinking. That would be the wrong conclusion to draw.” “If you take our growth rates over the last five years and compare to growth stats on the ECN space and you will find that we have grown at a faster rate.” Sammann notes that that there is a direct correlation between the peaks and troughs of the OTC and exchange-traded markets over the past five years. He says: “There is a symbiotic relationship between the listed products’ business growth and the OTC growth. When the OTC markets grow, exchange volumes grow and when the OTC markets are

CME Exchange

shrinking, the exchange markets are either flat or shrinking as well but there is a large differential in the growth rates. Both markets are growing but the exchange market is growing a lot faster. As we grow our business it is beneficial for the cash market participants and as they grow their business it is typically positive for our business as well.”

Factors driving growth in FX on Exchanges For Sammann there are several key factors driving the growth of volumes in FX exchange traded products. Over the past 18-24 months there has been a much greater appreciation of counterparty risk in the foreign exchange market. Sammann says that traders are much more attune to the risk in the bilateral nature of many of their FX transactions, and with fewer participants available, there has been a growing interest in finding broader pools of liquidity. “By providing the mechanism that eliminates the counterparty risk we can bring together a much more diversified and broad array of market participants, without the risk of endangering transactions or relationships. The central counterparty model has become very interesting for customers to add to the overall pools of liquidity,” he says. He also believes that the FX market is becoming much more aware of the need, and the benefit, for transparency both for execution, for market data, and also the transparency of the market data that comes out of venues like CME Group. One of the hallmarks of the exchange model is that everything transacted goes out as market data and january 2011

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Sammann says that customers are seeing that this rich amount of market data can help them make better trading decisions. Additionally, Sammann says that the continued investment by customers in technology has encouraged the exchange to do so too. Investment has been made in enhancing matching engines, improving matching speeds and investing in technology centres to enable quick, low-latency customer access. CME Group now has matching speeds for foreign exchange that are in the sub-3 millisecond range to cater for customers that are latency-sensitive. Sammann also believes the broad multi-asset class offering at CME Group is yet another benefit as once the initial connection is made for one product, adding access to other products and asset classes is easy. He says: “It is easy for us to cross-sell customers into foreign exchange, and as FX grows and matures as an asset class in its own right, customers from other asset classes like equities, or interest rates, can move seamlessly into foreign exchange.” For hedge funds, the access to deep liquidity, low entry and exit costs and competitive execution as well as the guarantees on counterparty risks are attracting these customers to exchanges. Equally, says Sammann, retail investors are just as well catered for. CME Group offers retail investors the same level playing field and access to the same prices as institutional players. For this reason Sammann says that the auction-style market of the central order book is very attractive to retail traders. “Everyone has access to the same price, on a model that CME Group calls First In/First Out, no matter who you are. This speaks to the integrity of our market,” he adds.

Move towards matching According to Sammann, there has been a significant shift in the past 18 months in retail and margin trading platforms that are moving away from the dealing desk model to matching systems. “We provide the most fair and transparent markets out there, and the products that are highly liquid and highly electronic are CME Group’s most successful,” he says. The FX e-micro contracts, launched last year, had further product changes in July, with the introduction of retail-sized futures contracts (one tenth the size of a standard futures contracts) which provide retail customers with a product that has the right risk/ reward ratio for them. 100 | january 2011

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For high-frequency traders, CME Group rolled out proximity hosting through a facility called L-Net, a proximity solution that allowed latency-sensitive customers to host their applications close to the CME Globex matching engine. Since then, the exchange has built a co-location facility that will go live in 2012. The application process for the first tranche of customers wanting space in the facility has just closed. Says Sammann: “This is our next step in latencysensitive technology innovation by moving from proximity hosting to true co-location, with a facility that is going to be owned and operated by CME Group.” As well as offering execution-agnostic clearing, Sammann says there is an increased interaction with central order books in foreign exchange and CME Group’s business reflects this. “Customers are looking for execution venues that are linked to clearing, like CME Globex. They are very happy with the matching speed, the breath of products and the safety and security of trades cleared through CME Clearing.” Options now represents 5-7 per cent of CME Group’s total turnover in foreign exchange, and Sammann believes that there will be an outpacing per cent of growth in options in the next couple of years, particularly because, as products with expiration dates between a month and a year, they are ‘counterparty intensive’.

“As we grow our business it is beneficial for the cash market participants and as they grow their business it is typically positive for our business as well.”

Derek Sammann

Venues, products and users: momentum builds for FX on Exchanges

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“There will most likely be more investment in onexchange options’ trading as more customers become comfortable with electronic trading of options on-exchange,” he says. Going forward, Sammann says that exchanges will not ‘win’ business exclusively at the expense of the OTC market. “The best thing we can do, to increase our volumes on-exchange, is to get them to add cash to their liquidity pool. Customers at CME Group are not just trading futures and options products, they are trading the OTC market as well, and we are trying to build broader market participation across both futures and OTC because when they add OTC to their futures liquidity, they tend to trade more in both. Sammann says: “It is a process of globalising and diversifying the customer base. We are not just trying to convert cash traders to futures traders. That just doesn’t work. It is very much the opposite. We take our successful futures traders and make sure they are trading in the cash market as well.”

Impact of regulation The new leverage rules and clamp down on unregulated margin trading in the US are also expected to spur new growth on the exchanges as retail investors look to currency futures to enable them to gain access to leveraged trades. To this end the North American Derivatives Exchange (Nadex), a retailfocused futures exchange regulated by the CFTC, has developed OTC lookalike contracts to offer fullycollateralised contracts to retail investors. Yossi Beinart, president and CEO of Nadex puts the size of the retail FX market in the US down to the fact that spot FX, and some commodities, are the only OTC markets that retail investors can trade. Now, the incoming regulation around consumer protection, market transparency and counterparty risk is driving this volume onto exchanges.

Nadex

He says: “The regulators have made the OTC market less and less attractive to investors. The capital requirements have risen dramatically and immediately wiped out a very large number of firms, mainly through mergers and acquisitions, leaving the spot FX OTC market with about ten major players.” Furthermore, the regulators are now ensuring the leverage is not better in OTC than exchange products, and brokers can no longer compete on leverage as they are all comparably regulated.

New alternatives to OTC products Beinart says the overall impact is that exchange trading for retail investors in the US is growing fast. Nadex offers two types of products, the binary option and the bull spread, that Beinart says combines the best of both worlds by offering limited risk and high volatility. The exchange’s binary contracts are all-or-nothing contracts that payout a fixed amount to the side of the trade that finishes in-the-money. Spread contracts offer traders a variable payout structure with controlled risk by limiting the value of each contract at the upper and lower ends of each spread’s range. A trader’s potential loss will not exceed the amount invested, and the potential gain is limited by the contract’s cap (for buyers) or floor (for sellers). Binaries can offer significant price movements even when the underlying market has very low volatility, allowing traders the opportunity to profit even in quiet markets. Despite their potential volatility, binary contracts are designed to limit the risk to traders january 2011

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so that they get the best of both worlds – multiple trading opportunities with limited risk. Beinart says: “One feature of the OTC market that some customers dislike is the fact that the slightest move against them can result in the immediate liquidation of their position. Even if the market went slightly against them for a brief period and then recovered they would have been ‘stopped out’.” Some of the strategies offered are very close to OTC spot FX trading, and some are more sophisticated and ‘option-like’. All are highly leveraged, all are strictly limited risk and none can result in a trader being stopped out by an intermediate adverse move. If the underlying market moves adversely beyond the range of the contract – the contract remains live until expiry, regardless of underlying market movement. A Bull Spread is a single contract equivalent to a daily or intraday call option spread strategy. The Bull Spreads’ settlement levels track the underlying markets within certain pre-set limits. Like Binaries, Bull

“There is a direct correlation between the change in the margin and the amount of trading that is done in OTC forex market.”

Spreads cap traders’ exposure, as settlement cannot occur outside the pre-set limits. Bull Spreads will, in general, move in price no faster than the underlying market, and have a payout structure which is variable, rather than “all-or-nothing.”

Making derivatives more accessible In total, Nadex offers 70 FX Bull Spread contracts daily for each of the five currency pairs traded. Beinart says the exchange has designed its contracts to make them familiar to the OTC market, to make derivatives easier to understand and more accessible. Launched in October, Beinart says the launch of FX bull spreads has already tripled the volume of spreads traded on the exchange. Also, for the first time in the exchange’s history spreads traded have outnumbered binary options. He says: “The bull spreads are a good and interesting alternative to trading spot forex. We have made the spreads much narrower, and shortened the terms and made them more attractive to investors.” The exchange currently has about 250 customers that are active, but it is gearing up for growth, and has just finished upgrading its entire technology infrastructure and back office system. “We now have capacity. We have a system that we are confident can sustain 5-7 years of growth,” he says. Furthermore, by changing its designation earlier this year, Nadex can now expand its reach to new customers much faster by signing up brokers as new members, rather than having to recruit customers directly. Beinart says this change in its distribution model, more akin to a traditional exchange, has already made a dramatic difference to how fast the exchange can grow. However, he believes it is unlikely that the highfrequency traders will come to the exchange as the small-sized contracts have designed for retail traders and are not suitable. Beinart believes that the new rules on leverage in the US will dramatically impact, and reduce, the OTC market. He says: “There is a direct correlation between the change in the margin and the amount of trading that is done in OTC forex market.” Nadex was formed when IG Group acquired the HedgeStreet Exchange in 2007. Re-launched initially as Hedge Street, it was then renamed in 2009.

Yossi Beinart

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Venues, products and users: momentum builds for FX on Exchanges

Beinart says: “Retail customers in the US are used to trading futures on indices, gold and oil and they are used to exchange trading, so we think they will be interested in trading forex as well. There are two kinds of customers we are going after: the OTC forex retail customer and the people trading on exchange in other asset classes through both traditional OTC forex dealers and traditional futures brokers, which are two very distinct market segments.”

Growth in the East Exchanges in Asia are also experiencing similar growth. Thomas McMahon, CEO of the Singapore Mercantile Exchange (SMX) believes that the unregulated independent FX platforms, enabled by technological advancements and operating in isolation, actually increase the lack of transparency in a market already risky by nature. He says: “Although there are many non bank or exchange affiliated platforms currently in the market, the costs of trading on such platforms are built into the spreads compared to cost transparency trading on a highly diversified multi-product currency and commodity/other financial instruments exchange.” He also believes that the sweeping regulation on derivatives trading that are among many other demands now pressing on investors, brokers and traders to enforce stricter risk management policies than ever before means volumes for exchange-cleared FX products will only keep increasing until they will eventually become the standard.

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pairs, addressing pan-Asian currency pair demands.” SMX’s technology backbone is provided by its parent group Financial Technologies (India) which is already at the cutting-edge of tech-centric exchange infrastructure. “Our open architecture is built on ISV partnerships and enables ever-increasing accessibility and connectivity to world-class FX trading platforms and best-in-class high frequency, algorithmic traders and trading systems,” McMahon adds. He says the SMX platform was designed specifically to be extremely scalable, but robust, at every developmental milestone. By offering multi-currency multi-asset pricing, trading and clearing, market participants gain tremendous cost-savings in terms of conversions, transfers and liquidation. McMahon believes that in the current regulatory environment FX trading on exchanges is set to become more widely adopted, even becoming the standard,

“Aside from leading global benchmark pairs, investors these days are also expecting more access to growing niche, regional, and exotic pairs alongside traditional vanilla products, and embedded incentives, such as fee discounts and/or rebates.”

McMahon says that investors coming to exchange trading are looking to trade currency pairs, directly complementing their commercial or non-commercial requirements. They are also currently seeking liquid markets with tight, competitive spreads, and a diverse product range. “Aside from leading global benchmark pairs, investors these days are also expecting more access to growing niche, regional, and exotic pairs alongside traditional vanilla products, and embedded incentives, such as fee discounts and/or rebates.” At present, SMX lists Euro-US Dollar futures and has listed some unique contracts such as Brent Crude futures that are denominated in euros and which can serve as a very effective currency hedge with an edge over available strategies in the market at present. McMahon adds: “Going forward, however, SMX will be rolling out major, exotic and bespoke currency

Thomas McMahon

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actively exchange-traded currency contracts globally, by number of contracts traded. A third exchange, the United Stock Exchange (USE), launched in September 2010, also offers futures on four currency pairs, including the dollar/rupee. In the first week of trading USE traded 5.64 million contracts. Although the contracts are small-sized ($1,000) MCXSX traded 79.4 million contracts in June 2010, while NSE’s contract traded 68.3 million times. Joseph Massey, MD&CEO, MCX Stock Exchange, says that recognition of the importance of hedging risk in volatile market and currency fluctuations has today’s markets has seen participants in all economies look to the exchanges. He also believes that globalisation will further increase the demand for exchange traded currency products, mainly on account of transparency, liquidity, flexibility of timing, exiting and pricing, cost of hedging and risk coverage.

Joseph Massey

“Indian investors are already highly active in exchange traded currency futures, and will look forward to trading not only on currency options on spot but also currency options on futures as and when introduced in the Indian market.” while unregulated FX platforms will diminish. He compares the trend to the move from open outcry exchange floors to the screen and fully-electronic 24/7 brokerages. And with this adoption McMahon believes that Asian exchanges will eventually rank higher among the world’s largest, exchanges, in line with the domino effect of emerging economies on trade and finance. He puts most of this trend down to the regulatory changes in the OTC markets, which he believes will eventually mean clearing for most FX products. However, He also believes that multi-currency and multi-asset pricing, trading and clearing exchanges will be preferred platforms due to cost-savings in terms of efficient use of collaterals.

India Exchanges in India have also experienced dramatic growth in currency contracts. The US dollar/rupee futures contracts traded on MCX Stock Exchange (MCX-SX) and the National Stock Exchange of India (NSE) have soared to become the two most

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Massey says: “Indian investors are already highly active in exchange traded currency futures, and will look forward to trading not only on currency options on spot but also currency options on futures as and when introduced in the Indian market. One of the innovations the market is waiting for is the timing of market and whether it should be extended to make these markets available during global timing, as currency markets are most active when the US is open.” Initially, MCX-SX introduced trading in the single currency pair, USD/INR, and subsequently in Feb 2010, added EUR/INR, GBP/INR and JPY/INR. Massey adds: “MCX-SX enjoys the highest market share in currency futures and the overall currency derivatives segment in India.” The exchange’s strategic partner, Financial Technologies (FTIL) group, has established itself as India’s pioneer technology company in the financial sector. “We have ensured that our users have all modes of high speed connectivity based on their needs with adequate resilience and fault tolerance. Similarly, as required and also as demanded, we have been providing our users with the necessary solutions for front end trading technology, back office, risk management, mobile trading and algorithmic trading,” says Massey. India’s telecommunication sector has grown and the exchange’s trading members can now choose connectivity through VSat, leased line or the internet. The trading infrastructures are also well developed, with regulatory permission for trading through mobile phones.

Venues, products and users: momentum builds for FX on Exchanges

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With the increase in cross-border transactions, which currently represent 65 per cent of the total FX turnover, according to the BIS survey, Massey believes that exchanges have a major role to play in terms of offering tighter bid-ask spreads and lower transaction costs. He says: “With the increase of trades denominated in other currencies, as suggested by the BIS survey 2010, we strongly foresee the market for these currencies along with the cross currency-pairs on Indian bourses.” “Going by the appetite and the growth in India and other emerging markets, more and more standardised products are expected to be introduced and one can be cautiously optimistic about the prospects of this market segment. We also hope that timing of this market can be extended so that Indian industry may cover its currency risk simultaneously, just as it covers its raw material risk on commodity exchanges.”

José Antônio Gragnani

“We want to double capacity in order to offer high frequency traders an even more secure environment.”

Brazil In May, Brazilian exchange, Bolsa de Valores, Mercadorias e Futuros (BM&F Bovespa) launched five new currency futures contracts for trading. Furthermore, Brazil Easy Investing, an order routing system designed for trading Brazilian equities in foreign currency, has just started to be developed this year to be launched next year. It will enable foreign investors to route orders in their local currencies and provides the simultaneous FX execution for the trading of stocks listed in Brazil allowing non-residents to match stocks in US dollars and other currencies. José Antônio Gragnani, chief business development officer at BM&F, says: “The strategies have already started this year, to provide differentiated fee tiers for day trade transactions executed by high frequency traders (HFT) . We have also created a high frequency trading committee to approve and monitor the HFTs. Additionally, we are implementing a market maker program in two phases, the first was in November and the second in January, for consolidated volume executed in more than one broker.” In the Bovespa segment, different tiers will be created for individuals and non-individual HFT investors. In the BM&F segment, the 70 per cent flat discount will be replaced by a volume tiered discount for day trades.

BM&F Bovespa Exchange

Exchange connectivity and trading infrastructures have been in development since 2008. BM&F Bovespa has provided four modules where DMA 1 and DMA 2 represent, respectively, access through a

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an important role in providing a viable risk management platform to mitigate those risks.

RTS Exchange

broker infrastructure and authorised access provider, while DMA 3 offers direct access and DMA 4 colocation, where the client installs its server inside the exchange to allow high frequency trading, under its responsibility and control. Since September, BM&F Bovespa has also offered all options of DMA to the equities segment. Gragnani says: “We are currently building two new data centres that will replace the five that we currently manage. We are also improving capacity, which is reviewed each year, and for this year, our goal is to double our current capacity to 3 million trades on the equity side and 400,000 on the derivatives side by the end of this year. We want to double capacity in order to offer high frequency traders an even more secure environment.”

The Middle East In 2009, the Bahrain Financial Exchange (BFX) set up its operations in Bahrain, in advance of its go live in early 2011. The BFX will be internationally accessible to trade cash instruments, structured products and Shariah-compliant financial instruments as well as derivatives. The BFX CEO, Arshad Khan, says that the growth and turbulence of global trade has given rise to increased exchange rate fluctuations and that currency derivatives play 106 | january 2011

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He says: “Users of currency derivatives are primarily interested in trading currency futures and options. Hedgers like the fact that currency futures and options offer them a standardised and simple way of offloading their currency risk without having to worry about market, credit or counterparty risk. Investors are happy to invest in currency futures and options due to their ability to provide leverage and higher potential gains.” The BFX intends to offer the full spectrum of currency derivatives in due course. In its first phase, the BFX will be launching dollar denominated futures contracts in euro, pound sterling and Japanese yen. The futures contracts will be similar in maturity, size and other specifications to those trading in international markets, providing investors an arbitrage window. The futures contracts would also help hedgers in the MENA region offload their currency risks due to unexpected movements in the euro, sterling and the Japanese yen. “We foresee a lot of potential in our currency futures contracts and are confident of achieving comfortable levels of liquidity for transactions to happen successfully and smoothly,” Khan adds.

BFX Exchange

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Arshad Khan

“We foresee a lot of potential in our currency futures contracts and are confident of achieving comfortable levels of liquidity for transactions to happen successfully and smoothly,” The newly-built exchange has chosen to operate on a scalable model ready to accommodate any kind of technological upgrades needed, instantaneously. Khan says The BFX is offering first of its kind services to its members, such as co-location of servers and an onsite trading venue to support highly technology intensive trading strategies. He adds: “The recent Bank for International Settlements (BIS) survey results reinforce the fact that exchange traded derivatives are here to stay. As trade in goods and services rises and economies start to integrate even more closely, risk management through standardised instruments is only set to rise as a service to mitigate general trading risks. In fact, the total outstanding notional value to June this year has already surpassed the total traded volumes in 2008 & 2009.”

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Khan believes plain vanilla futures and options will be the popular choice of instrument for some time. However, at the same time, he adds, institutional investors are evolving rapidly and technology-driven trading strategies will be the differentiating factor in defining access to markets like the BFX.

Russian perspectives In Russia, currency trading is also taking off. RTS Group operates the central counterparty, the

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settlement securities depository and the settlement house for rubles and foreign currencies. International members of RTS include Deutsche Bank, CSFB, UBS, and Morgan Stanley. The Futures and Options on RTS (Forts) market lists 36 futures and 13 options. Evgeny Serdyukov, director, Forts market, RTS Stock Exchange, says that investors are principally interested in volatile and highly liquid instruments such as the futures contracts on USD/RUB and EUR/USD. He says: “These contracts are interesting to market participants, both in terms of speculative trading and for hedging currency risks, which is sought after during times of financial market downturn. The futures contract on EUR/USD exchange rate has become a popular speculative tool, whereas the futures on EUR/ RUB currency pair are popular among hedgers.” RTS offers futures on USD/RUB, EUR/USD and EUR/RUB exchange rates and options on the USD/ RUB and EUR/USD futures contracts. Up until February 2009, RTS only traded futures and options contracts on the USD/RUB currency pair and launched the two further currency pairs in response to investors’ needs. Additionally, the exchange now offers futures trading on the USD/RUB currency pair with settlement on September 15, 2015 -- the longest

settlement term among existing instruments on the Russian stock market. Says Serdyukov: “This five-year instrument was launched due to numerous appeals from market participants who needed long-term hedging of currency risks. Russian enterprises and companies engaged in dynamic foreign economic activities, or who are subject to currency risks, can now plan their financial budget five years in advance.” The exchange has also launched new contracts for speculators. As E-Forex went to press, futures contracts on GBP/USD and AUD/USD exchange rates were set to be launched and in early 2011 the exchange plans to start trading USD/JPY and USD/CHF currency pairs. Market makers can connect to the exchange using both the FIX and FAST FIX protocols and algo traders are able to co-locate their servers, and get reduced fees for high frequency transactions, as well as access to software for testing their trading algorithms. Serdyukov says: “FX contracts are among the most promising derivatives instruments in the world. The experience of launching new derivatives on foreign currency on the Asian trading floors demonstrates that these contracts are among the most liquid ones. “The Russian market is no exception. RTS Stock Exchange is actively developing FX contracts. We see a considerable demand for FX contracts as a result of the Bank of Russia’s coherent policy in liberalising the Russian ruble exchange rate against the US dollar and the Euro, as this leads to higher volatility in the FX market.” While, for Serdyukov, the subsequent increased volatility from liberalisation in Russia increases the attractiveness of currency futures and options, the growing interest in exchange-traded instruments to both speculate and hedge currency risk is being echoed on all exchanges.

Evgeny Serdyukov

“We see a considerable demand for FX contracts as a result of the Bank of Russia’s coherent policy in liberalising the Russian ruble exchange rate against the US dollar and the Euro, as this leads to higher volatility in the FX market.” 108 | january 2011

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Technology and connectivity developments Catering for the growing demand for fast connectivity to exchanges, Transaction Network Services (TNS) has specialised in building private networks with low latency. John Owens, Vice President of Exchanges and ECNs, at TNS says: “We are completely agnostic to what venues customers want to connect to. This is something that is advantageous for the market’s players that are looking to exploit the opportunities that are arising in the FX traded space because they really need to make it as easy as possible for the

Venues, products and users: momentum builds for FX on Exchanges

equities space and more recently now in the foreign exchange space has been one of the reasons why volumes have increased so significantly over the last couple of years,” Owens says. “Consequently, all segments of the market have had to adapt to the demands that are being made by the highfrequency traders and hedge funds. This incorporates everything from the trading platforms by reducing the level of latency that exists at a processing level, as well ensuring that network latency is minimised, and the emergence of co-location of liquidity hubs.”

John Owens

“We have seen a significant increase in competition amongst equity exchanges looking to bolster revenues that have been whittled away from equities environments.” emerging participants within the foreign exchange trading space.” He says the foreign exchange space has been a huge growth area for TNS over the last 18 months, and that most of the growth has come from the FX ECNs. However, he adds, exchanges are looking to expand beyond their existing customer base. He says: “We have seen a significant increase in competition amongst equity exchanges looking to bolster revenues that have been whittled away from equities environments by looking to exploit other asset classes. There has definitely been an uptick in interest in the alpha that can be achieved on trading foreign exchange over and above the equities or the fixed income markets where interest rates have been very low and look to remain very low for the foreseeable future.” The liquidity on exchanges has attracted the highfrequency traders and according to Owens the increase in algorithmic trading and growth in volumes go hand in glove, as witnessed in the equities market.

Algorithmic trading “The development of algorithmic trading in the

The evolution of co-location has further complicated the myriad of connections trading firms need to manage today for, as Owens points out, even though prop traders may co-locate to be closest to one key trading venue, they, and their customers, still often want to trade, on other venues. “They will want to be able to arbitrage and get out to other markets as well to ensure they are getting good transparency on the global market,” he adds. This has both been an area of growth for TNS, and an investment, in the development of new low-latency colocation services in London, New York and Singapore.

Direct Market Access Also, the growth of electronic trading over the past five years has given rise to the demand for Direct Market Access and although from a regulatory standpoint and from a compliance standpoint trades are going through brokers, the exchanges have developed the systems to support their broker participants and members by allowing trades to be routed directly to the exchange. Owens says: “DMA is a hybrid of both models – adhering to the traditional model of trading through a broker but where the intelligence in the trade decision as to how the trade will be executed is being left to the investment management firm or the proprietary trading firm that is looking to direct that trade through to the market.” For Owens, the exchanges can learn from what they have done in other asset classes and the significant investment from exchanges in upgrading their technology speaks for itself. Exchanges are also building and adapting platforms to support multiple asset classes, and continuing to invest in lowering latency, developing new order types and accommodating new markets, and now the exchanges have had the experience of building equities and derivatives communities, Owens believes it will be easier for the exchanges to develop platforms to meet the needs of the foreign exchange community as well. january 2011

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Regional e-FX perspective

on

Brazil Heather McLean

On 22 September 2009, the credit rating agency Moody’s became the last of the big three rating agencies to grant Brazil the coveted investmentgrade status, clearing the way for deep pocketed US and European institutional investors to look towards the country as a source for generating higher yield returns from investment portfolios. At the same time Brazil has also been seeing rapid growth and demand for FX e-commerce and e-trading services from a wide variety of traders, investors and cash management professionals. Heather McLean sets out to discover what factors are driving demand for e-FX in this Latin American powerhouse.

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ast year Brazil emerged in better shape than other peers from the world financial crisis and now dominates Latin American securities trading, with BM&FBovespa, a Brazilian company created in 2008 through the integration of the São Paulo Stock Exchange (Bolsa de Valores de São Paulo) and the Brazilian Mercantile & Futures Exchange 110 | january 2011

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(Bolsa de Mercadorias e Futuros), being the largest exchange of the world in terms of market value and the leading exchange in Latin America. Carlos Areia, CEO at Phare Global Markets, explains: “As the Latin American market attracts more sophisticated investors from around the world seeking better investment alternatives and arbitrage opportunities, it also attracts interdealer brokers offering FX platforms and FX solutions to their customers. Investors and financial players have become more sophisticated and FX has started to be traded as an asset class to generate alpha and also as hedging strategy.” “The fact is that there is a North-South interest, with Americans and European financial firms seeking investment opportunities in Brazil, and a South-North interest with local financial firms seeking to invest into American and European assets,” continues Areia.

Demand for financial products With the recent dramatic increase in economic growth, Brazil has experienced a surge in the demand for financial products beyond the traditional

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asset classes,and that includes FX, agrees Ralitza Fortunova, Nomura’s head of FX e-commerce sales for the region. “Combined with the vastly improved telecommunications infrastructure, the demand for electronic FX services has increased exponentially. Corporates and institutions alike are taking advantage of the speed of execution and the price transparency afforded by electronic dealing.

“Positive regulatory changes now allow pension funds and asset managers to increase their foreign exposure,” continues Kwiatkowski. “Growing demand from the high frequency trading segment is also driving demand for prime brokerage services. Many clients with experience on single bank platforms are now seeking the benefits of multibank aggregation for best execution and workflow improvement.

“The current trend observed in Brazil can be likened to the early e-FX onset in Europe, when request for quote was the preferred method of execution, even after streaming click and deal pricing became a reality,” adds Fortunova. “Over time, we’re likely to see the majority of Brazilian clients execute on streaming prices and increasing their trade sizes as comfort levels rise.”

“In addition, we are seeing a demand from local corporations that desire to reconcile and integrate electronic trading with local government reporting regulations for account payables and receivables,” he adds.

There has been tremendous growth in the demand for electronic FX trading in Brazil, comments Jim Kwiatkowski, head of sales for the Americas at FXall. Increased recent global capital inflows have caused local traders and treasurers to look for the same type of workflow and best execution solutions that their counterparts in other parts of the world use today, he says.

Regulation Matt O’Hara, senior vice president and head of Americas Foreign Exchange and Money Markets at Thomson Reuters, comments: “The Brazilian FX market is heavily regulated and every FX trade must be reported to the Central Bank via the Central Bank system. One of the results, from the bank’s stand point, is the need for substantial back and middleoffice organisations to cope with the daily flows. january 2011

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Kwiatkowski adds: “The onshore spot market remains regulated and can only be traded with either local counterparties that have to offset the risk with the BM&FBovespa or with the BM&FBovespa directly. As a result, companies still have limited counterparties to trade spot BRL.” While Areia agrees Brazil has a highly regulated financial markets and national payment system, he observes, “The financial services industry of local banks, mutual funds, pension funds and hedge funds is very large, and the best way to access these customers is being physically present in the marketplace. You will not succeed or deploy your e-trading solution if you do not have a high quality presence through a local Brazilian firm, or unless you establish offices with local management to walk through the peculiarities of this market.”

Carlos Areia

“As the Latin American market attracts more sophisticated investors from around the world seeking better investment alternatives and arbitrage opportunities, it also attracts interdealer brokers offering FX platforms and FX solutions to their customers.” Usually back offices are double or even triple the size of the trading desk, due to the post trade reporting activities that are required after a FX deal is executed. If trades are captured over the phone or manually, the downstream processes are in turn manual. If trading is automated and standardised, the back office processes can in turn be automated. This allows trading volumes to increase while keeping operational costs fairly constant.” Hamilton Araujo, managing director at Alphastream, remarks: “FX trading in Brazil is usually associated with local business and foreign investment, so the transactions are highly regulated. In recent years, regulators have been actively involved in FX trading, as the USD/BRL pair is highly liquid. “The foreign exchange transactions carried out in the Brazilian foreign exchange spot market must be registered under the Central Bank of Brazil,” observes Araujo. “This limits the spot trading activity in Brazil. All the spot FX transactions need to be documented, submitted and approved, and they are operated by banks in the Brazilian financial system. We will see regulations play an important role in the development of electronic trading in Brazil.” 112 | january 2011

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FX platforms and ECNs There has been minimal penetration of FX platforms in Brazil due to the regulatory limitation on spot FX trading, says Araujo, unlike the US, where there are separate regulatory entities for foreign exchange and securities. “All trading activities are regulated by CVM, Comissão de Valores Mobiliários (Securities and Exchange Commission of Brazil) and the Central Bank of Brazil. BM&FBovespa is the only exchange for both equities and derivatives, so we don’t have

Hamilton Araujo

“We will see regulations play an important role in the development of electronic trading in Brazil.”

Regional e-FX perspective on Brazil

ECNs and dark pools, and brokers are not allowed to match internal orders. “However the market landscape might change overtime,” Araujo continues. “In particular, there are more service providers catering to foreign investors. Chi-X is now working with the local exchange for both institutional and retail customers to invest in the Brazilian market. Some banks provide foreign exchange spot rates for investors to buy or sell Brazilian stocks and close their FX spot operations at the same time.” On what penetration the major FX platforms and ECNs have in Brazil, Areia says from what his company has observed, there is brand presence but very few vendors have real customers. He explains: “In order to really penetrate the market efficiently, you must have a physical presence in Brazil. You also must develop products that cater to the domestic market. In order to really grow in Brazil, you must understand local regulations and adapt your product at the local level.” Fortunova agrees says: “The successful providers are those who have, and continue to recognise, the importance of local knowledge and presence, both key components to operating in Brazil. Nomura, as a relatively new FX participant, has built on the expertise of its experienced Latin American trading team to establish itself as a market maker in BRL and Andean currencies.”

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While Julio Beaton, senior managing director at Trade Station Securities, comments: “I have yet to see any of the leading ECN platforms in Brazil. Hedge funds I spoke with tell me usage is very small, and restricted to offshore hedge funds. The reason is that traditionally in Brazil it is cheaper and less complicated to transfer the operational risk of FX trading to larger brokers or financial institutions. The Prime Broker structure does not exist in the local market.” O’Hara adds that at this time, the more prevalent or well known platforms in the developed markets do not have a substantial presence in Brazil. “This is mainly due to the fact that the majority of domestic FX liquidity is transacted in the futures market, which these platforms do not generally support. Thomson Reuters Dealing is present in most major FX trading institutions in Brazil with around 50% of domestic spot and Brazilian NDF’s being transacted over the platform.” Beaton states the leading FX banks in Brazil are Banco do Brasil, Bradesco, Citibank, HSBC, and Itaú. He adds that some of the players in the futures brokerage are Link Investimentos (to be acquired by UBS, with the deal expected to close in Q4, 2010), ICAP, and BGC Partners. Leading FX banks in Brazil include Citi, ItaúUnibanco, Santander, Banco do Brasil and others, agrees Araujo. He adds that commercial banks provide

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services for spot FX transactions for customers, and all transactions are recorded in Sisbacen (The Brazilian Central Bank Information System), which allows the Central Bank to monitor and supervise the spot FX market.

Retail FX services On retail trading in Brazil, the BRL is a nonconvertible currency and the local FX market is highly regulated. FX is a non-listed derivative at CVM, therefore it cannot be traded or offered to individual investors at the moment. Fortunova adds: “The current domestic regulation inhibits the establishment of a retail segment in Brazil. However, efforts are underway to lighten the rules allowing this client type to emerge in the future. Economically Brazil continues to experience high interest rates, as a result of which locals are comfortable holding their own currency and perhaps have not felt the pull of retail FX that we are seeing in lower yielding economies.” And Areia comments: “Individual investors in Brazil are now getting into the stock market and as this

group gets more sophisticated, demand for FX products should increase. For now, our focus has been to position institutional solutions to top tier financial institutions.”

Buy-side interest in e-FX On what e-trading and FX e-commerce products and services buy-side sectors in Brazil are particularly looking for, O’Hara says buy-side firms are becoming more sophisticated and are looking for ways to improve efficiency and price transparency, while managing regulatory and compliance obligations. “Typically buy-side clients will look toward multibank offerings, as they help them to meet these requirements while achieving cost control objectives,” remarks O’Hara. “While obtaining the best price is very important, buy-side firms demand a much richer experience in the form of intelligent information and analytics that enable them to make informed trading decisions. Once the trade is captured, integrated and seamless straight through processing is incredibly important in order to mitigate risk, ensure compliance and create operational efficiencies.”

Ralitza Fortunova

“The current trend observed in Brazil can be likened to the early e-FX onset in Europe, when request for quote was the preferred method of execution, even after streaming click and deal pricing became a reality,” 114 | january 2011

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Araujo states that a lot of hedge funds and proprietary traders want to trade FX electronically. He says they see arbitrage opportunities within future derivatives trading: “One of the most popular strategies is trading the interest rates by trading futures contracts with different maturities of the US dollar against Brazilian Real. On the institutional side, FX futures contracts trading is more attractive than spot FX because derivatives products can provide more leverage.” While remarks: “Most funds trade FX on the back of either a global equities or fixed income trade so

Regional e-FX perspective on Brazil

>>>

FX futures and FX options electronically, but there are liquidity constraints. The hedge fund believes that liquidity is the main obstacle for FX electronic trading, with the exception of USD/BRL.” Beaton says the most actively traded currency in Brazil is the USD/BRL, with average daily volume of approximately US$15 billion per day. There are six crosses versus the Brazilian Real (BRL), he adds: EUR; GBP; JPY; CAD; AUD; and MXN.

they will execute spot, forwards and swaps. Some hedge funds and high frequency traders are trading FX for alpha, but the market is just now beginning to treat currency as a separate asset class. The most forward-thinking funds have set up off shore accounts and are acting quite similar to the most advanced fund managers we encounter in other regions. Corporations are using electronic FX trading platforms to settle their cash flow requirements and are attempting to integrate these platforms into their order management systems to simplify their workflow and to reduce the risk of errors due to manual input.”

Araujo comments that the futures contracts of the USD/BRL are the most traded pair for both risk management and speculative investments. Other currency pairs have little liquidity, he remarks. “There’s a derivative contract for rolling USD/BRL futures contracts traded together with short term and next term futures contracts, which is a common high frequency trading arbitrage strategy here in Brazil. You also see many institutions trading FX derivatives as a method of risk management, and hedge their overseas operations or for spot FX rates hedging,” he says.

EBS With regard to the EBS market, which covers electronic spot FX, NDFs and precious metals,

Anna Didier, global head of NDFs and head of Latin American markets at ICAP Electronic Broking, adds: “As OTC electronic trading gains traction in Brazil, we believe that buy-side firms would, like their counterparts in more established e-markets in other regions, seek improved access to prices, deep liquidity pools and effective execution. Our focus remains on the interbank community.”

Currency instruments and investments Beaton says growth and demand for electronic FX trading in Brazil is on the up. He comments: “Currently, spot is 80% voice, while futures are 100% electronic and NDFs are all voice. The other asset classes are all traded electronically, while FX electronic trading is slowly gaining traction.” The buy side is driving the demand for FX e-trading, notes Beaton. He comments: “One bank I spoke with, which ranks among the top five dealers, commented that its large corporate clients are requesting the ability to trade FX electronically. A large hedge fund commented to me that there is an interest in trading longer term

Matt O’Hara

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ICAP has seen demand in Brazil primarily for G7 spot but also for NDFs, says Didier. She adds: “EBS works in close consultation with our customers in Brazil to develop effective trading opportunities in currencies, instruments and order types relevant to their requirements. To that end, in Dec 2009 we added Brazil fixed NDFs to the platform, the idea for which was the direct outcome of conversations with customers interested in electronic access to the Brazilian market, and we also added USD/BRL and EUR/BRL spot for onshore participants only, supporting our customers in Brazil.” On currency instruments that clients are trading online in Brazil, Areia states: “We have customers trading on a more directional strategy (asset managers, family offices, corporate) and also customers trading to speculate; we have seen large G10 spot, outrights and swaps demand, but also an appetite for exotic currencies.” The Brazilian FX market is more sophisticated than some may think, states O’Hara. “It may be a developing economy, but the domestic market is very progressive with heavy technology utilisation. Due to tight controls on the domestic spot market, most speculative liquidity resides within the domestic futures market, which is accessed electronically via a screen or direct via an electronic feed. The domestic spot market is around 25% of the futures market and is mainly generated from the organic hedging activities of the domestic buy side.” He goes on, “There is a strong offshore NDF market that in many ways complements the domestic spot and futures model, the domestic spot and offshore NDF markets are typically transacted over the phone or via Thomson Reuters Dealing, especially in the interbank segment. As we see more banks adopt automated FX e-commerce distribution platforms like Thomson Reuters Electronic Trading, our expectation is that the domestic spot and offshore NDF markets will migrate to e-channels, following a similar route that the more liquid, freely convertible currencies in the developed markets have taken in the past. “

Electronic trading growth The FX market in Brazil has evolved and gained sufficient depth of liquidity to make electronic trading the clear way for the future, claims Didier. She says that currently, FX liquidity is primarily found in the futures contract at BM&FBovespa, which is 100% electronically traded. “Among market participants, there is great acceptance of e-trading, and as the market 116 | january 2011

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Jim Kwiatkowski

“Corporations are using electronic FX trading platforms to settle their cash flow requirements and are attempting to integrate these platforms into their order management systems to simplify their workflow and to reduce the risk of errors due to manual input.” looks for full convertibility of the Real, the OTC spot market is also expected to become fully electronic, a project in which ICAP’s EBS platform is fully engaged. The Brazilian regulatory authorities are keen for the transition to an OTC electronic trading to take place, since e-trading improves transparency and enhances authorities’ supervisory abilities,” she notes. O’Hara says similar to other developed regions, Brazil is quickly adopting the use of electronic trading systems. “Firstly to achieve internal efficiencies by automating the internal price discovery and deal capture process, secondly, to distribute pricing and related services to clients over electronic channels, and thirdly to access the various pools of liquidity and counterparties within the global FX market.” “Internal automation is very important to financial institutions that may have multiple sales desks spread across different centers within a region, such as Brazil and Latin America,” continues O’Hara. “Up until recently, sales people would call their traders for market rates, regardless of the size of the ticket. As you can imagine, this resulted in a lack of efficiency as

Regional e-FX perspective on Brazil

sometimes, sales people were spending time pricing a small ticket, while a large deal was waiting on the line to get priced, and often the bank would lose business due to the fact that they didn’t have the capacity to negotiate rates for all their clients at the same time. “Local banks realised that this lack of efficiency was truly impacting their results and as such, started to invest in systems and solutions to automate large portions of their vanilla flow. This made their sales people more efficient and productive, and enabled them to become true sales advisors as opposed to high priced trade facilitators. They could now focus on developing their business with existing clients, deepening relationships, selling more complex, structured or involved hedging strategies and increasing their client portfolio,” states O’Hara. The second trend, comments O’Hara, is related to the adoption of electronic medians for trading, information discovery and post trade processing, that liquidity providers are now providing their clients. As with other developed regions, price transparency is now no longer restricted to the interbank market, so the liquidity providers are seeking innovative solutions to provide to their clients in the constant quest to provide differentiating value which will result in subsequent trade flow, notes O’Hara.

Julio Beaton

“A large hedge fund commented to me that there is an interest in trading longer term FX futures and FX options electronically, but there are liquidity constraints.”

>>>

“Local liquidity providers are acquiring proven private label trading technologies to integrate into their client facing online or e-commerce experience,” O’Hara adds. “While price discovery and trading is at the heart of the proposition, pre-trade solutions, such as chat or research, are often made available in addition to robust post trade confirmation, payment and settlement functionality.” O’Hara says the third trend is around globalisation. He remarks: “The FX market is the only true global market, and as rapidly developing economies such as Brazil grow, attracting interest from the offshore market, they need to be connected to the rest of the world and the rest of the world needs to be connected to them. Domestic or closed markets such as Brazil typically specialise in their domestic currencies, and as such are typically liquidity providers of their local currencies to not just their local clients, but the global market, whether it be a convertible currency such as Mexican Peso or a non convertible such as Brazil, which will be traded in the offshore market as a NDF. Similarly, local liquidity providers are not typically strong in the international currencies and will in-source liquidity from the international market for the more commoditised currency pairs,” concludes O’Hara.

Investing in communications infrastructure Trading volumes on Latin American exchanges are soaring, states Areia, with Brazil leading the charge on the strength of a commodities-based economy. Areia says this means that technology and communications infrastructure will also need to receive solid investment to keep the risks of doing business low, and help to sustain this global appetite for Brazilian assets at reasonable transaction costs. “During the past five years we have seen a lot of investment in technology and communications, especially at BM&FBovespa,” notes Areia. “The BM&FBovespa promoted electronic trading actively and has now co-location services available for all BM&FBovespa markets,” Areia states. “However, today it still takes significant time and investment to get the right infrastructure in place to achieve optimal performance of electronic trading solutions (low latency, reliable and fast network connectivity, redundancy, disaster recovery sites, dedicated lines and hardware). Education and the language barrier is another challenge, as is understanding how to use new technology efficiently.” On how the communications and technology infrastructure in Brazil compares with other South january 2011

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American states, Beaton comments: “Brazil has a well developed banking system and it would be able to embrace new technologies and trading platforms as they become available. In Latin America, Brazil is the leader for derivatives trading, and BM&FBovespa is the sixth largest derivatives exchange globally.” Brazil leads the innovation of electronic trading in South America in terms of market development and technology uptake, states Araujo. BM&FBovespa reported a 70.7% surge in volumes traded in its derivatives segment, and the exchange is aiming to ten-fold the number of investors to five million in the next five years, he says. “I would say that we can expect that electronic trading will continue to evolve through the local exchange as the Brazilian market plays a more important role in the global economy.”

Brazil as central hub for LA? Opinions are split on whether Brazil will become a central hub for FX in Latin America. Areia says Brazil is likely to end up acting as a central FX hub for the region. “There is a strong and growing interest from

Anna Didier

“As OTC electronic trading gains traction in Brazil, we believe that buy-side firms would, like their counterparts in more established e-markets in other regions, seek improved access to prices, deep liquidity pools and effective execution.” 118 | january 2011

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the global investment community in participating in the Brazilian and Latin American marketplace. Just as an example, according to a recent Bloomberg News article, all-time low borrowing costs in the US and Europe have contributed to investors putting $3.8 billion into Brazilian bonds this year in the quest for higher yields. “Political stability, controlled inflation, (very) high interest rates, an abundant supply of natural resources, including water, land and a favorable climate, means Brazil has the opportunity to be the world’s largest agribusiness player, supplying the world market while also providing affordable food for its own population. All these facts combined have attracted foreign investment and contributed to an organic growth for FX demand as more goods, financial instruments and services are traded across borders,” added Areia. Areia concludes: “There are plans in Congress to make the BRL a fully convertible currency in the medium term, to strengthen Brazil’s position as an investment and business hub, with regional focus on Latin America, and global projection and connections. The main initiative behind this goal was a beta project called the Omega Project which is now called Brain, an achronism for Brasil Investimentos & Negócios (Brazil Investment and Business). Even though these are the plans, full convertibility is still a number of years away. Brazil would have to lift restrictions now in place with the capital account and this may take some time. However, I believe everyone would agree that the country is moving that direction.” There’s no doubt that Brazil is a potential central hub for Latin America, with all eyes keenly focused on it for the future, says O’Hara. That being said, he adds that Latin America is a very large region and each country has its own unique set of opportunities and challenges. “Brazil’s FX market is largely orientated around the Futures model and one has to ask the question that in order to truly internationalise, can this be the model for the future, especially as the rest of the global FX market operates on an OTC basis? . The countries surrounding Brazil, such as Chile, Colombia, Peru and Argentina, all have their unique financial agendas but do operate on an OTC basis, in some cases with established clearing and regulatory reporting mechanisms,” continues O’Hara. “Mexico is a good example of how a Latin American country can successfully internationalise its currency, following the move to convertibility of the Mexican Peso over a decade ago.”

Regional e-FX perspective on Brazil

Barriers Araujo notes: “Brazil has strong potential to become the central hub of FX trading for South America, with the maturity of the market and technology infrastructure, but on the other hand, Brazil has strict spot FX regulation that impacts on the growth and liquidity for this market. We may start seeing more liquid markets in countries with less regulatory limits on spot FX trading, such as Chile and Mexico, but with smaller total traded volume. The spot FX trading in Brazil will be more active if the market is more accessible and available to set more liquid spot rates.” Jake Rue, Nomura’s head of Americas FX bank and e-commerce sales, remarks that while comparisons may be drawn between the central hub for South East Asia, Singapore, and the direction that Brazil is currently heading, Brazil will not necessarily become the central hub for Latin America. He notes: “It’s easy to draw similarities between the current economic environments of Brazil and Singapore but there are some stark differences; Sao Paolo does not have the

historic mercantile trade networks that Singapore enjoyed for centuries during the days of the maritime empires. Also, Singapore’s advantageous geographical location easily allowed its evolution from a key trading port, to a major financial hub, something Brazil does not share. “Although the other South American countries are said to be suffering from ‘Brazil envy’, not having a single unifying language will make it more difficult for Portuguese-speaking Sao Paolo to establish itself as the financial capital of South America,” suggested Rue. “There have been recent efforts by the Andean countries to establish their own cooperative effort to maintain their financial market autonomy.” Jake Rue

“Although the other South American countries are said to be suffering from ‘Brazil envy’, not having a single unifying language will make it more difficult for Portuguese-speaking Sao Paolo to establish itself as the financial capital of South America,”

Rue concludes: “Finally, and this is true for all of South America, having non-convertible currencies increases the need for local operations, adding yet another barrier to entry and evolution. We see an increasing influence of Sao Paolo on the South American financial markets, but it will be quite some time before it is established as the financial capital of that continent.” january 2011

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SDX from SuperDerivatives – the weapon of choice in the FX e-trading arms race FX options today still only represent between 4-7% of the USD 4 trillion daily notional in FX, however they typically generate more than 15% of banks’ profits, and this disproportionate contribution looks set to grow as the switch from voice to electronic trading continues. The prospect of central clearing for interbank FX derivatives trades has seen the industry devote a significant amount of resources – money, time and people – to developing technical and operational capacity to cope with an arms race in electronic trading. These investments are mandatory and a strategic necessity for banks that wish to retain a competitive advantage.

I

n this environment, with vanilla products centrally cleared, traded electronically and producing low margins, the most profitable opportunities for banks lie in offering investors and corporations more bespoke options products. As transparency and liquidity in vanilla products increases, it is likely that both investors’ confidence in using bespoke structures and banks’ hunger to offer these higher margin products will rise proportionately. To take advantage of this new opportunity, banks must ensure their structuring and sales teams are equipped with the optimum set of tools to maximise their productivity and efficiency in this arena.

Launch of SDX To this end, SuperDerivatives, the derivatives pricing, management and revaluation provider, recently launched SDX, the next generation multi-asset front office system. SDX provides a set of remarkable structuring 120 | january 2011

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and sales productivity tools to equip a banks sales force. With a few clicks a salesperson can identify a zero cost strategy, back test its effectiveness, generate a term sheet and trade it, thereby providing an enhanced service to the end client SDX supports banks in the quest to grow volumes in bespoke FX derivatives investment and hedging products by developing the knowledge, tools and capabilities of the sales force. For banks that want to arm their salespeople, as well as for clients that want to have the best defence systems, SDX is the weapon of choice. The system delivers advanced functionality and greater flexibility to dramatically improve its clients’ productivity in vanilla products, exotics and complex structures. SDX delivers best in class tools to manage not only FX, but also interest rates, equities, commodities, energy and credit instruments.

PRODUCT LAUNCH

pricing. Seven years ago it delivered the concept of front office to sales desks. “Five years ago SD developed the most comprehensive multi-asset pricing system. Now, a decade on from the company’s inception, SD is raising the bar once more with the ultimate front office system that will change the way institutions manage derivatives.”

Setting the standard SDX sets the standard in user friendliness; the new sales, trader and structuring desktops put specialist tools at the user’s fingertips.

“SDX brings to a peak a decade of know-how and innovation in front office solutions,” comments David Gershon, CEO of SuperDerivatives. “Ten years ago SD brought transparency to the world of option

SDX combines intuitive, user-friendly functionality and data entry. Enhancements include complete interaction with Excel spreadsheets, powerful wrapper functionality for structures and a very flexible options/deposit/ swap/bond structure generator, the ability to quickly view historical simulation of every trade idea prior to execution, advanced client relationship management (CRM) functionality, an online quoting and execution vehicle, multi-asset report generators and customised workflow automation. SDX delivers a revolution in system transparency. Users have the flexibility to directly upload their own pricing models, including the release of popular pricing models with their source code. SDX also begins the introduction of SD’s mobility strategy, which will see SDX and a range of new applications made available over mobile technology. The system has been tuned to maximise the user’s experience on mobile devices such as the iPad, allowing the webbased service to be accessed from any location at any time. “Whether you are a sales person, a trader or a risk manager and whether you trade vanilla products, exotics or complex structures, SDX will significantly enhance your productivity, broaden your derivatives usage and enable you to exceed your targets,” continues Gershon.

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Reaching a crossroads: is it time to re-think the management of electronic FX options The FX options market is the world’s largest and most liquid options market, and while a small fraction of contracts are traded on the exchanges, most of the FX options volume is traded in the OTC market. But with the regulatory spotlight on the OTC market, and the likelihood that clearing FX options through a central counterparty (CCP) will become a mandatory requirement for banks, Frances Maguire explores where we currently stand with the electronic trading of FX options and whether a rethink is needed about how they are traded and processed in the future.

W

hile the FX options market was the last to benefit from the wider reach of electronic trading, greater automation has made it more available electronically, albeit mainly for the more vanilla structures. The need for better transparency in FX options trading prompted the launch of SuperDerivatives, an online FX options benchmarking service, in 2000. Dr David Gershon, founder, president and chief executive officer of the company, says at present, only simple and vanilla options are being traded electronically. This has been in place for some years and the market is fairly matured. He comments: “Past innovation on the electronic trading side has really been about connectivity. Current innovation for us is focused on risk management and the fact that we can now support a larger variety of trades, almost every structure that exists, whether it is multi-asset 122 | january 2011

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class basket options, dualdigitals and any combination of currency pairs. We can support very complicated options structures through the full lifecycle. In addition, we have recently switched to cloud computing and grid computing, which made the calculations so much faster, enabling complex structures to be priced on a real time basis.” He goes on, “We allow banks to send us data in an extremely enriched way and we support many protocols, to provide banks with transparency, accuracy, cost control and risk

>>> management.” He adds that the company has actually created a standard protocol which, it is hoped, will become an industry standard for the integration of FX options. Gershon points out that the solutions SuperDerivatives has developed make integration much faster than people think. “The record is that we have a bank that integrated to us in two weeks.” He believes it will not be long before all vanilla products are traded electronically. “It will happen. Eventually everybody will have to be there. In my opinion it is matter of one year, or perhaps a matter of months.”

Quality of pricing For Gershon the key decider on whether a platform will succeed is the quality of pricing. Even if the platform only offers one single asset class, if it has extremely tight prices and extremely good liquidity, it will succeed. A company that is focusing on faster pricing is 360T Trading Networks which owns and maintains one of the most advanced trading technologies for OTC financial instruments, capable of trading in streamingprice and quote-request mode. It offers RFQ multibank execution for FX options on a real time basis and managing director Alfred Schorno says the portal has witnessed a very positive increase in volume over the past two years. He says: “With the growing number of market makers quoting, we can confirm that the execution of first generation options on our portal has reached the status of being a standard procedure.” From mid-December trading on volatility base for first generation options and option strategies became available. Schorno says: “We are working with a range of market makers to integrate their pricing engines for auto quotations and therefore making faster pricing available to be ready in just a few months. Furthermore developments are underway to enable a

David Gershon

“We allow banks to send us data in an extremely enriched way and we support many protocols, to provide banks with transparency, accuracy, cost control and risk management.” stronger interlink between analytic tools and trading features.” Furthermore, 360T has developed full end-to-end straight through processing interface for the complete trading lifecycle of options traded on the platform to be fully supported after execution. This includes the deal export of options to TMS as well as confirmation matching services like Misys, which are able to match the options confirmations. Schorno adds that by bringing more market maker pricing engines on board, 360T has been able to increase and enhance the level of automation of FX options workflows. He believes that while the FX options are relatively mature as a trading instrument, it is their delivery that is of greater interest, going forward. He says: “Having already now a wide range of FX-options tradable electronically I would describe the actual situation as being not ‘new’ anymore. What is new is that one can trade them, multi-bank, in a more competitive environment.” january 2011

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by clearing concerns, but a generic, product-agnostic approach to lifecycles would help beyond just FX options. In addition, any sort of standardised, multilateral, lifecycle-event management for expiries, fixings etc would be advantageous. This is especially so if clearing becomes more widespread,” says Khan. LCH.Clearnet is currently building a CCP for FX options, expected to go live in the second half of 2011. Across the industry, banks are working to increase levels of automation in FX options processing and Khan says that the early stages of clearing adoption for FX derivatives is the main market-wide driver at the moment. He says that for the risk management of FX options, clearing will necessitate multilaterally agreed valuation models and VaR calculations. Khan says that RBS is working to provide a single trading experience, in terms of APIs and systems, both internally and externally, across all asset classes and products. Alfred Schorno

“With the growing number of market makers quoting, we can confirm that the execution of first generation options on our portal has reached the status of being a standard procedure.”

Standards Khalid Khan, head of FXO Front-Office IT at the Royal Bank of Scotland, says that the bank is continually refining and broadening its adoption of FIX and FPML to improve pricing integration and distribution. He says: “The increasing relevance of ECNs, because of price aggregation (and in the case of derivatives, primarily due to clearing-related developments), necessitates interoperation and decreases the relevance of bilateral trading.” RBS develops solutions for the management of FX options trade lifecycles specific to the client’s requirements but Khan adds that greater standardisation across trade processing of all asset classes will make things easier. “The move towards structured and hybrid products was curtailed somewhat by the credit crunch, and may be restricted 124 | january 2011

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>>>

FOCUS

This also includes building domain-agnostic data mining over those channels. He also believes that customers can build the same efficiencies by using standard processes across products. He says: “We are entering a new era of electronic FXoptions trading; clearing alone ensures that. The most successful strategies will be those that leverage generic solutions across all asset classes.”

e-option growth curve But for Stephen Best, CEO of FX Bridge Technologies, out of the multitude of FX banks there is only a handful, probably fewer than ten, that can electronically stream a volatility surface for options. “They may have an application as part of their single bank platforms, but to be able to write to an API, there are very few banks that are set up to do that,” he says. He says that while the growth curve of electronic FX trading has been consistent over the past ten years, especially in terms of the buy-side coming on board, the adoption of electronic trading for FX options has significantly lagged. “Quite simply, the main reason for this is that it hasn’t been widely offered as part of most e-commerce packages,” said Best, “although it’s starting to take off now.” However, Best says that solutions being developed, at present, are fairly basic vanilla option structures, such as calls, puts and spreads, but he expects the market will grow quickly to include more sophisticated structures, exotic options, and binaries. “It is the banks that realise that this is something they need to do, and they are willing to provide the tools to take options trading forward.” According to Best, the development of electronically traded options is likely to be along the same lines of other instruments – enabling flexibility, and straight through processing for transactions. These features are pertinent to all asset classes but two key features that he believes are important, specifically for options, are integration with the user’s desktop order management and/or treasury systems as well as comprehensive analytics. 126 | january 2011

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Integration & analytics Integration will differ depending on market participants, with corporates integrating their treasury systems and institutional investors and hedge funds integrating their order management systems. “The need to integrate order execution is extremely important,” Best says. Further, robust options platforms must support the importation of trades done on other platforms— whether this is through APIs or middleware-so users can then model their overall risk. This capability is going to be extremely important.” For Best, the second priority will be analytics. He says: “This is about helping the end user choose which option structure best suits the exposure, or express their view. There are many ways of expressing a directional and/or volatility views. Analytical tools that help whittle down and determine the right structure will be critical.”

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FOCUS

But unlike pricing and pre-trade tools, the post-trade process is execution-neutral. Best believes firms will compete more on pre-trade and trade automation APIs and on getting information into and out of systems, cleanly, without manual intervention. Platforms need to be able to present risk in a way that is easily understood by the user, in order for it to be compelling. Clients need to see and manage risk in its entirety. In the case of options, the downside is multi-dimensional, and users need to be able to model ‘what-if ’ scenarios, not just for options, but options, spot and forwards. Best says: “The growth in options trading will come from users who are going to be trading options often in combination with other products, not in isolation. They will be overlaying options on existing spot and

“If you come up with a platform that provides options trading, you have to be prepared to help users understand how to gain the full power of it.”

forwards positions. If you come up with a platform that provides options trading, you have to be prepared to help users understand how to gain the full power of it.” To this end, FX Bridge, which provides platforms for trading spot, options and CFDs, also white-labels a comprehensive online educational software package and modelling system for clients to distribute both to their customers, and to ensure their sales people are comfortable and knowledgeable in discussing every aspect of options trading. For Best, however, at this stage, in terms of strategy, half the battle is just showing up. “There is not much out there. For most banks, just getting basic functionality will go a long way to helping them be a leader in this space. Over the next year, the providers that come to market with solutions will lead the way.”

Client needs Igor Gitsevich, Director of Solutions, Capital Markets & Investment Banking group, at SunGard, says that the biggest needs for clients such as hedge funds are centered around risk management , p&l and reporting – all the aspects of the trade after the fund administrator or prime broker. However, he adds, the banks need this and more back office processing capability. SunGard has two products supporting these functions – Sierra and Front Arena – delivered as modules so that customers can mix and match to fulfill their specific needs, which are changing fast. Gitsevich says that, recently, there has been a big push for more exotic instruments to be built out by the banks that are at the forefront of FX options trading. They have handled the vanilla and exotics, such as barriers and duals, and now they are going to the next level of exotic options that really incorporate components of traditional FX options with interest rate products, such as power reverse dual options. He says: “When it comes to integration and the ability to provide the risk and p&l around these products, banks are looking at either developing those models internally or incorporating third party models and this speaks to the flexibility of the system.”

Stephen Best

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This means that banks either have internal systems or if they are market makers and need to push out pricing and liquidity out to the customers, they need a front end. There has been a large growth in bank portals, especially for FX spot and equities, but

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Gitsevich believes, for FX options, the industry is in a transitional period at the moment. “Some of the larger banks had portals to push out liquidity for FX options into the market and I think they are now examining how they can develop richer functionality around that,” he says. He also adds that the banks are at an important crossroads at the moment due to the fact that the trading applications for each asset class have grown up in a siloed fashion and are trying to work out the best way to go forward. Gitsevich says: “As a value-added experience, it can be a headache for a customer to keep switching to completely separate platforms to trade FX, equities or interest rate products, and the goal right now is definitely having FX incorporated with all the other products. This is what the banks are striving for.” What they are struggling with, perhaps, is the challenge of providing client offerings at varying levels of client sophistication. One size does not fit all. “How do you provide FX trading to a corporate customer and a hedge fund simultaneously when the same product has to fulfil very different needs?,” he adds. Igor Gitsevich

Data is key Today, information, or data, is a key component of any offering, and a deal-breaker. Gitsevich says: “You can have the best solution, or the best platform, but if you can’t offer out the underlying data, in an easy and accessible fashion, it is no good for them. This is where mechanisms like open systems, or APIs, that allow customers to extract data from the system on an as-needed basis, become essential. The number one complaint from a bank about a system is that the data is there, but they cannot get it out, and, says Gitsevich, an issue that would prompt them to look elsewhere for a platform.

“What will drive volumes is if there are platforms that make it easier or more understandable for customers to trade. This may be driven by the retail side – a lot of the volumes in FX have been retail-driven in the past.” in analysis of counterparty risk. “This is getting the highest level of scrutiny these days. Credit lines and trading capacity are no longer taken for granted and while before credit checking was end of day or weekly, now it is as real time as possible,” he adds.

The need for access to data is especially important when it comes to the high-frequency trading. Algorithms and the use of APIs are particularly important in opening the door for electronic trading and Gitsevich believes that the industry participants are waiting to see how they can leverage this for FX options.

Going forward, with the greater restriction on leverage and how much can be traded on margin it is thought that FX options could be a natural outlet to enable trading on leverage. Gitsevich adds that there are also concerns about whether firms would be able to process increased volumes of FX options, but he believes that there are solutions available, coming from the cash FX side, especially for the larger banks.

Likewise, while there is no change in the risk management around exposures, there is more interest

He says: “The volume in FX options is now starting to increase. What will drive volumes is if there are

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platforms that make it easier or more understandable for customers to trade. This may be driven by the retail side – a lot of the volumes in FX have been retaildriven in the past.” The drive this, and any growth according to Gitsevich, the first step is automation of as much of the process as possible. The next step is pushing out more services through the portals, such as risk management and analytics, to give customers the same level of sophisticated services that proprietary traders have. But, he adds, holding back through fear of margin erosion will not work: “If one bank doesn’t do it, the next one will,” he says.

Keeping integration costs down Murex’s MX.3 integrates the key components of pricing, distribution, and analytics into a modular framework that makes it possible for an institution to leverage on the offered flexibility and openness in specific areas, such as analytics, without added integration cost. Analytics, pricing, distribution and risk management functionalities are fully integrated in MX.3 even though the components are logically distinct. Franck Dewannieux, Product Manager of Murex e-Trading platform , says: “This allows the institution to integrate its own model for an existing product without the need for any specific work on the risk engine or the distribution layers. Distributed prices as well as risk tools will simply inherit from the new model through the shared and unique evaluation engine within which the institution’s model is integrated.” In terms of integration of these functionalities within the bank’s architecture, MX.3 provides a layer of web services that give access to a broad functional coverage, from pricing to operations, and that rely on industry standards to offer state-of-the-art scalability and security features. According to Dewannieux, a key factor is to have the same engines perform the

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very early in the chain and flexible rules based on a number of parameters ensure automatic spreading of prices based on customer characteristics, credit, liquidity and market risks, deal characteristics and market condition. This allows automating an increasing percentage of the quotes.” Once captured, Dewannieux says, the transaction should be automatically completed, automatically hedged when the delta is exchanged with the customer, often automatically back-to-backed and then processed in an exception-based workflow that maximised STP in all aspects related to validation, confirmation and payment generation. “Automation works hand-in-hand with control though and it is the key to be able to instantaneously switch to a mode where certain steps become manual to address specific conditions.” For Dewannieux, one aspect of pricing and risk management that is particularly important to high volume, high speed electronic transacting, is volatility management. Not bid/ask management or volatility spreading, but actually managing the whole volatility surface in live time. Franck Dewannieux

“It’s critical in the world of live streaming volatility quotes that the volatility is always valid, and that means automating those dependencies.” same duties along the chain of functionalities that intervene during the trade lifecycle. He says: “The same analytics, pricing, evaluation engine, the same volatility management tools and interpolation methods should be used for the initial pricing, the limits checking, the risk management, the event management, the generation of accounting entries, etc. This reduces the need for expensive low-value added reconciliation processes.”

Flexibility and control In a business that is becoming increasingly competitive, it is fundamental to consider the complete chain to ensure that all opportunities for the automation of FX option trading processes are taken advantage of. Dewannieux says: “The two main concepts are flexibility and control. The automation needs to start 132 | january 2011

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He says: “All currency pairs have a volatility dynamic, where volatility is to a greater or lesser extent dependant on the spot level. Not just the absolute level of volatility, but the skewness and kurtosis all change as the spot changes, at rates that vary across tenors, and in highly skewed pairs like USD/JPY those volatility changes can be significant and rapid, and of course like all things related to options they aren’t constant, but have convexity. It’s critical in the world of live streaming volatility quotes that the volatility is always valid, and that means automating those dependencies.” Murex has taken the approach of making dynamics applicable at multiple levels in varying ways, such as calibrating its ‘Tremor’ Local Vol/Stochastic Vol hybrid model and using the calibrated dynamic to drive a continuously adapting volatility surface to sales forces, websites, portals, not only for exotics priced with Tremor, but the surface applies to vanillas priced with Black-Scholes. Dewannieux says: “These same continuous dynamics apply to portfolio risk management, bringing a new meaning to ‘live revaluation’ and the Greeks of every transaction are smile dynamic consistent. A

Reaching a crossroads: is it time to re-think the management of electronic FX options

continuously changing volatility surface needs to be transparent and we’ve included a lot of tools to let traders visualise and control the dynamic. “It’s not auto-pilot, it’s a user controlled and finetuned cruise-control, and the end result it that traders can keep streaming valid volatilities with less manual intervention, and less surprises. Volatility surface dynamics are a reality of the market place and the thought of live quoting in high volume markets without having them well integrated to your system is quite daunting.” State-of-the art platforms like MX.3 enable users to build MIS reports on all data generated by the option trading activity: quote/hit ratios per customer segment, currency pair, spread level, volatility level, etc. This information can be used for high-level strategic analysis.

Entering a new era According to Dewannieux, there is no doubt that as in the cash business, volumes are growing, latency is decreasing and maximising market share is becoming even more important. He adds that we are entering a new era of electronic trading for FX options He says: “Options revenue, as a percentage of cash business revenue, has multiplied for players that have the right distribution strategy and capture significant flow. People often think of e-services as capturing transactions directly from end-users, but that’s only a fraction of the potential and you have to think holistically. Whether ensuring that sales specialists have constantly dealable prices, distributing to the wider global branch network, feeding multi-user portals or mono-bank to end-user web applications, automation is the name of the game.”

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e-Forex talks to Tom Higgins, CEO of Gold-i Tom, what core products does Gold-i offer customers? All our products have been designed to help brokers to manage their business, reduce risk and increase profits. We are continually looking to innovate and develop our portfolio – for example we have recently updated our Gold-i Gate Bridge to version 2.49 plug-in to further enhance trader processes by fully supporting B-Booking and Instant Execution. Gold-i’s suite of integration products is spearheaded by the Gold-i Gate Bridge, which connects retail trading systems (such as MetaTrader 4 and 5) to internal or external liquidity providers. The Gold-i Gate Bridge is recognised as the market leading fast, super low latency smart routing product, achieving an average of 2ms latency.

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The Gold-i product portfolio also includes the Gold-i Gate Link, which connects MetaTrader to your back/middle office or CRM system for real-time, twoway trading data synchronisation. Other Gold-i utility products, the Gold-i Bolt-Ons, are also available and particularly popular are the Gold-i MAM, which splits trades for post-trade allocation, the Gold-i QuoteChecker, which disables trading when quotes freeze, and the Gold-i MarginCaller which emails clients when they go on Margin Call or get Stopped-Out.

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Gold-i is a distributor of the MetaTrader 4 and 5 trading systems, why do you think MetaTrader continues to be such a popular platform for FX trading? We all know that good forex software is crucial to profitable trading. MetaTrader’s success as the most popular forex trading platform in the world is primarily because of the extremely advanced functionality it gives to traders – from automated trading strategies and trade execution to charting and analytics. In essence, it gives the private trader the power of the professional trader at a fraction of the cost. Another reason for its success is that it’s easy to use and is very intuitive. As most forex brokers support it, the trader doesn’t have to switch forex trading platforms every time (or any time) he or she switches brokers. This has ensured continuing success and market dominance.

Why have issues associated with trading technology integration suddenly become so important for many brokers, particularly in FX? With the death of phone broking, almost everything is traded electronically and this means that trading technology integration is key to brokers’ survival and profitability. In addition to this, global regulatory changes mean that more and more brokers do not wish to take any trading risk and are opting for an STP model, using the Gold-i Gate Bridge. In what ways do Gold-i integration products help to give clients a competitive edge? Gold-i provides the fastest and most reliable integration between retail and institutional financial trading systems on a global basis. As we are not tied to any specific liquidity provider (LP) we can offer true multi-LP access for all brokers for any asset-class. Our products enable brokers to connect MetaTrader to external (or internal) liquidity providers in the most effective and cost efficient manner, automatically covering all broker trading risk with banks, in real time. How does your Gold-i Gate Bridge differentiate itself from other common bridging solutions? Super low latency and high frequency trading are the driving forces in foreign exchange and CFD trading and the Gold-i Gate Bridge has significantly lower

latency, higher reliability, and is much faster than competitor products, by many factors. Unlike other bridges, the Gold-i Gate Bridge allows full use of the order types that the liquidity provider and MetaTrader support. Orders can be executed directly by the liquidity provider, giving the client the best opportunity for order filling at the best fair price.

Increasing numbers of retail FX brokers are looking to cater for the needs of high frequency FX trading firms. Do you expect this to increase demand even further for your low latency products and services? Absolutely. We expect more and more demand across the whole asset class. Our products are highly scalable and will work in any financial trading sector, not just retail, on a global basis. We envisage that growth opportunities will also include indices, equities, futures and many other asset classes. Looking ahead, where will you be aiming to grow your business and take advantage of new opportunities for delivering next generation trading technology solutions? Gold-i has already started to expand into institutional trading and we are in a unique position of being a specialist in large as well as small scale trading systems integration. Low latency and high performance are key to retail brokers but even more critical to institutional firms and we hope to see significant growth from extending our institutional client base. As exchange integration is so key for MetaTrader5, we also envisage growth through the uptake of this product. In terms of Gold-i products, we will continue to innovate by working closely with our clients to identify the most effective products needed to help them to trade profitably. Our vision is to remain at the forefront of trading technology integration. Whilst we maintain our focus on product development, we are also looking to extend our geographical reach. We already have distribution arrangements in Asia, the US and Europe and will continue to remain focused on offering best of breed products and high service levels to our global client base. For further information on Gold-i please visit www.gold-i.com

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Solving the Post Trade puzzle: helping retail FX providers achieve increased operational efficiencies The retail FX business has always been a market that generated a fair amount of wariness among banks. Generally speaking no bank turns down a customer but retail customers are not always profitable prospects. This lack of profit does not result from a poor risk and reward equation or the too great a threat of default. Instead it is the result of poor operational economics and the cost of processing so many different customers for so little value. In this article Nicholas Pratt examines how new post trade FX processing solutions can help reduce some of the draw backs associated with delivering retail FX services and also assist providers to take advantage of new business opportunities. “

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he operational constraints are coming from the banks that have to process all of the small trades performed by their retail FX customers. They do not have the capacity in their downstream systems to support such high transaction volumes.”says Jill Sigelbaum, executive vice president, global sales and alliance at Traiana, a US-based provider of post-trade processing services. “Liquidity providing banks in the FX market are concerned that processing many very small notional tickets could slow down the processing of a large ticket in their risk book. For the prime brokers, they just want to keep these retail trades out of their downstream systems because the time spent processing all of these small notional tickets could be spent processing the large value trades of more profitable, institutional clients.” she says.

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Demand for more efficient processing Sigelbaum says that Traiana has become an integral part of the retail FX market due to the fact that its products help to keep down the processing costs of the banks’ operations. There are a number of developments that are pushing the demand for more efficient processing, says Sigelbaum. “A lot of the retail brokers have to date been aggregating their trades and then holding back from trading out their positions until it reaches a certain volume or accumulated notional value of say $50,000. So although they may end the day flat they are exposed to a certain amount of intra-day exposure.” Unsurprisingly, in the current market conditions, regulators are taking a keen interest in any example of exposure to risk and the retail FX brokers are becoming more wary of the intraday risk they are exposed to, says Sigelbaum. “A lot of them are looking to move to an agency model where they are doing back-to-back trades for every transaction made by a retail client - even as low as $100. However, no prime broker would have interest in taking a $100 trade and processing it through their back-office. It costs money to settle through CLS and to even pass the trade through their downstream systems since valuable capacity is used up, particularly as there could be hundreds and thousands of such trades every day.” Traiana has attempted to resolve this issue by developing an aggregation service that sits outside of the prime broker environment, says Sigelbaum. “We capture the trade directly from the liquidity

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provider and from the retail broker once they have been executed. We match those trades which then makes them eligible for netting. The netting rules are designated by the prime broker and the liquidity provider so they decide when the trades are aggregated and delivered to the prime broker. Commonly this is done at two-hour intervals or an accumulated notional value of $100,000. “The beauty of this system for the prime broker is that we aggregate trades by currency pair. So if a retail broker is trading 10 currency pairs, the prime broker will receive 20 trades at every aggregation period. This means that the prime broker can price their services more aggressively to retail brokers because they know

exactly what their flow will be and they can determine what the cost of credit will be. It becomes a completely predictable business for the prime broker to be in as a result of our product. Furthermore, Netlink employs a secure network model so specific participants in the trade flow - prime brokers, liquidity providers, retail FX brokers – have appropriate visibility into the trades as they pass through the matching and aggregation january 2011

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trade the client makes and then trade each one backback to remove that exposure.” Even with a service such as Traiana’s Netlink, there is a cost involved in adopting this single transactionbased model for limiting exposure, so is the cost of this passed down in anyway to the end investor (who will typically end up paying for the cost of processing, risk management, compliance and any other cost involved further up the transaction chain)? Not likely, says Sigelbaum. “It is a competitive market so I doubt that any broker would look to pass on the cost to their clients. With the reduction in risk that such a model brings and the savings that can be made through a service such as Traiana, any cost involved is easily absorbed. The move to an agency model also makes the business completely systematic.”

Jill Sigelbaum

“A lot of the retail brokers have to date been aggregating their trades and then holding back from trading out their positions until it reaches a certain volume or accumulated notional value of say $50,000.” process. This transparency and automation help boost operational efficiency and lower operational risks since exceptions are identified in real-time.”

The issue of high transaction volumes, managing the exposure involved and overcoming the processing challenge is not just unique to the retail FX market, although it is more prevalent there, says Sigelbaum. “It is also an issue for the systematic and high frequency traders that are trading tens of thousands of tickets a day and are in out of positions all day. “The high ticket volume has implications for the back-office and the fixed cost nature of interbank settlements,”

Netlink was built for two purposes, says Sigelbaum – to build scale for large volumes of retail trades and to keep these trades out of the banks’ back-offices. “These back-offices were not built for such a purpose and to rebuild them is a costly business that involves a lot of risk. So being able to allow the banks to retain their current infrastructure and to put a service in front of them that normalises the data removes a large problem.”

Limiting exposures Traiana is currently live with 10 retail brokers that have adopted the agency broker model of performing back-back matching trades to limit their exposure and is also in conversations with another 10 retail brokers that are looking to move to this model, says Sigelbaum. “This move takes the risk out of their business. They have no exposure, it becomes a brokerage model where they take their fees from every 138 | january 2011

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Andy Coyne

Solving the Post Trade puzzle: helping retail FX providers achieve increased operational efficiencies

In essence, Traiana’s Netlink is a matching and netting service based on a network, and the network is an integral part of the service, stresses Sigelbaum. “Most banks will have some form of trade aggregation system in-house that works on a bi-lateral basis. However, when an FX broker is dealing with retail clients, the prime broker then has to look at the bilateral aggregation services of six or more banks, which is not going to be an attractive option for them. Therefore a network where everybody is using the same service and looking at the same data is the only viable method, especially the prime brokers.

Processing challenges in retail FX One prime broker that employs Traiana’s Netlink service is Citi which is well aware of the processing challenges created in the FX retail space by the high ticket volume and the low notional value of each ticket. “The high ticket volume has implications for the back-office and the fixed cost nature of interbank settlements,” says Andy Coyne, global head of FX prime brokerage at Citi. “The low notional value creates issues with the economics of each trade and whether it is profitable to operate in the retail FX market.” Fortunately, there are a number of trade aggregation solutions available in the retail FX market and Citi uses several in its operations, including Traiana’s Net Link solution. “We were the first prime broker to go live with Netlink,” says Coyne. “The benefit is that it enables the executing broker and retail provider to match and aggregate trades before they are passed onto the prime broker.” Using Netlink has led to a 98% reduction in ticket volume which has eased the pressure on the backoffice and increased the profitability of each trade.

“We regularly trade between 800,000 and 1 million trades a day and there is no way that we would pass all of those trades onto our back-office so the use of aggregation has been a great help.” Services such as Netlink provide flexibility to retail FX brokers allowing them to aggregate by time period or triggered by notional aggregate trade size. The most important thing is that Citi is still able to show clients their true real-time positions, p/l and margin situation in our client facing front end, CitiFX Click,despite awaiting the next group of deals to arrive from aggregation cycle. There is of course a cost for using these aggregation solutions but, says Coyne, the size of the savings that prime brokers are making in the reduction of back-office work and the increase in the profitability of each ticket means that the cost is one that prime brokers are happy to pay. The savings made benefit all market participants, FX Prime Broker, executing broker and client. The emergence of trade aggregation solutions has also made the retail FX market more attractive to prime brokers and executing brokers once again. The retail market would be made even more attractive if more executing brokers were to join platforms such as Traiana’s Netlink, says Coyne, although he adds that adoption and membership has picked up very well in recent months.

End of the old business model Another service provider offering post-trade processing systems for the retail FX market is UK-based DealHub. According to Tim Finch, head of sales and marketing at DealHub, the inefficencies of posttrade processing in retail FX are placing considerable

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pressure on its participants. “When we consider who qualifies as a provider of retail FX trading services the obvious choices might be the many hundreds of retail brokerages like FXCM, CMC and Gain Capital, but in fact we need to look beyond the frontline and right up the pyramid to the Tier 1 banks who provide them with liquidity. “Regulatory requirements on capital adequacy have meant that the old business model of holding a large book of open client positions is no longer possible, and so the necessity of hedging individual trades has increased overall ticket volumes substantially for both bank liquidity providers and the retail brokerages themselves. The need to service these high volume clients, to have a resilient high volume low latency STP architecture capable of processing a million transactions per day has been recognised by many of the larger players; whilst this only equates to 55 trades per second over a concentrated 5 hour market period, it is the ability to cope with spikes in ticket volumes that are generated due to news or economic releases, or large orders going through the market that differentiates the most highly tuned FX offerings.”

Advantages of ticket aggregation Finch says that new post-trade processing services are able to assist the high volume FX providers to reduce their risks, save costs and take advantage of new business opportunities. “Banks prefer to minimise the traffic to their back office processing systems wherever possible to reduce costs, so netting and ticket aggregation solutions to relieve these pressures are welcome. The DealHub Aggregation solution allows tickets to be aggregated down to a pair of buys and sells in any currency pair, and complex business logic 140 | january 2011

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can set up an ideal netting ‘strategy’ that produces a suitable reduced flow of aggregate trades that can be sent downstream based on time of day/number of tickets/ volume rules or any combination thereof. In many cases where a brokerage uses several liquidity providers it is more suitable for the solution to run on their side or in a hosted environment between them and their liquidity banks. “The DealHub solution installed at the bank uses algorithms to control queue prioritization, where in any one second the highest priority trades are sent to the downstream system first, so that those systems always receive a number of trades in that one second they can cope with, but in a priority order. Optimizing these flows to downstream systems prolongs the life of what are often the most expensive parts of the entire posttrade processing cycle: a replacement front office risk or back office processing system is a big decision for any bank. Queue prioritization allows the operations area to ‘enable’ the business, where higher ticket volumes are no longer a constraint on new client business,” says Finch.

Analytical procedures Analytical procedures can also be applied to post-trade FX data to facilitate more efficient business operations with respect to risk, compliance and trading activities, says Finch. “In addition to high volume retail traffic, internal flows can often exceed other external traffic, especially in cases where the bank splits trades for risk purposes, creating additional back-to-back trades that may need routing to different risk systems. The DealHub Routing and Processing engine allows banks to create and then optimise these flows, whilst still facilitating low latency STP. Latency monitoring can be put in place that identifies each stage of the trade lifecycle to highlight any sticking points, or where other systems are slowing the end-to-end passage.”

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Strategic Insight: “

Outsourcing & Analytics for more efficient FX brokerage operations Heather McLean explores why FX brokers should consider outsourcing many of their back office functions and in what ways outsourced analytical procedures can be applied to a brokers risk, compliance and trading activities to facilitate more efficient business operations.

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n today’s trading environment, broker dealers of all kinds have equipped their front offices with advanced technology to facilitate more efficient

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trade execution. However, few firms have upgraded their middle and back office technology, says Sam Mele, founder and managing director at Firm58. He claims many brokers are still relying on spreadsheets and legacy systems that cannot easily scale, are prone to error, and ultimately consume the gains acquired from front office advances. “Outsourcing middle and back office functions provides brokers with the ability to quickly and cost effectively protect revenues in addition to providing greater business intelligence.

>>> “Electronic trading today is far more complex since the introduction of electronic communication networks (ECNs), with trades often broken up into many parts across multiple venues,” continues Mele. “Manually calculating rates, rebates, and other fees is time consuming and cumbersome. If done in a vacuum, this processing work is siloed from other key metrics, such as the profitability of a particular client, venue or trader. To compete in today’s global market, FX brokers should consider outsourcing many of the horizontal functions associated with fees, commissions, and payouts to free up time to work on proprietary strategies and other competitive differentiators.” Mele continues that this renewed focus on operations is not unique to FX brokers. According to a recent report from the TABB Group, any firm that does not have a robust, globally integrated set of controls over execution costs, commission management, and compensation is at risk of losing clients and seeing deterioration in the return on its buy side relationships. The research continues, that any firm that still conducts such client analysis manually, or on ad hoc basis, cannot compete against those who are turning client analytics into a science (Reinventing the Relationship: Institutional Brokerage Profitability, by Adam Sussman and Cheyenne Morgan, The TABB Group, September 2010).

Play catch up Erika Cohen, business intelligence specialist at Boston Technologies, says brokerages are looking for ways to catch up. She states: “The FX market space has evolved into complex online trading systems with traders becoming more savvy and educated on ways to increase profitability, whether it be with advanced trading strategies or educational tools and programmes to guide them. With these increased trading abilities, brokerages are looking for ways to increase efficiency and reduce their risk exposure. “The optimal solution is to purchase a fully built, functioning vehicle that comes equipped with a full range of accessories and functions,” continues Cohen. “Just like a car, a comprehensive business operation has many moving parts that need to work and react cooperatively. FX brokers should consider outsourcing their back office operations for many of the same reasons they outsource their technology of their trading systems and platforms: cost of development; maintenance; experience; skill; and sharing the cost with other users.”

Sam Mele

“To compete in today’s global market, FX brokers should consider outsourcing many of the horizontal functions associated with fees, commissions, and payouts to free up time to work on proprietary strategies and other competitive differentiators.” Cohen adds that by outsourcing back office functions, efficiencies achieved include: administering day to day operations; reconciliation of data; organisation of data from multiple platforms; and risk management solutions. Alexander Ryvin, CIO at Finatek, remarks: “Running an efficient back office is, ultimately, all about effective information management. How an FX broker stores, retrieves, collates, disseminates, analyses and controls the data is an absolute key to whether it is operationally efficient or not. If this is not an FX broker’s core competency, then most likely the broker is willing to benefit from the capability of a partner in this sector to deal with these matters instead of investing its own time and efforts,” observed Ryvin. “Small and medium sized FX brokers, compared to the big ones, have clearly defined core competencies,” Ryvin continues. “Thus for these companies it often makes sense to outsource their non-core areas to the reputable provider specialising in that area, and to january 2011

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that allows a client-facing brokerage to focus on its strengths, which are traditionally sales and marketing.”

Why outsource? Cohen states that exponential growth can be obtained by focusing on what one knows best. “Outsourcing back office operations to a company that understands the technological complexity of the market, is experienced with managing large volumes of data, can create a dynamic system, and assists the brokerage to apply strategic and analytical performance tools, will increase the confidence that the brokerage is skillful and not just lucky, and will prove to be more profitable and longer standing than its competitors.”

Erika Cohen

“Applying outsourced analytical procedures, such as viewing trends, categorising client trading activity on a trade by trade basis, and being able to create forecasts from existing data, will facilitate a more efficient business operation.” redeploy resources to focus on sales and customer service in order to maintain and grow their business. Basically, we believe a broker should outsource those processes that do not give it differentiation in the market, but concentrate on the services related to growth in its FX trading business and services that a broker must provide due to regulatory requirements.” While Stephen Leahy, president of Capital Market Access Partners, a distribution partner for oneZero Financial’s technology and services, states: “The pros of outsourcing much of the traditional broker activities, from risk management, to account opening processing, to technology support, have finally begun to outweigh the cons of outsourcing.” “Forex brokers face increasing regulation in multiple jurisdictions, and a generalist technology support company cannot be expected to keep up with the continuing change,” adds Leahy. “But the firms dedicated solely to FX can reliably handle much of the specialised technology and operational support 144 | january 2011

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By outsourcing, brokerages can benefit from already existing procedures, says Cohen. “A brokerage can apply existing procedures developed for other customers to manage risk, compliance and trading activities or procedures developed by the outsourcing company. Applying outsourced analytical procedures, such as viewing trends, categorising client trading activity on a trade by trade basis, and being able to create forecasts from existing data, will facilitate a more efficient business operation.” Mele adds: “For any broker dealer, access to detailed trade data provides a level of granular information that can assist both internal and external compliance requirements. Whether it’s on demand access to the trades or configurable reports that indicate trade exceptions, firms that choose an experienced solution provider to manage post trade data can improve workflow, position themselves to respond quickly, and gain strategic insight across the business. “Today, many broker dealers lose time and valuable resources to the manual process of searching through paper tickets,” he continues. “With a SaaS solution such as those provided by Firm58 and others, these same companies can meet their internal compliance needs while lowering processing costs.” While Ryvin points out: “Another significant advantage of outsourcing is that it is based on an operational expense model, rather than a capital expense one. As financial institutions continue to focus on cost, outsourcing provides a very predictable cost basis.

Strategic insight On how the strategic insight provided by a new generation of analysis tools can help FX brokerages

At

Boston Technologies

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Call us at +1 617.314.6800 or visit our website at www.bostontechnologies.com

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to optimise their revenue streams, improve cost management and deliver long term profitability, Mele comments that many firms look at hosted solutions to achieve time savings, but he says they fail to understand that the new generation of outsourced solutions can be utilised strategically, to gauge the true value of client relationships via the management of fees, commissions, and payouts. He explains: “Relying on trade volumes and average prices to calculate client profitability is a recipe for failure. Most brokers have no means of determining profitability and measuring costs precisely using existing in-house methods and systems. For example, understanding profitability at the trade, client, venue, and group level can influence where to direct order flow. The transparency that comes from an aggregated view of trade data allows sales teams to fill and execute orders faster. Also, the ability to support cost-plus billing and other specialised pricing schemes can help a broker enter new markets and take on new market making and HFT clients.” While Cohen adds: “It can often be quite complicated to determine how much revenue a brokerage is making when one considers the variables associated with this, such as rebates to IBs, rollover, accounts with various markups, and accounting for customers whose business is generated purely on a volume or commission structure, as opposed to the spread. A better knowledge of where revenue is generated from and what areas are most profitable will optimise revenue streams,” In addition she says, “A better knowledge of costs and where the costs are being generated, and why, will improve cost management. By creating stability within the revenue models and cost structure, you will help deliver long term profitability. With the use of these new generations of analytical tools, one can now have better control over their revenue and cost models to strategically increase profit margins. In addition, brokerages can detect patterns which allow them to take advantage and focus company growth in the right direction.”

Competitive advantages As to what ways adopting an outsourcing model coupled with business analytical solutions may provide competitive advantages for FX brokers, Ryvin says that advances in technology have aided the decision to choose between the two outsourcing options: buy-in packages; or the SaaS model. 146 | january 2011

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Alexander Ryvin

“…we believe a broker should outsource those processes that do not give it differentiation in the market, but concentrate on the services related to growth in its FX trading business and services that a broker must provide due to regulatory requirements.” When the most established FX brokers built their trading platforms inhouse, there were very few packaged solutions available, and the SaaS model in FX did not then exist, explains Ryvin. This lack of choice, combined with standard practices at financial institutions, made building inhouse the most appropriate choice. Today, there is a much wider choice in terms of technology solutions and providers, including packaged solutions with optional customizations, and the completely outsourced SaaS model that enables financial institutions to subscribe to a trading solution without purchasing it. Ryvin notes: “Where a perceived competitive advantage exists, big firms will continue to develop solutions inhouse, and the largest FX brokers generally remain committed to the inhouse build concept. They see some areas such as pricing, algorithmic trading and risk management as real differentiators and have focused their research and development capacities into these fields, because they believe that these components are not offered or well served by existing solutions.”

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“Medium sized brokers are more likely to buy in packages and customise any additional aspects they require, while smaller FX players are generally looking to adopt the SaaS model,” he adds. The move towards an outsourced model is being led by smaller FX brokers and new entrants into the FX markets, continues Ryvin. He says they are willing to sign up for a service and take a ‘pay as you go’ approach to technology. “By outsourcing, these companies can come to the market more quickly than those that build inhouse or those that buy in a package with customisations. Technology has changed sufficiently for firms to consider outsourcing and it usually involves a two-step approach. “Firms will start out with a SaaS approach where the software provider manages the solution and runs it. This is a well established approach and has been very successful,” says Ryvin. “The next step is managed services, where company runs the software inhouse, but a software provider manages it. This option “The pros of outsourcing much of the traditional broker activities, from risk management, to account opening processing, to technology support, have finally begun to outweigh the cons of outsourcing.”

is becoming more popular, because the financial institution can step in quickly and take over at any time it feels like it. This has given FX brokers much more comfort about the level of control they have over processes and services.” The build versus buy versus outsourcing model will always be different for every financial institution, adds Ryvin. He states: “Cost can drive these decisions, but not always. Sometimes a financial institution finds it difficult to hire and retain qualified IT staff, and in other cases it may want to come to market in the shortest time period possible. By utilising any of the outsourcing options, companies can be up and running in almost no time to offer eFX trading services to their clients.”

Stephen Leahy

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Handling Risk Leahy remarks: “Risk and trading are the two aspects of FX brokerage that most easily give way to outsourced specialist firms. Trading platforms are notoriously tough to implement, maintain and integrate from a technology side. Specialist outsourcing firms have developed their business by focusing on handling these roles. Rather than hire a staff of specialists to maintain a trading platform, FX brokers can outsource their technology needs and pay for just the amount they need.”

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“As for risk management,” he comments, “Capital Markets Access Partners was created on the premise that for the owners of an FX brokerage, their return on investment is higher by passing through most of their risk, rather than handling it entirely in-house. While the returns to an FX brokerage may be higher by handling all risk internally, in the long run there will be significant swings in P&L over any period of time. An FX brokerage using this internal risk model must have more capital on hand to handle the risk, and may have to operate for months at a time without positive revenues when all risk is handled in-house, additionally, a fulltime 24/6 staff of qualified dealers is expensive to operate. So the higher potential reward of handling all risk internally is offset by the volatility of the returns.” He says a better business model for FX brokers is to pass risk over to firms who specialise in risk management and to generate transactional revenues with each client order executed.

While the top line revenues may not match the potential for internally-managed risk, there is less expense, less capital needed, and revenues are directly tied to expenses in a pass-through model, Leahy notes. He says: “For the FX brokerage owner, the return on investment is higher with a pass through model.” Leahy states: “Our experience in the industry is that FX brokerage firms are best at sales and marketing operations. Adding the technology and risk management functions to this core is how you add risk to a brokerage’s operations. If a firm can focus on its strengths and outsource the functions where it does not have a core competency, the brokerage will grow.” Concluding, Leahy remarks: “It really is a decision for the owners and senior managers of a firm; keep all functions in-house and assume the financial and operational risks to achieve potentially higher rewards, or outsource where you can and focus on growing the entity from a market share perspective.”

Create an FX ECN business with the unique White-Label Solution of a Swiss Bank As many businesses would probably agree, the first steps in implementing a new service or product are the most challenging to overcome. High start-up costs, shortage of technical resources, lack of professional back-up and support from a strong partner in the new domain are the most typical obstacles that become insurmountable for many otherwise promising ideas. Asset management or Forexrelated companies are no exception

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hether a company that already successfully operates in the market decides to expand its activities in the Forex market and set up its own Brokerage solution or an ambitious licensed and properly regulated start-up decides to build a new business in the Forex market – all of them will face these challenges. In an endeavor to overcome these hurdles, Dukascopy Bank SA has launched a new cooperation programme – ECN “White Label”, which aims to provide partners with a fully integrated tailor-made solution for offering online currency trading to their clients. The fundamental advantage of the programme is the virtual absence of implementation and maintenance costs combined with the opportunity to generate revenues from clients’ commission straight away after the start of the project. The uniqueness of Dukascopy’s offering is strengthened by an unprecedented combination of advanced IT competences and Swiss Banking traditions – all bundled in one integrated product.

White Label partners receive a fully functional Back-Office system at their disposal, the access to trading platforms, all-encompassing reporting and a 24h support from Dukascopy Bank SA. All products and software are accordingly rebranded to match the partner’s corporate design. This customization extends from appropriately signed email forms with the partner’s contacts and logos up to a partnerbranded platform and reports design – all provided by Dukascopy Bank SA. Via the multifunctional Back-Office system WL partner’s specialists obtain full control over the activity of their traders, get access to collateral accounts management, accounts and commission maps creation as well as a handful of other functions that enable managing an entire FX Brokerage solution. In contrast to the offers that already exist in the market, the White Label programme of Dukascopy Bank is based exclusively on in-house developed IT and intellectual solutions. This ensures both full control over the system’s components and the integrity of clients’ data, which are the inherent prerequisites of the values traditionally associated with Swiss banking traditions recognized for outstanding security and reliability. The clients of the WL partner, in their turn, get a mediated access to the SWFX – Swiss Forex Marketplace, one of the world’s largest ECN liquidity aggregators, which implies the possibility to benefit from the same renowned advantages that Dukascopy clients do – a fair transparent trading environment, equal trading rights and opportunities to all clients, a single data feed, the tightest spreads, data integrity etc. The complete implementation of a Standard White Label programme takes up to 3 weeks, from application to launch. Any institution in compliance with regulation can start the process by applying for an evaluation by Dukascopy Bank SA to start benefiting of a unique technology. Applicants face a unique opportunity to become partners of a regulated licensed Swiss bank while still preserving such essential values as flexibility, individualized approach and promptness.

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Robin Osmond

LMAX: bringing a neutral and transparent service to Retail FX e-Forex talks to Robin Osmond, CEO of LMAX, the first Multilateral Trading Facility (MTF) for Retail Contracts for Difference (CFD) and FX trading

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Robin, how does the LMAX trading model work? LMAX operates an exchange model, an MTF to be precise, that brings retail and institutional traders together across a wide variety of financial instruments so they can trade on a more level playing field. It is a completely neutral service – an open platform with no dealer acceptance, no hedging of client positions and no re-quotes. We do not trade against our clients. Instead, we bring buyers and sellers together directly without brokers and other middle men taking their cut. Traders are able to make their own price rather than being restricted to passively taking prices. The platform has been designed to bring the benefits and efficiencies of institutional exchange trading to the retail market. What instruments can be traded on this Multilateral Trading Facility (MTF)? LMAX allows customers to trade rolling spot FX contracts and CFDs in equity indices, commodities, bonds and interest rates, with other asset classes to be added to the platform in due course.

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What key advantages does your platform have over the current broker-led model which is widely prevalent in Retail FX? The current broker-led model for online trading of rolling spot FX and CFDs is outdated and doesn’t work to directly benefit the customer as the interests of parties are not aligned. LMAX offers a clear advantage as we bring transparency and fairness to the market bby providing an exchange platform and a business model that wants its retail traders to be as successful as m possible. p T To clarify, LMAX takes a different approach to the ttraditional broker model. A broker makes a price for a given underlying instrument such as EUR/USD and th the customer has no option but to accept the price ooffered to them. In many cases the broker will ‘hedge’ the position by trading into the underlying market, th bbut often they won’t and will only profit if your trade ggoes against you. In effect, they are running risk aagainst you and need you to lose in order for them to make a profit. We never take positions against our m ccustomers – as an exchange LMAX is entirely neutral.

H have you gone about ensuring you can provide How a high level of actionable liquidity? IIn order to provide high levels of actionable liquidity, a number of sophisticated institutional market makers january 2011

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– including Goldman Sachs, J.P. Morgan and Optiver – provide pricing on the platform. Retail traders will trade against each other or these institutional liquidity providers. In addition, customers can set or take a price of any given instrument – in essence, retail clients can become market-makers themselves on the LMAX platform.

LMAX is based on Betfair’s original matching engine. Are you confident that the technology will migrate and is robust enough to cater for the huge trading volumes associated with FX? Absolutely. We are individually registered and authorised by the FSA and although LMAX is based on Betfair’s original matching engine, we have invested significant time and resource into research and development to refine this model for financial trading. The platform is capable of processing hundreds of thousands of transactions a second at incredibly high speeds and is essentially an institutional platform repurposed for retail investors. 154 | january 2011

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How does your charging structure operate? LMAX charges commission on a completely transparent per-contract, per-trade basis. On LMAX there are no hidden charges. Who clears your CFD trades? CFD trades are cleared via LCH.Clearnet – a central counterparty (CCP) used by the likes of the London Stock Exchange – with J.P. Morgan clearing FX transactions. We are one of the first CFD trading platforms that clears trades through a CCP. In addition to executing trades, what other services are available to the users of your platform? In addition to the trading services that we offer, we have also created the LMAX Community that allows customers to share ideas, trading strategies and actively contribute in the development of the platform. LMAX isn’t just about giving retail traders the ability to trade with each other and on more equal terms with the institutions, it’s also about giving traders the ability

LMAX: bringing a neutral and transparent service to Retail FX

to interact with each other and giving them access to tools, information and education to help them become better traders. LMAX also allows clients to trade like a professional trader by giving access to its Application Programming Interface (API). Increasingly, the trading strategies of professional traders are developed and executed using APIs. This improves the speed and the effectiveness of their trading by allowing them to execute complex trading patterns quickly and efficiently without

“We feel the current broker-led model for online trading is outdated and we have a different model to anyone else in the market, and one that customers will find compelling.”

the emotions of the trader getting in the way. With LMAX, clients can build a trading strategy using our API access to execute trades directly on the LMAX MTF.

The LMAX service will obviously be of great interest to Retail FX traders. Are you expecting to see significant demand from Institutional traders as well? It’s not core to us. We do not want to open the model so it becomes just another platform for the buy-side. Every aspect of the LMAX service is about bringing the benefits and efficiencies of institutional exchange trading to the retail market. The platform brings retail and institutional buyers and sellers together in a wide variety of financial instruments.

Are you planning on adding other asset classes to the platform in the coming months? Yes, LMAX will move in time into other asset classes, dependent on where there is greatest demand. We will offer individual stock equity CFDs in early 2011 for instance.

Do you think the arrival of exchange-based, centrally cleared solutions such as LMAX will ultimately transform the traditional way Retail financial trading markets have operated and are you surprised that a trading model like yours has not been adopted by this industry before? Yes. We feel the current broker-led model for online trading is outdated and we have a different model to anyone else in the market, and one that customers will find compelling. The MTF model and centralised clearing provides the transparency and security that the retail market has lacked and which clients, regulators and the market are increasingly demanding. For the first time, retail CFD and FX traders can access an open order book with wholesale institutional liquidity across a wide variety of asset classes with all the protections you would expect. We are not really surprised that a trading model like ours has not been adopted by the industry before. Creating a safe and secure platform, providing centralised clearing and developing the technology integral to a high-speed financial exchange is a huge undertaking and one that requires a significant investment of time and resource. This has been a three year project but has been well worth the wait. january 2011

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ITC Barcelona 2010 The International Traders Conference was held in Barcelona, Spain in Autumn 2010. e-Forex was a media partner at this event which included many important keynote speeches, several live trading sessions, a panel discussion and a special dinner party to celebrate the10th Anniversary of FXstreet.com

RECENT EVENTS

The World Moneyshow London The 6th Annual World Moneyshow London was held over 2 days in November. The event had a busy schedule including a wide variety of speakers, live trading workshops, panel discussions, exhibitor presentations and drinks receptions.

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LiteForex Group in Nigeria and opinions regarding the currency trading. As part of the seminar, the final of LiteForex’s “Great Hundred” regional contest was held. The most successful traders were awarded and those who showed the best trading results on their trading accounts. The awards ceremony was held in the conference hall of Sheraton Lagos Hotel.

The presentation from LiteForex group of companies which took place on 13 November 2010 in the city of Lagos, Nigeria, was a major success and aroused great interest among professional traders of the Forex market. There is no doubt that such success reflects credit on the organizer - International Forex Show Company LTD. A competent advertising campaign and information program which supported this event, received positive reports from the guests.

“A number one priority for us was to introduce the full range of our services and facilities to our guests and also to present a new project – MultiRebate”, said LiteForex’s General Director Yuri Voloshin. – “Face to face communication with Nigerian traders was a great experience for the managers of the Company. We were pleased to hear traders’ opinions and wishes. I am sure that we will apply all proposals we received here to our trading conditions in future, because focusing on our clients has been LiteForex’s main objective through all periods of its activity.” Believing that the work of LiteForex group of companies in Nigeria deserves high assessment, Online Forex Traders Association of Nigeria (OFTAN) added a new honorary reward “Best Forex Broker in Nigeria 2010” to LiteForex’s prizes and status.

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The representatives of Online Forex Traders Association of Nigeria (OFTAN), students of schools and institutes (NETOSHI FOREX TRAINING INSTITUTE - NFTI), and banks’ representatives were visitors of the seminar. Each group of guests found a lot of useful information. The program of the seminar made it possible for the visitors to assess the state of the brokerage market, identify tendencies of its further development and choose a reliable business partner for the professional work of the Forex market. Discussion between LiteForex’s clients and guests of the seminar with the Company’s representatives also included professional advice, sharing of experiences

“The new reward is an excellent incentive for LiteForex team to improve service” - said Yuri Voloshin. – “We will continue to provide our clients with innovative products and favourable cooperation conditions. LiteForex group of companies constantly strives to ensure the most advantageous and comfortable trading conditions for its clients.” january 2011

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seminar from the LiteForex group of companies’ management and representatives took place as part of the presentation. Everyone’s attention was drawn to the innovative project - MultiRebate. This new service represents a multi-level program of reimbursement of the part of spread. Innovative conditions of the MultiRebate project will give all LiteForex’s clients the opportunity of building up a new format of partnership.

BROKER STUDY

Stavros Lambouris

AFX Capital Markets Bringing experience, passion and technology to online FX e-Forex speaks with Stavros Lambouris, CEO of AFX Capital Markets

Stavros, when did AFX Capital Markets (AFX Capital) commence operations and what type of trader and investor are you providing services for? AFX Capital was established in mid 2010 as a privately held company with a focus to meet the needs of retail and institutional clients looking for a broker who can provide a complete range of financial products. In terms of our market approach, we are targeting audiences across the globe from various market sectors as part of our business development. We want to satisfy every trader that wishes to trade with these markets as long as the applicant meets the criteria for opening an account as this is highly important and we strongly emphasize the presence of a regulatory environment. AFX Capital is licensed and regulated by CySec and fully complies with MiFID and other international financial and regulatory requirements. How important is this type of client guarantee now becoming in Retail FX industry? As I mentioned, the regulatory environment is of a huge importance not only to investors but to our 160 | january 2011

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business as well, especially in today’s financial situation. The global economic conditions have led investors to look for alternative investment opportunities in the financial sector which are strictly supervised and regulated. The fact that we are licensed and regulated by Cyprus Securities and Exchange Commission and additionally registered with 27 regulatory entities such as the FSA, CONSOB, CNMV, AFM to operate in all member states of the EU, provides the security and confidence of being part of a strong regulatory environment, as MiFID requirements offer a strong base where clients can feel at ease.

How would you describe the mission of AFX Capital and how do you go about delivering an exclusive and customized service for your clients? Aside from the fact that we are driven to become a major player in the Online FX industry, we want our brand to be associated with high standards and we intend to do it by investing in two very important elements: the people within the company and our clients. We believe in making the markets more approachable, providing value and excellent service within the technology and innovative products that traders need. This can only be achieved by encouraging our people to be innovative, strive for professional excellence and always be loyal to all our clients, old and new regardless of their account size,

>>> big or small. This means taking an uncompromising approach to the standards of client service and constantly looking for new product offerings.

What types of trading accounts do you offer? We offer four different types of trading accounts consisting of the Micro account, the Standard account, the EA Scalping account and, the ECN account all of which offer the advantage of trading various products using one account. Spreads start off as low as 0.8 pips with initial deposits ranging from €200 up to €20,000 depending on the type of account opened. The advantage of a Leverage facility applies to all of our accounts allowing investors to open positions with larger amounts using only a portion of their investment capital, enhancing profit margins with respect to account size. The size of the Leverage again depends on the type of account, with leverages up to 500:1 and no commission fees applicable. A trader can certainly find what he is looking for in terms of flexibility and products. How many currency pairs do you currently offer and what other instruments can clients trade with AFX? With AFX clients have access to more than 40 currency pairs, including major Forex pairs such as EUR/USD, USD/JPY, EUR/JPY and the GBP/USD. AFX also offers clients the opportunity to trade CFDs across various markets including Metals, Oil, Commodities and Indices. CFDs offer narrow trading margin requirements where it is not mandatory for the client to pay for the full value of his position and instead can submit a deposit or margin, leaving him with available capital for other trading operations. These are very attractive products ideal for short-term or long-term trading strategy. The instrument types range from Metals such as Gold, Silver, and other precious metals; Commodities which include agriculture products such as Corn, Soybeans, Wheat; Energy products consist of Brent, WTI and natural Gas. Finally the Indices products cover major indices such as the Dow Jones Industrial Average, the Nikkei 225, and many others. You use the MetaTrader 4 trading platform. What key features do your clients particularly like about this platform? The MetaTrader 4 platform offers advance charting and technical analysis tools with the highest level of system stability which is considered by many traders to be the industry’s leading platform. MetaTrader 4 is client friendly with outstanding market execution response, supporting more than 20 languages and provides daily live market news coverage. In addition to this it also contains a strategy tester to help determine whether clients approach work in market

conditions. Overall the MT4’s platform characteristics and advantages are in line with our corporate goal of making the markets approachable to our clients through the use of cutting edge technology.

What services does AFX Capital provide to enable clients to test their trading and investment skills before commencing live trading? We provide a Demo account service in which clients can test their trading ability allowing them to execute trading positions and buy/sell various products. The Demo service also offers live updates on market news. Demo january 2011

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accounts are available to download via our website free of charge by simply completing a Demo account registration form online. Demo account expiry is never ending providing there is account activity, and if there has been no activity for longer than 30 days, the account will automatically expire.

Can clients undertake mobile trading with AFX? At AFX Capital we understand the need for mobile trading technology therefore our innovative applications provide clients with two convenient mobile application options designed for the trader on the move, allowing them to trade from their own phone, anywhere and anytime. The AFX Mobile application contains a fully functional MT4 trading platform, with access to market news, and the advantage of managing your account with the function to place all order types. The AFX iTrader has been designed specifically for the iPhone. As an AFX Capital client we provide you with our free App AFXiTrader which gives you full and secure access to your trading account, news, and trading history.

What opportunities are available for companies to partner with AFX Capital? Partnering with AFX Capital can provide individuals and companies with various prospects in which they can maximize their potential. Depending on whether you are an individual client, an Introducing Broker, Institutional Investor, Portfolio Manager or a financial organization that is interested in White Labeling, we can provide tailor-made conditions to suit your needs. For each new partner we are available to assess their situation in order to provide them with the best solution to capitalize on their potential.

Our goal is to provide the right business opportunity for potential partners that are aligned with the general business process and company standards.

What plans do you have for extending the online Forex products and services you currently offer? Our business model is based upon providing all services under one intergrated account making it easier for traders to participate in the capital markets. Our product offering is already quite substantial but we are always striving to provide more competitive products. We will definitely be adding some more products in order to expand our product offering as we always endeavor to provide alternative trading solutions for our clients. The product development team constantly evaluates certain sectors of which we believe would be a great interest to our clients and we should therefore be adding additional products in the near future. Looking further ahead, are you considering expanding your business activities beyond Cyprus? Cyprus undoubtedly provides an ideal platform for operating our business. The fact that we are based in a European country that is regulated and meets the criteria of the European MiFID requirements enables us to provide these standards of investment services to investors around the globe. In addition to this Cyprus is also a stable financial and commercial center which links Europe, the Middle East, the Gulf and the Far East which are our target audiences. We feel that it is also important to have a more localized approach to markets that are important to our business development so it is within our business plans to have a local presence in regions outside of Cyprus. We are in fact already in the process of establishing a branch in another European country to serve our local clients more efficiently. What’s the easiest way for new clients or trading partners to contact AFX Capital? Direct contact with AFX Capital is fast and easy thanks to our 24 hour dedicated customer service team, who can be reached via our live chat service, via telephone or via email. All details can be found on our website at: www.afxcapital.com under the ‘Contact us’ section. Our professional team is eager to answer any inquiry proving the best possible service to individuals that would like to open a live account or a demo account. Here on our customer service team we are committed to delivering an exceptional service to our clients across the board.

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Coding, backtesting and strategy optimisation techniques for Automated FX

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eavy marketing efforts frequently bombard traders with promises of an effortless road to riches via black box systems. Of course, what sounds too good to be true invariably is. I won’t claim that all for-sale systems are not worth their purchase price. Yet expecting to buy a worthwhile trading system that claims to achieve virtually risk-free returns is unreasonable. When in doubt, any systems that show client testimonials with posh new houses, luxury cars, and extravagant lifestyles should be avoided.

By David Rodriguez, Quantitative Analyst at DailyFX

Modest barriers to entry have made automated trading more popular than ever, and the explosion of pre-packaged automated trading systems have particularly flourished through FX markets. What was once the playground of only the most sophisticated speculators is now accessible to anyone with an internet connection and a modest-sized trading account.

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These disclaimers are not to completely dissuade the individual trader from automated trading; there are certainly advantages that should not be ignored. Perhaps the foremost advantage applicable to many traders is simple: it removes most emotion from trading. Though automated trading systems require a good deal of manual attention, the extent of active maintenance is most often less than the equivalent manual trading strategy. A trader can more easily let their trades run their full course and avoid the most common over-trading follies.

Where can one start? There is obviously no one formula for success.

>>>

Frequency of Weekly Highs and Lows in British Pound/Japanese Yen by day of week, 2000-Present

Personally I like to start with the simplest idea possible, start my research in statistical software to see if there’s anything to justify my hypothesis, then move onto coding into automated trading software. I most often resist the temptation to dive straight into coding for a fairly simple reason: once confronted with a screen of code, trading ideas become abstractions and it is altogether too easy to create rules with little foundation in sound logic. It is easiest to work via example than to speak in total abstractions. As such I’ll use a concrete idea that showed promise every step of the way. We will work through four key steps that I feel are most conducive to creating viable trading ideas: • • • •

Research and Design Code and Debug Backtest and Forward-Test Assess and Reassess.

Weekly Seasonality Research and Design the Strategy: My colleague told me he had done some work that showed currencies tend to make their highs and lows for the week on Mondays and Fridays. I decided to test this idea with hopes that it could form part of an automated trading strategy. I turned to R, my preferred statistical analysis package, to run some basic analysis on said trends. Sure enough, Highs/Lows tended to occur on the first and last trading day of a given week about 60% of the time. Such a percentage was hardly a guarantee that any subsequent trading would be profitable, but it was certainly a starting point.

How do we turn an idea into a trading strategy? From the onset it is important to emphasize one point: simpler is better. Though it is quite the temptation to start with as many parameters and trading rules as one can imagine, we aim to test whether our original idea holds water. In this case I wish to test whether weekly FX seasonality can produce a worthwhile trading system—not whether FX Seasonality can be combined with sunspot activity and the phases of the moon to produce an attractive equity curve. We are reasonably confident that the currency pair’s highs and lows will be established at the beginning and end of every week, but we cannot know whether Monday produced the high or low during the trading session. Instead we will wait until the second trading day and prepare for either outcome by selling stop entry orders at both the high and low of the preceding january 2011

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>>> simpler than removing entire blocks of code and restructuring our strategy’s logic altogether.

daily bar. Given that we likewise expect the high and low will be established on the subsequent Friday, we will put a simple order to close the trade as close as possible to Friday’s close.

Coding and Debugging When it came to coding said idea, I of course had a number of different options. Though the strategy itself would have been straightforward to code into many different trading languages, I am partial to platforms built on Microsoft’s .NET architecture. The wealth of readily available libraries and resources for .NET projects generally makes prototyping considerably faster than in other development environments. A guide to programming is beyond the scope of this article, but I recommend that those looking to learn find books that emphasize interaction and hands-on programming. Once comfortable with the syntax and structure of a specific programming language, one can then move on to the documentation and coding examples specific to the automated trading platform of choice.

Code structure: Our code will obviously look different for any particular strategy, but it should always follow roughly the same structure. We want to design our code such that subsequent tweaks and changes are as easy as possible. This means building trading logic into different modules that can easily be added, subtracted, and tweaked without the need to restructure the rest of our code. In concrete terms, this means making sure that major blocks of code are confined into their own methods and classes where appropriate. Adding/ subtracting methods from final execution is much 166 | january 2011

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Such intelligent coding likewise makes debugging far more straightforward. If we can break individual bits of logic into smaller pieces, we can see exactly which part of our ‘machinery’ has failed. It is difficult to emphasize exactly how important it is to spend a great deal of time debugging one’s code before doing any real strategy assessments. This means looking at individual trades, placing extensive commands to output text through every step of the trading logic, and feeling certain that the code is performing exactly to one’s specifications.

Backtesting and Forward-testing The bread and butter of hypothesis trials, backtesting and—more importantly—forward-testing will tell us whether our trading ideas have merit. Boilerplate disclaimers emphasize that past performance is by no means a guarantee of future results. Most of the difficulty with backtesting is that historical data will never reflect true transaction costs due to factors such as slippage and changing market conditions. Another key limiting factor is that a lot of automated trading software does not allow the trader to test ideas on the highest-frequency possible—individual ticks. We get around both key limitations with forwardtesting on live data and, when we feel more confident with our results, testing our ideas with modest live trading capital. Problems with backtesting nonetheless become less significant when we test lower-frequency systems. Given that our intraweek seasonality system trades on daily changes and at most places several trades per week, these issues are less of a concern. Yet traders who look at backtests of systems trading on progressively higher frequencies should keep such limitations strongly in mind. There are systems (such as the one I used for this report) that allow usage of tick data, but the transaction cost and slippage limitations remain relevant. In our backtest we obviously want to see the bottom line—whether or not the strategy generated through our testing period. Yet good automated trading software should also give us a number of other

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trade that has drawn down over $500 has never made a worthwhile profit. This implies that a relatively short stop loss could limit losses while not getting in the way of most profitable trades. Our Maximum Favorable Excursion points out similarly interesting results. It seems that our raw strategy is particularly poor at taking maximum profits on our best trades. The natural temptation would be to set a fixed profit target that would maximize our historical profits. Yet that leaves us at very clear risk for over-optimization. important diagnostic tools so that we can truly get a sense of how well the system operates. At first glance the system shows promise on the British Pound/Japanese Yen currency pair. This is exactly what I like to see for a proposed trading system: with no modification, there is a reasonably steady and positive equity curve. Of course the above example shows that the system suffers frequent drawdowns and is far from perfect. We can get a better idea for potential tweaks in seeing the particulars of this trading algorithm. I will perform my first wave of strategy assessment before turning my strategy onto forward tests.

Assessment and Reassessment There are a great number of diagnostics we can run on our backtested results. In this particular case, I see that the system is reasonably effective, but is the strategy truly taking full advantage of its most successful trades? For more insight on efficiency I like to look at individual trade diagnostic plots. In this case, I use “Maximum Adverse Excursion” and “Maximum Favorable Excursion” charts. The adverse excursion chart will show me how large an unrealized loss each individual trade achieved, while the favorable excursion shows maximum floating gain before final profit or loss. The Maximum Adverse Excursion chart shows me that this strategy is very aggressive in closing trades at their worst drawdown. According to this analysis, any 168 | january 2011

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Maximum Adverse Excursion

Maximum Favourable Excursion

I would rather look at our original code to see if any shifts would make an important difference in historical performance.

Back to square one: Researching and Development Strategy development is a cycle, not a linear process.

Coding, backtesting and strategy optimisation techniques for Automated FX

At this point it is important to emphasize that we optimized across parameters we knew to be grounded in intuitive logic. With optimization there is always risk that we attempt to pick strategy parameters that produce the best equity curve and not necessarily those that make the most logical sense. When we go into our optimization trials with a greater sense of what should work, we have a greater chance of producing results that will work. Frequency of Intraday Highs and Lows by Time of Day in GBPJPY pair from 2009-2010, Eastern Time

We once again move to the Backtesting and Forward-testing stage, which shows

With our admittedly limited assessments in hand, we will go back to our original design and look for potential improvements. Our initial idea was very simple: on Tuesday, set buy and sell stops at Monday’s respective high and low. On Friday, close any open trades at the end of the day. Our strategy works on the assumption that Highs and Lows will occur on Monday and Friday, but it is doing a poor job of maximizing profits. Thus it seems worthwhile to see the tendency for the GBPJPY to make highs and lows at specific points during the day.

us a significant improvement in hypothetical results. At this point I feel confident enough to forward-test and check the validity of my strategy. Once I have a good sample size, I will once again Code and Debug, Assess and Reassess and likely do more Research and Development before dedicating live trading capital to the system.

Back to research: It seems that the pair is quite unlikely to make its daily highs or lows near the New York session close (17:00 Eastern Time). Thus it seems reasonable to rethink the logic of our trading strategy and change the time at which it closes trades. A quick optimization across strategy parameters shows that a Friday close time of 03:00 Eastern Time produces the best riskadjusted returns, which is largely consistent with what we see in our statistical tests.

Strategy Development: A cycle, not a static and linear process Throughout this process I have attempted to show several key themes. First and foremost, strategy development is a cycle and not a linear process. Work is never complete, and virtually no system is good enough to stand without intervention. Second, strategy logic should always start with what makes intuitive sense. If one mashes away at code for long enough, a perfect equity curve is inevitable. Yet the likelihood of such a system working in the future is relatively slim. With this basic process and approach in hand, I believe the likelihood of producing a worthwhile trading strategy is much improved. january 2011

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InovaTrade offers world-class business WHY[ULYZOPW ZVS\[PVUZ MVY IHURZ ÄUHUJPHS institutions, brokers and private investors through its White Label, Asset Manager, Prime Broker and Business Finder programs. Partnership solutions can be customized according to our partner’s business strategy, ^P[OÅL_PISLPUJVTLZOHYPUNWSHUZHUK]HS\L adding support features. We offer several different trading platforms, including: MT4, InovaTrader Inter-banking Platform, and any interface with FIX API. InovaTrade’s Research Department offers clients premium technical analysis and research products developed by a leading team VM ÄUHUJPHS HUK LJVUVTPJ L_WLY[Z >P[O V]LY 50 years of combined industry experience, our analysts produce high-quality technical analysis and macroeconomic reports available to clients on a daily basis. For more information please visit our website www.inovatrade.com or call us directly at: +507.836.5513

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Down to the cogs: getting to grips with trading methodologies in Managed FX

Timothy J. Maxwell is Principal at QP Capital LLC ([email protected])

In today’s volatile world, Managed FX advisors utilize a variety of different approaches. However, the most successful methodologies seem to satisfy certain criteria. This article describes such criteria in detail and can serve as a good foundation in an investor’s search for an ideal advisor.

Fundamental vs. Technical Analysis In a well-designed program, both approaches can work equally well. In many cases, fundamental analysis uses global trends or news to determine the direction of the trade, while technical analysis is used to determine all the key levels (e.g. entry, stop-loss, and target). The key to fundamental analysis is being able to interpret global events and news properly and consistently. 172 | january 2011

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In a technical program, the trade’s direction and key levels are determined only by technical analysis. Most technical programs are based on a combination of signals generated by several indicators. Since there are hundreds of common and custom indicators, there are thousands of technical systems. The key weakness for many technical systems is performance sustainability. Often, inefficiencies are quickly exploited and the system stops producing results after several months of good performance.

Program Styles Programs are typically classified by the average length and desired profit for an average trade – see Fig.1. The areas of preferred style are highlighted. Scalping is not a good idea, as it can rarely be sustained, as the fund grows in size. Long-term trading can take years to determine if the program’s performance is up to par.

>>> Typical Program Workflow Fig. 2 overleaf shows a simplified version of typical trading program. Real-time data continuously comes as the program’s conditions for generating a signal trigger the workflow pictured above. This process is almost always automated. Program’s modules can be a part of one or multiple software platforms. If the modules are distributed, the communications between the modules is usually automated as well (via one or more common interfaces). Development Platforms There are many software packages that can handle various aspects of FX trading. However, two packages are the most popular: MetaTrader (www.metaquotes.net) and MatLab (www. mathworks.com).

Fig. 1: Program Styles

Source: QP Capital LLC © 2010

MetaTrader (MT) is a full FX development platform with a built in real-time data feed (varies from broker to broker), multi-timeframe charting, dozens of built-in indicators, its own programming language (MQ), automated trading systems (called Expert Advisors or EAs), and much more. Most of the current development is done in MT4 (version 4), even though MT5 (version 5) has been released. The newest version is not backward compatible. Most system developers feel that re-writing their code from MT4 to MT5 january 2011

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Fig. 2: Typical Trading Program Setup

is not necessary, despite some advanced capabilities of MT5. There is a large user base of MT4 that has created hundreds of custom indicators and EAs available to public. Matlab is used when heavy math calculations or complex algorithms are required that could not be easily implemented in MT. The historical data is imported into Matlab prior to program development. There are applications to link Matlab to MetaTrader. Trading Tools There are software packages that are not typically a part of the advisor’s main development platform.

Data Providers Typically, FX data is provided via a broker’s trading platform. MetaTrader has its own real-time and historical data that is provided by the broker through which the account was opened. The number of available pairs for trading is limited by the broker. Some advisors use data from third-party providers, such as eSignal (www.esignal.com), due to better aggregated pricing and availability of hundreds of trading pairs and crosses. Tool

Source: QP Capital LLC © 2010

Trading Costs Managing trading costs properly can mean a difference between a success and a failure, as the FX trading is not a truly “zero-sum” game. There are three major costs associated with FX trading: • Spreads & Commissions Spreads and commissions could be often negotiated directly with the broker. Typically, the higher the trading volume, the lower spreads and/ or commissions get. • Rollovers Rollovers occur every night. Often, continuous rollovers cause negative impact to open positions. The advisor has to pay close attention to these costs, especially in case of position- and long-term trading. • Slippage In more cases than not, slippage has negative effect on performance, especially if “Soft” stop losses are used (see “Soft” Stop Losses). The trading program has to execute efficiently, so that slippage is minimized and trades are never missed.

Typical Use

Example

Neural Network

Figure out complex relationships on the chart that are not apparent

Neuroshell Trader www.neuroshell.com

Genetic Optimizer

Speed up back-testing/optimization, find optimal parameters quickly

TSGenotic www.genotic.net

Pattern Recognizer

Locate all pre-defined patterns on the chart automatically

Nison Candle Scanner www.candlecharts.com

Risk Analyzer

Determine proper trade size based on certain criteria

@RISK www.palisade.com

Fig. 3: Trading Tools

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Source: QP Capital LLC © 2010

Down to the cogs: getting to grips with trading methodologies in Managed FX

If managed carefully, these trading costs should amount to under 15% of yearly compounded ROR. If not, they could easily erase otherwise positive returns.

Risk Management & Drawdowns The best Managed FX programs are modeled not to achieve the highest possible absolute return, but to maintain solid risk-reward ratios. One of the best ones is called the Calmar Ratio. Compounded Annual Return Calmar Ratio = Maximum Drawdown Programs with a Calmar ratio less than two should not even be considered (e.g. the program returned 80%, but had a 42% maximum drawdown). The best programs offer a Calmar ratio of five or higher over at least three years of trading history. Usually, each trade’s maximum potential loss is capped with a stop-loss at 0.5%-3% of overall available capital at the time. Programs with seldom, but high-winning percentage of trades can afford more risk per trade (e.g. 82% historical wins, 3% max loss per trade). More active programs with less winning percentage, typically risk less per trade (e.g. 62% historical wins, 1% max loss per trade). This is done in order to minimize drawdowns, as losing trades can add up quickly, one after another.

Leverage Most programs utilize only a portion of maximum allowed leverage by their broker (typically 50:1). This is done via a risk management module. Most advisors use 2:1 to 10:1 leverage. Using leverage higher than 10:1 would typically work only for a short-term style of trading. Diversification Typically, trading more pairs/crosses provides higher diversification, unless they are highly correlated (e.g. EURAUD and EURNZD). Correlated pairs add overall exposure to a particular currency and decrease diversification. Hedging Hedging in Managed FX is primarily utilized in programs with highly correlated pairs in order to achieve some level of arbitrage. A simplified example of such trading is shown below:

o Buy EUR/USD o Sell GBP/USD o Sell EUR/GBP By utilizing such a tri-hedge (each pair/cross must be traded in precise proportion), the advisor can theoretically achieve a profit if any of the legs of this trade temporarily deviate from its proper pricing, while maintaining almost a riskless complex position. This type of strategy may be more applicable to exotic pairs and crosses, as less liquid pairs typically offer less efficiency. Of course, there are factors (see Trading Costs), that make this strategy a challenge.

High-Frequency Trading (HFT) There is a relatively small number of advisors utilizing these types of strategies due to significant required hardware/software investment and extensive expertise. HFT strategies typically work with NDD (No Dealing Desk) brokers or banks. There are four main HFT strategies for FX: • Market Making – placing orders within current spreads (often within one pip) • Ticker Tape Reading – interpreting unusual price action (volume) • Event Arbitrage – interpreting recurring events (e.g. FOMC meetings) • Statistical Arbitrage – capturing short-term market inefficiencies

Automation Platforms, such as MetaTrader, allow for full program automation. Programs are able to receive real-time data, generate signals, send them to the broker, and receive confirmations all from the same platform. This allows for 24/6 trading without human intervention. Many advisors choose to generate automated signals, but execute manually for final control over trading decisions. Back-Testing & Optimization Platforms allow for back-testing of strategies as far as historical data allows. Typically, an automated program can be easily back-tested. This is a great benefit, as it allows the advisor to test the robustness of his program before live trading commences. It makes sense to back-test a program as far as possible to see how it behaves in ever-changing market conditions. january 2011

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Return Stats Monthly RORs Average Monthly ROR Yearly Comp. ROR Annualized ROR

Trade Stats Total Trades Average Trades/Month Winning/Losing % Pips Won/Lost Fig. 4: Performance Analysis

The back-tested (hypothetical) performance results should not be submitted to potential investors, or submitted in conjunction with live results (see Performance Analysis). Optimization allows for dynamic changes in program’s parameters during back-testing to achieve maximum profitability, lowest drawdown or some other preset goal. While some specific optimization might be good for development, over-optimization (also called “curve-fitting”) is a bad practice. It produces great hypothetical results, which are fictional and have limited practical applications. Solid programs should work well with any combination of parameters, and optimization should be used only to fine-tune certain ranges (such as current volatility of a certain currency).

Parallel Processing Most FX system development is done on Windowsor Linux-based PCs. With recent rapid advances in processing power, many applications (e.g. Matlab) offer plug-ins for parallel processing (e.g. Parallel Computing Toolbox). This allows for quicker runs through multiple iterations of complex calculations. There are three ways to achieve robust parallel processing today, without help of a traditional supercomputer: 1. By using multi-core PCs (e.g. hexacore) 2. By using clusters of PCs (e.g. grid computing) 3. By using GPUs (Graphical Processing Units), which are inherently multi-core. NVIDIA (www.nvidia.com) has developed CUDA (Compute Unified Device Architecture) – a platform for utilizing GPUs for computations. CUDA could be used from many financial applications (e.g. Matlab). Methods listed above could be combined for even greater performance.

Synthetic Instruments If the advisor’s broker does not offer a certain pair or 176 | january 2011

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Ratios Sharpe Sterling Calmar Treynor

Charts VAMI Run-up ROR Distribution Profit per Pair Pip Distribution

Source: QP Capital LLC © 2010

cross, the advisor can create a synthetic equivalent. For example, to buy a synthetic RUB/ZAR cross, the advisor would simultaneously sell USD/RUB and buy USD/ZAR. The cost for synthetic FX instruments can command a healthy premium since two spreads and/ or commissions are paid in addition to the increased slippage (see Trading Costs).

“Soft” Stop Losses When dealing with non-ECN (Electronic Communication Network) brokers, the advisor should always try to use “soft”, not “hard” stop losses. This is done because some non-ECN brokers (brokers with dealing desks) would “stop-hunt” (temporarily move current bid/ask to hit the stop loss level artificially) in order to increase their revenue. A soft stop loss resides on the advisors computers and transfers to the broker only when the stop level is hit (or nearly hit). This might create some slippage, but that would be negligible in comparison to potential losses from “stop hunting”. The soft stop losses are usually accomplished by using an API to the broker’s trading interface. ECN-type brokers charge commissions for their efforts and generally do not “stop-hunt”.

Performance Analysis It is crucial for investors to monitor program’s performance on a monthly basis. Some advisors simply report monthly returns and drawdowns, while letting investors get the rest from their broker’s statements. Others provide their clients with the full picture, including graphs, charts, and detailed statistics. Fig. 4 above features some of the most useful performance aspects. Some advisors utilize software/websites (e.g. www.myfxbook.com) to create their performance snapshots, while others design their own (often in MS Excel). Conclusion By utilizing the concepts from this article, investors can obtain a deeper understanding of the inner workings of their potential advisors and make more informed decisions.

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TRADERTALK

TraderTalk Fisycs Capital – taking emotion out of the trading process e-Forex talks with Alexandre Vigier and Arnaud Amsellem founding partners of Fisycs Capital, a systematic investment management firm based in Paris. When was Fisycs formed and what type of investment objectives was it designed to undertake? AV: Fisycs Capital is an independent entity established in November 2009 and solely owned by its founding partners. The company received its authorization from the AMF (Autorité des Marchés Financiers) in France in October 2010 and is now a fullyfledged asset manager. As a money manager our goal is to provide investors with above average return with as low as possible volatility. This is achieved through not focusing on any asset class in particular, we prefer instead to investigate different strategies and keep only what provide good enough return to risk ratio. Investing only liquid asset classes guarantees that our clients can meet their financial constraints at any time. Finally our systematic approach rationalises the investment process and 178 | january 2011

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Alexandre Vigier and Arnaud Amsellem

>>> remove any emotion from the trading decision. Both of us experimented this approach for many years as Quantitative Portfolio Managers for different institutions and it proved to be efficient. We decided to set up our own shop to push this logic even further and building the entire company around those concepts of Quantification, Diversification and Liquidity.

Who are the key people involved in the firm and what are their main day to day responsibilities? AA: Alexandre and myself as founding partners and owners of the company are making the final decision on all major issues. As a systematic asset manager we

are heavy users of IT and data and this takes a good portion of our time. We are defining the research agenda together and distribute the tasks. In addition we do most marketing presentations together. However, Alexandre having an extensive knowledge and background in trading technologies is the best person to decide on trading and IT infrastructure. He actually spread his time equally between IT issues,research which entails coding up ideas in prototyping languages, interpreting the results and implementing the models in live environments, and trading. I spread my time between the operational tasks and the research. Even if we try to externalise as much as possible anything that is not directly business related, we still have a fair share of operational issues to deal with. I take care of most of them. In addition, I do the research as well. In my case it means a lot of coding especially back test calibration and result reviews.

You have more than 12 years experience researching, developing, implementing and managing quantitative equity strategies. What do you like about working with FX as an asset class? AV: The ample liquidity of the FX market makes it a playing field of choice for anyone who is interested in quantitative investing. Coming from that kind of background it is just a natural extension of what I was doing previously. However there are several differences that make the FX market even more attractive. Firstly FX offers diversification relative to the strategies (or asset classes) we already offer. Secondly there is a large offer of ready to use (i.e. clean) data. Gathering usable results is quick as opposed to equity where one needs to invest heavily in data and databases to extract any usable information from the market. Finally the FX market is very simple in the way it works and the trading technology offer is more advanced than for equity for example. AA: This makes the full R&D cycle much shorter and efficient: the feed back from the market can be gathered almost right from the start. A typical example is MT4. There is a myriad of brokers offering the ability to trade via MT4. Even if it is not suited for professional money managers, opening an account (or even demo account) and monitor portfolios is made possible with little programming and with very limited capital. january 2011

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Fisycs focuses exclusively on ultra liquid markets. Was that decision influenced by your investors? AA: Fisycs Capital has been set up as a multi assets shop and we intend to keep it that way for the foreseeable future. We strongly believe in diversification and investing in all liquid assets is a major step in that direction. Our decision to enter the FX market was motivated by two different factors. Firstly, Alexandre and I both have been Quantitative Portfolio Managers for years we therefore have a strong bias toward systematic investing. As a result, the FX market offering such a deep liquidity is a must have for us. Secondly, investors acted as a catalyser for our FX strategies. AV: We started to research FX Intraday strategies initially because they were offering maximum diversification compared to the programs we already traded. But as we started to talk to investors about it we felt a strong interest and spot FX grew quickly from a research project to one of the major asset class for our company. Today we are dedicating roughly 50% of our time to this asset class.

How would you describe your investment philosophy? AV: Our investment philosophy is articulated around three major ideas:

>>>

Systematic • Our investment approach is entirely quantitative • Research and Development are the corners stone of our investment process • We are constantly looking for improvement in our strategies Diversified • Asset Classes - We invest in all liquid markets regardless of the asset class • Regions - We cover North America, Japan and Europe • Investment horizon - Positions are kept between a few minutes and a few months • Models - Many systems come into play in the final portfolios • Positions size - Many small size positions in the portfolios at any time Liquid • We focus exclusively on high liquidity markets to guarantee maximum transparency • Our investors can meet their financial constraints at any time

What range of strategies does Fisycs offer? AA: We offer both intraday and lower frequencies (i.e. daily) strategies. We do not focus on any particular type of strategy, we prefer instead to identify an idea and test it extensively. Ideas are generally coming from academic articles or market stylized facts that we are trying to translate into investable processes. If initial back tests prove to be encouraging we are moving the strategy to paper portfolio then live trading. As of today we are trading strategies with holding periods ranging from a few minutes to a few months with no particular bias toward persistent or anti persistent strategies or any particular cross. The number and nature of crosses traded is tailored to clients constraints and requirements. We always start with very liquid crosses and add less liquid ones to gain diversification. We also started to investigate latency dependant strategies recently but we are not ready yet to open it to investors.

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TRADERTALK

How diversified do you consider your investment activities to be? AV: We are paying a particular attention to diversification as it is a key concept of our investment philosophy. As a company Fisycs Capital invest not only in the Forex market but in futures and cash equity as well. We perceive diversification as a multidimensional component of our investment process. We identified five major axis in that component. • Asset Classes - We invest in all liquid markets regardless of the asset class • Regions - We cover North America, Japan and Europe • Investment horizon - Positions are kept between a few minutes and a few months • Models - Many systems come into play in the final portfolios • Positions size - Many small size positions are preferred to a concentrated portfolio Regarding the FX market in particular the three major axis of diversification are: crosses, trading frequency and models. Our goal as quantitative portfolio managers is not only to come up with the best possible models but to find the best possible balance between those three axes as well.

Your investment approach is entirely quantitative. What do you consider to be the key strengths and weaknesses of adhering to that? 182 | january 2011

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AA: Different people will come up with different answers but for us there are three major advantages to approach investing in a systematic way.. Metric of investment performance: By setting proper hypothesis, one produces back tested results that should be very close to live trading. We identify strength and weaknesses of strategies much quicker. It removes any emotion from the trading process. The machine does the job regardless of the state of mind of the trader. Scalability: most if not all quantitative approaches, being based on statistics, requires a lot of data which is best suited to liquid markets. It translates into investment strategies that are by construction highly scalable. As of today, we estimate we can manage up to $1 billion on our FX strategies without having to change anything. Replicability: once a strategy is identified for a given instrument, it usually does not take a lot of effort to apply it to others. It potentially increases the level of diversification and the capacity with little marginal work. AV: There is however one weakness: The black box perception: having spent years explaining quantitative investment to investors, we sometimes struggled to get the message across. It takes a lot of effort to translate a sophisticated investment process relying on advanced techniques borrowed from different scientific fields into plain English.

TraderTalk

In what ways do you leverage your research agenda to help improve the design of new investment strategies and the ongoing enhancement of your existing investment processes? AV: Our research agenda is driven by the needs as defined by the already existing material. We define two general themes. First we constantly reassess the adequacy of the behaviour of our existing strategies, the ones already invested. Sometimes, mostly often, we do not need to come back on them, no red light having being fired. Then we define our research targets to be as different as possible from what we already have, in order to guarantee that we will ultimately come up with a non correlated source of alpha. As far as we experienced this, a good common sense at the very beginning of the research process is the key. We do not try to data mine huge amounts of data (the best way to find spurious relationships) we prefer instead to follow financially sound ideas. What trading platforms do you use and what factors influenced your choice? AA: Being a fully systematic house we needed a robust framework capable of handling a large amount of data. We were actually looking for the following features: Very good brokers connectivity, extensive testing capability, flexible programming language, possible link to back/middle office and, to a lesser extent, low latency.

>>>

After reviewing what was available, we decided to use several products : On the one hand, SmartQuant and QuantFactory from QuantHouse. For the later (institutional version of the software), we developed FIX connectivity from scratch with the major players in the FX space. On the other hand, Dukascopy, which is a high performance platform. In addition it provides a Java based programming language (JForex).

How did you go about building your trading IT infrastructure and what steps did you take to improve the operational management of the business? AV: As a start-up we need flexibility but as a Quantitative Asset Manager we are constantly crunching numbers and we therefore need a lot of computer power. Cloud computing offers the best of both worlds: Computers can be bought and dropped at will with the added benefice of not having to worry about the maintenance. We distinguish three types of machines. The ones we have on our desks are mainly used for communication, monitoring and light coding. When it comes to testing and heavy programming we have several external servers that are also used to run simulations. In case of very heavy calculation we rent computing time. Finally there is a third type of machines used solely for production purposes. Live trading activities are hosted on those dedicated servers with very low failure rate. This was actually an important criteria when we decided on external providers.

What back-testing methodologies do you employ to confirm that a strategy is relevant to your long term trading goals and performance criteria? AA: Our experience thought us there is never enough testing when it comes to systematic investing. Unfortunately time is scarce so one need to come up with a research methodology that is not only rigorous but time efficient as well. Years of experimentation allowed us to come up with a three steps R&D cycle that has been extensively tested and proved to be efficient and robust. Prototyping Starting from the same dataset we implement the strategy in two different programming languages usually R and C++. It avoids leaving any major bug in the code. Until we reach the exact same result with both implementations (i.e. identical trade signals) we keep on carrying tests.

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Paper Portfolio Once we are happy with back test results we set up paper portfolios and track the system behaviour until we get fully confident with what we observe. Live trading Once we are comfortable with the paper portfolio we move to live trading which entitles recoding the strategy in our trading platform in C# or Java depending on the client choice of platform. Usually starting with very small trade size that we increase gradually over time. The feed back from the market is an important source of changes and improvements.

What key risk management frameworks have you put in place and how do you adjust your investment horizons? AV: Risk management is embedded in the trading itself. Every strategy is designed with strict maximum drawdown constraints and we attach to every single position a stop loss and a take profit. Putting multiple strategies at play in a portfolio produces well bounded volatility that we are constantly monitoring. Deviation from a normal range is subject to close scrutiny. AA: As part of our maximum transparency policy, we are also offering to clients the ability to push what 184 | january 2011

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we call the “panic button”. In case of extreme event, the client can interrupt trading at anytime should he requires it. Obviously there has to be a very good reason to do so. Finally for strategies running on high frequencies, we do not keep any overnight position. For all intraday strategies we do not keep any position opened over the week end where the liquidity is scarce. There is no explicit reference to horizon in our investment strategies. However, as a rule of thumb, the holding period goes from a few minutes to a few months depending on strategies.

Looking ahead, where will you be looking for new investment opportunities and what new strategies are you considering employing? AV: We are constantly researching new investment strategies with one underlying concept in mind: diversification. We only start investigating a strategy if it potentially offers low correlation to existing systems. In the FX market one major axis of diversification is trading frequency (i.e. holding period). We currently trade all but latency dependant frequencies and obviously this is high up on the research agenda. We started to put the necessary pieces together and when time comes we will start presenting it to investors. We are also investigating other asset classes as long as they offer the level of liquidity compatible with the transparency we want to offer to our clients.

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