Traders, vendors seek to modernise chronically underinvested FX tech

Foreign exchange is the largest and most liquid market by a long way. In April 2022, when the Bank for International Settlements last took a snapshot of market activity, it found that $7.5 trillion dollars of currency – more than twice the entire GDP of the UK – was being traded on FX markets every day.

But the technology that underlies this huge chunk of the world economy tells a different story. With near total automation in equities and dedicated efforts to electronify fixed income stealing the budget, as well as the limelight, FX modernisation often takes a backseat. Years of underinvestment have left firms with a patchwork of trading systems – the average FX professional actively uses eight different platforms, according to a report released earlier this year by Refinitiv (part of London Stock Exchange Group).

Since the Covid-19 pandemic, a perfect storm of geopolitical turmoil, rising rates, and high inflation has led to extreme volatility in FX markets, bringing the value of an efficient forex desk into sharp focus. But if overcoming “app overload” is the biggest reward for firms hoping to modernise their FX tech stack, it is also the greatest challenge.

According to an FX trader at a US investment bank, managing the sheer amount of platforms can be a job in itself.

“The last shop that I worked at, we had a multitude of applications. Not only did we have an in-house execution system, we also had an external one. We had prime brokerage execution systems that we had to do some extra trades on to roll our position forwards. And then on top of that, for a certain subsection of FX trades that we used to do, we had to execute on bank platforms individually. So for each clearing bank or prime broker, we had maybe four or five applications that we had to go and execute some systematic trades on.”

The problem is no less acute for the buy side. For smaller firms without access to trading platforms, FX price discovery typically involves multiple phone calls or emails. For more high-tech asset managers, the workflow is even more heavily layered. An order management system (OMS) feeds into one or more execution management systems (EMSs), which aggregate pricing. Another platform is sometimes needed to perform allocation, reconciliation, or standing instructions. And post-trade requirements only add to the complexity.

As a result, firms across the market are mulling tech upgrades. Most recently, Nomura announced an FX overhaul, rolling out new pricing tech and a single-dealer platform. In a survey of North American chief financial officers, 81% of respondents told FX marketplace MillTechFX that they were looking at new technology to automate FX operations.

A senior executive at an FX technology provider says institutions trying to modernise their FX tech are attempting to fix years of underinvestment in one go.

“The problem is that none of these apps are initially created to work with each other. They’re very much self-contained. And the majority date back to a time when a broader sense of integration was not on the cards,” says the senior executive. “The question is, is it the right strategy to try and integrate them? Or is it a better strategy to try and figure out ways to navigate the workflow from a different source?”

Special FX

Despite the size of the market, FX is often perceived as second order, making the technology uniquely difficult to integrate. Corporates transact in FX as a necessary function of overseas business activities, and asset managers invest in trading systems based on which markets they specialise in, with FX capabilities usually considered afterwards.

On the sell side, banks have to cater to two very different trading activities: price distribution allows institutions to extend liquidity to clients; aggregation enables them to participate in the interbank market, offsetting currency that they cannot distribute. Integrating price distribution engines with aggregation capabilities – all while maintaining a view of available liquidity – is notoriously difficult.

Last year, London Stock Exchange Group launched Workspace for FX, a tool designed to bring a host of trading activities as well as liquidity, data, and analytics into one workflow. Bart Joris, head of sell-side trading proposition management at LSEG, explains that while larger banks have the budgets to build their own desktop environments uniting pricing and aggregation, medium-sized and smaller banks may not have the resources.

“Connecting two best-of-breed systems together via an API is never easy. Whereas if you do it natively in the systems themselves, you can create a full seamless ecosystem in one go. We’re bringing the full FX workflow into one system, via Workspace. That way, a trader can focus on the value of the human trader – ‘How would you hedge now? What risk do you want to take?’ – rather than the pure execution, because the system itself can do that,” Joris says.

The senior executive at the FX technology provider adds that firms are reluctant to undertake big replatforming projects or decommission existing technologies in the current environment, with very low appetite for operational risk. Recalling their time on a team deploying new FX services at a large bank, they say “the main issue was not necessarily to find money to spend, it was to spend it. Processes are very, very slow.”

For example, the lead time to onboard new developers could be six months, they say. Even partnering becomes a significant administrative task, taking months or years rather than days or weeks.

“The positive is that it creates a greater amount of filtering. But at the same time, it also stymies a lot of innovation. You see a lot more innovation in retail, unfortunately, than you see quite often in the larger institutions,” they add.

Looking ahead

With so many systems and functions to consider, some sources have decided that attempts to modernise FX technology must focus on optimising and connecting existing workflows through interoperability, rather than starting from scratch.

“I think the solutions that will perform better will be those that are able to deal with the historical legacy of what’s in place, while being able to move clients to the next level. A gradual approach to redesign how the workflows are operating, with the view that you can't just be very disruptive from the outset,” says the senior executive at the FX tech provider.

This notion of gradual change aligns with LSEG’s program of modernisation for its FX product set. The Workspace launch was only one installment in a raft of upgrades worth up to $366.7 million. It includes a migration of FX matching services to LSEG’s Millenium platform, which CEO David Schwimmer said would improve latency by a factor of 10.

LSEG's Joris says new products are set for release in the coming months, but he adds that they will not all be brought to market simultaneously to ensure a smooth integration process. “It will be more of a gradual introduction to the market. The Workspace framework allows us to do that – we can plug in new workflows as we bring them to the market without impacting our clients,” he says.

In addition to the matching migration and the development of Workspace, LSEG is focusing on new partnerships with existing trading systems and venues. The company's FX execution platform, FXall, recently partnered with fixed-income trading platform Tradeweb, integrating an FXall screen into the workflow of emerging market bond traders. Clients trading emerging market products can hedge local currency risks by executing an FX swap trade on FXall within the Tradeweb workflow.

Similarly, the exchange group has announced that FXall will provide the back end for FX execution for multi-asset trading technology provider Tora, which it acquired in 2022.

“This is where I see the biggest change coming, for example the integration of FXall in Tora. FX needs to be distributed to channels where the clients are present and active. Eighty per cent of all FX is the result of other activities, like cash management for corporates or equities activities. Integration in the platforms which drive the FX transactions will be key to success,” Joris says.

Joris believes that once the problem of integrating various applications has been addressed, the next evolution in FX will happen at the level of execution, where a shift from post-trade transaction cost analysis to in-trade analytics will start to yield alpha.

“Analytics at the moment of trade will start to drive the decisions during execution, adjusting algorithms during the execution itself following market conditions, which can be more aggressive or less aggressive. I would expect that for the buy side, the current drive in spread compression will halt, and value creation will happen through the smartness and interaction of your execution with the market,” he says.

The senior executive at the FX technology provider agrees that the behavior of the buy side is likely to shift. But with the process of changing EMSs sometimes taking one to two years, they also ask who will foot the bill for the increasingly complex integrations. With the heavy burden of technology costs currently borne by the sell side, the executive believes buy-side users will soon start to face resistance.

“Nobody wants to talk about it because, of course, it’s much more comfortable to not pay. But if it’s not through them paying, it will be through the pricing. It’s a circular argument. You can’t walk away scot-free forever,” they say.