The Last Look…

Much noise has been made about the impending shift to T+1 settlement in North American securities, but with one week to go what is the mood like in the FX industry, and have we made any actual progress towards solving what for some remains a big issue?

At face value, for all the papers, ideas and discussions that have taken place, not a lot seems actually to have been actioned in the FX market. We will continue to settle in the same fashion, albeit some firms are likely to miss out on the netting benefits of CLS, at least for the short term, and aside from some firms that are likely to do more with their custodian, we are going to trade the same way. On the negative side, firms are not going to build desks or business units in the US, nor do they have time to jump through the regulatory hoops they would have to get through to do so.

In some ways, this reflects the whole T+1 debate – it has always really only been about a significant minority in our market, investment managers.

Generally speaking, too many (but, I should reiterate, probably only a significant minority) asset managers continue to push down one of three paths: (i) they expect their LPs to do all the heavy lifting for them; (ii) they are going to “throw people at the problem”; or (iii) they are going to lean heavily on their custodian.

Potential solution (i) is really a non-starter, because the problem is not with the LPs or service providers – most , if not all of whom are ready and able to cope with the change, it’s with the asset managers themselves, or at least those who have been laggard in moving to meet the challenge. This leads into (ii), which is easily achievable, but is neither sustainable nor sensible. The T+1 changeover is a processing problem, not a trading or risk issue, and therefore requires a technological solution. Merely adding, or throwing more staff to the office on a weekend will more than likely only serve to increase the number of errors – and in securities markets, at least in some parts of the world, errors = fines.

There is an irony in how the solution that can actually save the fund managers is one they shied away from after the process was abused by certain parties – Standing Instructions

This leads us with the only really sensible solution for most funds – their custodian. Assuming the custodian is what everyone claims to be – client-centric – then they will either move their cut-offs later, or develop a solution to enable clients to trade later. There is an irony, to those of us who remember the dark days of the FX conduct issues, in how the solution that will actually save the fund managers is one they shied away from after the process was abused by certain parties – Standing Instructions! All banks have cleaned up their act in this field – at least with the big clients, SMEs still seem to struggle to get decent rates – therefore Standing Instructions, on a batch or individual basis, can help alleviate the problem.

Six months ago, just about everyone I spoke to amongst the asset management community was adamant they would not go back to Standing Instructions, but here we are, with many of these firms having done little or nothing to meet the changeover challenge, and SIs are probably the only path open to them. So long best execution policy!

Those firms that have done some work seem comfortable with where they are, and a few sources are telling me that their response is alleviating – but not eradicating – another sore on the FX market, the month-end Fix. The sources are telling me their clients are executing their predicted fixing flows in the day or two before month-end, and then executing a final “adjustment” trade on the day itself.

This is leading to lower month-end flows and less market impact for those that still persist with the fallacy that a five-minute TCA for a 20-minute execution is acceptable, nonetheless, even the “improved” market impact is still trotting in at more than $350 per-million! This is, of course, an inefficient use of cash, albeit for a day or two – an inefficiency that will no doubt be conveniently ignored (like most inconvenient truths), by a majority of trustees.

It is hard to see how this issue evolves, although there is a genuine mood in the industry that we will react as our understanding grows of the real problem. Will the solution be the discovery that the custodians actually provide very good execution quality? Or will new technology disrupt the incumbents providing services in processing and settlement? Perhaps a new business emerges from the fogginess of uncertainty that everyone flocks to, and perhaps (please!) end-users finally take an in-depth look at how they use the FX markets?

All these questions will be answered in time, but thus far it has all been speculation; from next week, the education begins.

colin@thefullfx.com