Financial Transaction Costs in the Spotlight
Managing the currency exposure of a portfolio is more important than ever. In fact, fund managers are expected to increase their total foreign-exchange trading volumes to $2.3 trillion a day by 2022, from $1.5 trillion now, according to consulting company Aite Group in Boston. With best execution under the microscope, thanks to Europe’s Markets in Financial Instruments Directive II and other regulatory developments, buy-side companies are looking to transaction cost analysis, or TCA, to help measure trading performance and optimize processes.
FX, of course, is mostly traded electronically today via multibank platforms such as Bloomberg’s FXGO , aggregators, electronic communications networks, or single-bank platforms. Of the total notional volume traded by institutional investors globally, 75 percent is now traded electronically, up from a little more than 43 percent before the credit crisis.
So if you’re looking to benchmark spot, forward, or FX swap transactions, here are some unique data sets and functionality you can use.
First, run BGNE to display executable, streaming spot prices in real time. BGNE covers 101 currency pairs with the best bid/ask prices available from FXGO. In addition, for each currency pair, prices are shown for four or five volume tiers. For example, in EURUSD, the function displays bid/offer prices for notional amounts of €5 million to €10 million, €10 million to €20 million, €20 million to €30 million, and more than €30 million.
For TCA, this feature is key. To truly measure leakage from an executed trade, the size of the trade needs to be considered. A trade executed in €50 million needs to be benchmarked against a price in €50 million, not €1 million—otherwise, larger volume trades will automatically show greater leakage (and worse execution) than smaller notional transactions.
For forwards and FX swaps, the FX Forward Calculator uses indicative pricing from hundreds of brokers. Run USDJPY Curncy FRD , for example, to display the U.S. dollar-yen FX forward curve and to price broken-date forwards and FX swaps. FRD has long had end-of-day historical pricing available for both standard tenors and broken dates. It’s also easy to see intraday movements of standard tenor points and outrights. The challenge, however, has been to provide an intraday historical broken-date price at a specific time. The function was recently enhanced to offer point-in-time pricing. Let’s say you price up a broken-date forward for the end of the first quarter (03/30/18) in the top right-hand panel of FRD. You can now adjust the Pricing Date and Time fields and see how that changes the pricing. For TCA purposes, this enables you to compare a transacted broken-date forward vs. the Bloomberg generic (BGN) price at the exact time of execution—down to the second. This data can also be pulled into Excel via the Bloomberg API via the FX Toolkit. For more info, go to XLTP XFXTK .
Another important enhancement to FRD is the addition of pillar-date tenors, which are also called “turn” tenors and refer to the last day in a given quarter and the first day of the next. Asset managers and corporations often hedge their exposure to these tenors to coincide with portfolio rebalancing and balance sheet considerations, respectively. That can cause interest rates to differ significantly from normal levels at these times, especially at yearend because of illiquidity, a longer-than-average lending period, and the desire to bolster a balance sheet with cash for reporting purposes. The forward pricing for these broken dates can also differ significantly when they are priced by interpolating between ordinary tenors.
Consider the yearend example. First, turn on the enhanced pillar-date setting by clicking on the Settings button on the red toolbar, selecting Tenor Settings and ticking the check box next to Use Pillar Date Tenors. Then price an FX swap of 12/29/17 against 01/04/18; the midprice is –9.06 JPY pips. (A pip is the minimum price change for a particular currency pair.) If you turn off this setting, the pricing will change to –4.47 JPY pips—a significant difference! So now when an asset manager or corporation compares the execution of trades with these dates, they will benchmark to a far more accurate price. The sell side can also now distribute the pricing of these new pillar dates via Bloomberg to increase the transparency of these tenors.
Finally, for benchmarking or transparency, run BFIX for the Bloomberg FX Fixings function. BFIX, which became International Organization of Securities Commissions-compliant in May 2016, produces 5,000 fixings across spot, forwards, and nondeliverable forwards every 30 minutes while markets are open. On Nov. 15, the window for all spot fixings was moved to a 306-second window. Results are published on BFIX within 15 seconds of the end of the fixing window for USD-based pairs and within 1 minute for all pairs. BFIX is based on a time-weighted average price of the arithmetic midrates of BGN prices. (For exact details, see HELP BFIX .) Because both the European Central Bank and the Bank of Canada discontinued publishing market rates over the past two years, a number of users have adopted BFIX instead.
Minde and Mendolia are FX and economics market specialists at Bloomberg in New York.