The Last Look…
Posted by Colin Lambert. Last updated: June 5, 2023
Although I don’t think the lack of buy side adoption of the FX Global Code is as serious as some would have us believe – a lot of the really big asset managers have signed up – there is little doubt there is what some might call a natural imbalance in adoption, but is in reality, something of a sore for the FX market. The fact is, the Code will have much greater gravitas and importance if a majority of the big buy side firms are signed up and there is a better balance between sell and buy side.
As noted in our report on the release of the proportionality tool, the number one comment from non-adopters is something along the lines of “the Code doesn’t really apply to me”, followed by, “It’s a sell side solution for a sell side problem, and, inevitably, “I don’t have the resources to do the adherence work”.
I have news for those on the buy side that think the latter – you should give the tool a try. I adopted the persona of a buy side firm that asks for prices on a reasonably regular basis (say three times a day), who does not receive client orders, or handle market orders. I did use a benchmark, as many buy side firms do (and not just in the asset management space), and I was, at some level, responsible for confirmation and credit/settlement risk. I was not a market maker.
I answered the 18 questions in the proportionality tool, you can find it here, which took probably five minutes – and that included reading some of the “hints” provided to assist someone answering the questions. The task was simple and straightforward and immediately provided me with a graphic that told me in black and white (actually it’s green and red), what Principles applied to me.
As an example, for my entry, 43 of the 55 Principles were relevant – and yes, I was disappointed that my two favourites, 11 and 17, were in red!
On which point, while the new tool is clearly valuable, it doesn’t address, for me, one of the bigger issues around buy side adoption, namely guidance to help them take responsibility and address the services provided to them.
As an example, a question in the tool asks, “Do you employ last look in your electronic trading activities?” Few of these firms use last look, but they are often subject to it, so it might be worth providing a second layer of help that helps them better understand the questions they should be asking of their LPs, and the metrics they should be monitoring. The same could be said for those participants whose LPs pre-hedge at certain times.
If we can provide a second layer of assistance, in the form of “things to be monitored” for example, it would help buy side firms understand the Code is relevant to them, but would again be focused, rather than generic.
The fact is, too many buy side firms lack responsibility when it comes to their FX activities – which remain an administrative burden to many, rather than a source of increased efficiency and even Alpha they could be. By providing them with an easy-to-use tool which would highlight where they should be asking questions, the Code would become even more useful, and open to, buy side firms.
Every journey has to start somewhere, however, and this should be a big step forward for buy side adoption given how it is lowering one of the biggest barriers to entry. I accept that having done the questionnaire firms will still need to allocate resources to matching their practices to the Code, but the resources required will be reduced, sometimes significantly.
Mass adoption of the FX Global Code comes when the buy side understands one of the core tenets of the Code from the start, accountability
My fear, however, is that firms will still ignore it because they still believe it’s not relevant to them, which means the GFXC has to maintain the momentum generated by this release, perhaps through an outreach campaign at local FXC level? This means the key is generating an argument that unequivocally tells the buy side it is relevant – and that it comes down to them taking a degree of responsibility for how their business is handled.
If a firm has a reject rate of 0.1%, but that 0.1% generates a $10,000 execution cost, should the execution desk be responsible if it happens too often? Perhaps more relevantly, if their reject rate is 3-4% or higher, the cost will be not insignificant, so the firm(s) should ask questions of the LPs responsible for the rejects – note to some buy side firms, you won’t like the answer as the problem may well be you!
Equally, should a buy side firm better understand the money they are giving away through pre-hedging? At the moment, my sense is too many accept pre-hedging as the necessity it is for very large orders, but do little to calculate the cost and how it could, perhaps, be done better (hint, it’s called an independently benchmarked algo).
Should these firms also better understand TCA? After all, they would insist on a 30-minute order at 2.15pm being benchmarked over the complete time horizon of execution, why do they accept a five-minute TCA for a 20-minute order at 4pm?
The reality is, the proportionality tool is a very useful starting point for the buy side in particular, to engage with the Code, and that is a very good thing because I suspect a few hold-outs will now look to do the work involved to adopt. It is only a start, however, for the only way the buy side truly engages on a mass scale is if it understands it has to take responsibility for managing and monitoring its service providers’ activities (mainly LPs).
More pertinently, perhaps, mass adoption comes when these firms understand one of the core tenets of the Code from the start, accountability. Perhaps only when they are held to account for how they run this important aspect of their business, will they recognise the value?
