On the 23rd of August, the Securities and Exchange Commission (SEC) adopted new rules that aim to bring more transparency to the $20 trillion private fund industry.
The best execution guide for forward thinking Fund Managers
23 September 2021
What’s stopping fund managers from accessing FX best execution?
With all the controversy and regulatory intervention relating to FX best execution in recent years, fund managers know what is required of them – so, what’s stopping them?
The short answer, in our opinion, is that it's labour intensive and difficult. Fund managers may need to identify and approach new FX counterparties, form new relationships, put ISDAs in place and set up new trading systems – It can be exhausting! The whole process, from start to finish, could take anything up to a year (in some cases longer) which can be time consuming, especially when FX might not be a core business operation.
The fun doesn’t stop there. Let's say a fund manager has gone through all the necessary steps and now has a multi-bank panel at their disposal for FX execution. Each counterparty might have different trade processes and systems to navigate – for this reason the fund manager might have to make an additional investment in an aggregator platform to centralise price discovery.
After all that, the fund manager might not see a fully transparent breakdown of FX transaction costs and may need to perform transaction cost analysis (TCA) through an independent TCA provider to evidence best execution - this too can come with its own costs.
Wouldn’t it be nice if there was an end-to-end multi-bank solution that evidences best execution and provides full cost transparency?
First, let's take a step back to understand FX best execution and why it is often in the spotlight.
What is best execution?
There are many factors to take into consideration in the quest for FX best execution:
- Price and cost
- Speed and likelihood of execution and settlement
- Size and other factors directly related to the execution of the order
Often price or cost will be considered the highest priority, although for these to be the primary focus, there needs to be an operational robustness in all other components, such as settlement and speed.
Furthermore, considering the foreign exchange market is the largest and most liquid financial market in the world, it would be a fair assumption that transparency and best execution would come as standard, however, we believe this is not the case and some fund managers are still catching up.
How it’s regulated and why it matters
Best execution is covered by various market principles and regulation originating from the FCA Conducts of Business Sourcebook and Principles of Business, the FX Global Code of Conduct and, most notably, MiFID II.
Combined, they stipulate that investment firms should:
- Treat customers fairly
- Deal with market participants in a consistent and appropriately transparent manner
- Take all ‘sufficient’ steps to obtain the best possible result for the client when executing orders.
However, any fiduciary firm should consider best execution as a core component of best practice and not simply a regulatory obligation to satisfy.
Increasingly, investors are also questioning fund managers around their FX execution policy and requesting ongoing transaction cost analysis. Pursuing best execution has other positive impacts too, notably the reduced transaction costs as a result of increased competition between counterparties.
A history of controversy
Since the 2008 Global Financial Crisis, the FX market has had its fair share of negative press. The forex rate-rigging scandal grabbed the major headlines in 2014 and significant fines were handed down to some of the world’s largest banks. However, in the background, stories relating to a lack of transparency and poor FX execution practices were rife.
- In the US, a series of high-profile lawsuits were filed by pension funds against their custody banks, claiming that the banks had charged excessive fees for FX trades, deriving from a lack of transparency around how, and when, trades were being executed.
- One such lawsuit alleged that for more than a decade the custodian in question had conducted FX transactions in “an unfair and deceptive” way to maximise its profits at the expense of its customers.[i]
- Closer to home, in 2014 the FCA published a press release titled ‘FCA finds firms unable to deliver best execution’. The article looked at 36 firms, finding that many “do not understand key elements of the rules and are not adequately controlling client costs when executing orders.”[ii]
In 2017, the FCA highlighted that investment managers had not been particularly engaged with assuring best execution for their clients.
According to the FCA, some firms had been addressing the issue and are showing “good practice”, however the bulk of the industry is trailing behind.[iii]
Is outsourcing the answer?
Research published by the investment consultant Russell Investments “Still Overpaying for FX” (July 2012) analysed 173,000 FX trades conducted on assets totalling approximately $76 billion and concluded that for an average $1 billion fund, savings of $330,000 per annum would have been achievable from the adoption of an agency approach where FX trading is outsourced to a third-party specialist.
In some cases, funds could have saved much more.
The Russell study explicitly suggested the consideration of a model whereby a third-party specialist agent is appointed to manage FX trades and pursue competition among a panel of counterparties to achieve the best possible price. [iv]
Given that no one bank will be able to offer the best price on all currency pairs at all times, there are significant advantages to transacting with a provider that can offer the best price among a “panel” of banks, rather than with one bank on a bilateral (and fundamentally uncompetitive) basis.
What is an end-to-end best execution solution?
The good news is there are solutions in the market that will manage multi-bank set up and execution on behalf of fund managers. Before asset managers embark on changing their existing FX framework, they might consider first understanding the quality of their execution by doing a transaction cost analysis (TCA).
TCA goes hand-in-hand with best execution and can be used as an ongoing audit of FX practices as well as to hold existing FX counterparties accountable.
Forward-thinking fund managers could consider seeking out a wholesale FX marketplace that delivers full transparency at each stage of the execution process, offers real-time reporting and independent TCA, providing complete visibility of their FX execution costs and enabling them to demonstrate best execution.
How MillTechFX can help
MillTechFX by Millennium Global is the FinTech affiliate of Millennium Global Investments, one of the largest specialist currency managers globally. Our multi-bank market helps institutional investors and managers significantly reduce both FX costs and operational burden associated with FX execution and rolling hedging requirements.
We provide access to a transparent marketplace for comparative FX execution from up to 10+ counterparty banks, while harnessing a unique and significant pricing efficiency for our clients.
Read more here from our Joe McKenna Blog series.
- This document, including the information provided herein, is provided for information purposes only and does not constitute an invitation or offer to subscribe to or purchase any of the products or services mentioned.
- The information contained is intended for Professional Clients (or elective professional clients only). MillTechFX does not target retail clients as the products offered by MillTechFX are not suitable for, or made available to retail clients.
- The information herein is not intended to provide, and should not be relied upon for, accounting, legal or tax advice or investment recommendations. You should consult your investment, tax, legal accounting or other advisors.
Joe McKenna, Head of Institutional Solutions
Joe has over 15 years of experience working in FX markets and has held various senior positions both in the UK and overseas. Most recently, Joe was on the Investec Fund Solutions team, helping fund managers with bespoke lending and derivative solutions, covering each stage of the fund lifecycle and multiple layers of the capital structure.