Custody FX Data Taking a Step Forward: BestX
Posted by Colin Lambert. Last updated: August 29, 2022
One of the more persistent sores in FX circles in recent years has been the quality – and oversight – of execution quality by custodians. Initially this manifested itself in the lawsuits brought against leading custodians in the middle of the last decade, claiming they often executed the vast number of small custody-related trades at rates that were most detrimental to the clients.
Change occurred in the wake of those lawsuits, however what they really highlighted was the lack of adequate timestamps – something that took longer to solve, mainly due to what was still a largely manual process at many buy side firms. This lack of timestamps, in turn, made it hard, nigh on impossible, to effectively monitor execution quality.
The last couple of years has seen progress, however, and this in turn has provided transaction cost analysis (TCA) providers with more ammunition to help clients understand their FX execution quality – a point made in a new paper released to clients by BestX and seen by The Full FX.
In the paper, BestX points out that this improvement in the availability of accurate data has allowed it to collate over four million custodian trades, representing over $5 trillion notional, which provides, the paper observes, “a good position to establish meaningful insights into the data”.
A high-level observation of the data finds that the proportion of spot and outright forward custody flow in emerging markets and NDFs is increasing, while in FX swaps the market remains dominated by G10 currencies.
More pertinently, however, the paper highlights the improvement in data across the board and how this is happening in step with an increase in outsourcing of their FX business by asset managers. It acknowledges that without timestamps accurate TCA and conclusions over execution quality are all but impossible, and that some gaps exist compared to the data available in-house, however “the data quality has dramatically improved”.
This is possible, BestX says, because the firm has worked with numerous custodians in recent years and now has direct connectivity to seven, a number it expects to rise to nine by the end of 2022. This data includes timestamps and references to the appropriate benchmark used by the client where it is mandated. It provides, BestX adds, data good enough to provide even fill-level timestamping, “fundamentally changing how this can be monitored – meaning the real ‘oversight’ in this case is the assumption that the data capture hasn’t improved or isn’t available”.
The paper highlights data from one custodian that moved to providing timestamps around May 2021 and the improvement in the average spread is quite stark, meaning clients no longer have to rely on range-of-day analysis and have more reliable and consistent results. This is an improvement seen across the board, BestX writes, meaning time is being saved as the “noise” is reduced.
“Legitimate outliers may warrant investigation, but the historic suspicions and opacity have melted away to more constructive discussions between buyside and their custodians,” BestX states. “This is all the more important as the outsourcing trend continues to gather pace.”
By establishing these feeds, clients are able to establish an automated monitoring system using BestX for their custody FX trades, embedded with their own particular execution rules. “Not only does this bring the oversight in line with in-house execution, with the appropriate tolerances, but the timeliness of those notifications on T+1 means no longer do people have to dredge through the data at the end of the month, or quarter, to identify anything they want to raise to their relationship manager,” the paper points out.
The paper acknowledges three remaining challenges, solving the first of which, adding more custodians, would enhance the “network effect”, especially when it comes to peer analysis, which BestX initially did only for non-custodian flow. The aforementioned number of trades and notional captured, now means the firm can present its peer analysis in the custody FX world.
The second challenge is sub-custodian data, which, the paper observes, can be difficult for a custodian to control, especially in low volume, thinly-traded markets. This is an issue raised by the Investment Association earlier this year, but even here though, BestX says advances are being made because some custodians are now capturing the time the trades are sent to the sub-custodian as well as the time they are returned – thus narrowing the analysis window.
The third, and slightly related, challenge is market data from onshore markets, where data quality can be mixed thanks largely to many of them still being voice-dominated. The paper cites analysis of one day’s trading in USD/TWN where the onshore market data granularity was clearly inferior to that in offshore, more electronic, markets. “As the market data available continues to improve, the analytics are ready – but we still find windows of stagnant quotes within the onshore market data,” the paper states. “We are working with some market data providers to try to highlight and solve this, and appreciate input from our client base, but at times there remain legacy issues as the markets are not fully electronic (far from it in some cases).”
There is reason for optimism that the challenges highlighted by BestX will be overcome as the creep of technology into emerging markets continues. Even though that will take time, it is a positive step forward for the FX industry as a whole, that, to return to an earlier analogy, at least one running sore is less inflamed than it was.
For the end investor, better oversight of what actually takes place at the custodian can also only be a good thing, and the for those firms themselves, the ability to provide data to a third-party for analysis also continues to lift the clouds that have hung around that sector for almost a decade.
It may be one step forward in a longer journey, and the end client needs to maintain the pressure on custodians to adopt what should be market standard practices, but as the BestX paper concludes, “The bar has been raised.”