We highlight some of the costs associated with FX execution and hedging that fund managers should be aware of and rank them in order of transparency.
What are the barriers to best execution for corporates?
22 September 2022
Best execution is one of the most commonly used terms in foreign exchange (FX) and across other financial markets.
Yet despite all the controversy and regulatory intervention relating to FX best execution in recent years, many senior finance decision-makers at corporates still don’t understand how to achieve it or realise they aren’t achieving it, due to opaque nature of FX execution.
So, what actually is best execution?
Best execution is a regulatory requirement that investment services firms, executing orders on behalf of customers, take all sufficient steps to obtain the best possible results for their clients.
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, nature and other factors directly related to the execution of the order
Best execution is covered by various market principles and regulation originating from the FCA Conduct of Business Sourcebook and Principles for Businesses, 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
What barriers do corporates face when trying to achieve best execution?
We believe many corporates are paying more than they need to for FX and struggling to achieve best execution. In our view, there are three main reasons for this:
Inability to compare the market
For corporates who trade FX for payment or hedging purposes, FX can be seen as second-order: they transact in FX not because they ‘want to’, but because they ‘have to’ due to international business activities. It is thus often operationally inefficient for them to set up and manage multi-bank relationships.
This makes it difficult to compare the market – so when executing trades, corporates and asset managers are often beholden to limited sources of liquidity. At any given time, they may not be able to trade at the best available rate as they have no other access points to the market.
Pricing transparency is a recurring problem as FX costs are typically hidden in the spread. The transaction cost on any given trade can be calculated as the difference between the rate traded at, and the mid-market rate at that point.
For example, if a corporate buys €5m of USD at 1.1890 and the mid-market rate at the time was 1.1860, the transaction cost on the trade would be 0.25%, or €12,500. This is not an explicit cost as the treasurer won’t receive an invoice for this amount; rather, it’s a hidden implicit cost. Let’s make no mistake though: it’s just as much of a cost.
Best pricing for bigger firms
One of the main issues in the FX market, in our opinion, is that clients are provided rates in different capacities depending on what kind of client they are – a concept called “tailored pricing”.
As a result, the best rates are reserved for institutions that transact the highest volumes, meaning mid-sized corporates and asset managers are often neglected and struggle to get the best possible deal.
A 2019 paper from the ECB found that banks were overcharging small corporate customers for FX services, charging hedging rates as much as 25x higher than their bigger, more sophisticated customers.
How MillTechFX can help corporates achieve best execution
MillTechFX is an FX-as-a-Service (FXaaS) pioneer that enables corporates to access multi-bank FX rates via an independent marketplace. Our mission is to democratise multi-bank FX execution and provide a level playing for corporates.
Our end-to-end solution automates the FX workflow and ensures transparent best execution – saving clients time and costs.
- Easy and quick onboarding – Rather than spending months (even years) setting up multiple FX facilities with different counterparties, firms can sign up to a multi-bank marketplace and transact within weeks with up to 15 Tier 1 counterparty banks.
- Best execution and hedging management–. Firms benefit from multi-bank access without having to manage multiple relationships and processes. Firms can transparently compare and execute FX rates from multiple providers on a single marketplace and ensure best execution with a simple click of a button.
- Cost savings: MillTechFX has saved clients up to 80% on their execution costs
- Transparency –MillTechFX offers a fixed fee service, including third-party Transaction Cost Analysis (TCA) to ensure total cost transparency.
Jason Gaywood, Head of Corporate Solutions
Jason has over 20 years’ experience in the deliverable FX and Payments space. During his time in the industry, he has worked extensively across the UK, MENA, North American, and Australasian regions. Prior to this, Jason started his career as a graduate at Liberty Brokerage Inc. (now part of TP ICAP plc) where he spent six years as a US Treasury IDB.