FX HedgePool to push into spot market by year end

Buy-side P2P swaps matching engine to launch new service for WM/R benchmark

Matching-engine-comes-to-spot-FX

FX HedgePool, a buy-side matching engine for currency swaps, is planning to make a push into the foreign exchange spot market. The peer-to-peer trading venue is laying the groundwork to bring its model to spot matching for the WM/Refinitiv benchmark by the end of 2022.

The move is in response to the growing wish among the company’s expanding community of buy-side participants to provide liquidity to each other.

It will be the first in a series of new services that FX HedgePool aims to bring to the market over the coming months, as it plans to increase the size of its team.

“We believe there’s a huge opportunity for traders to manage their WM/R spot orders even more efficiently,” says chief executive and co-founder Jay Moore. “Much like HedgePool’s swaps model, the spot model eliminates market impact, avoids unnecessary costs and streamlines workflows. Automating passive flow through a peer-to-peer matching platform introduces operational scale while enhancing performance for end investors.”

Rather than sending multiple fixing orders to banks ahead of the desired fix, FX HedgePool’s new service will see the company acting as a central hub for all the orders received from its buy-side clients. It will then conduct internal and cross-client netting.

As is currently the case with FX HedgePool’s swaps product, orders received prior to a specific lock period will be committed for execution at the defined benchmark. Any residual trades after the netting engine has matched the orders will be handled by the company under pre-determined rules.

Clients will send instructions ahead of time for how the platform is to handle trades that are unfilled. FX HedgePool says this will essentially enable it to streamline a process that many in the market have long seen as operationally risky, and thereby offer a “one-stop shop” solution.

The short lock period will be determined ahead of the fix. The aim is to ensure there is ample time for a large number of orders to be placed, for a maximum number of trades to be matched and for the residual amounts to be managed.

The new offering could help FX HedgePool capture and retain more buy-side FX trading flow. Moore says the spot fixings are designed to support both existing members that are trading swaps and new clients that may or may not be doing swaps transactions.

Spread winners?

Both banks and buy-side participants have welcomed the new product, though some question whether the total cost of trading can be lower when spreads are already compressed.

“It would be interesting to see what advantage [peer-to-peer] would give to a client,” says James Binny, global head of currency at State Street Global Advisors. Although the firm does not use FX HedgePool, Binny says he supports the P2P model in principle and believes it has a lot of potential.

Many asset managers assume the impact on the market will be lowest during the window around the 4pm fix, when liquidity is at its deepest and trading volumes are at their highest. These managers therefore continue to use the benchmark regardless of whether its pricing offers the best value for their clients. Most of the FX trades that take place during the window involve swapping non-US currencies back into dollars.

However, spreads can be just one component of the total cost of trading – particularly during the window around the 4pm fix, when information leakage and predatory trading by hedge funds and high frequency traders can lead to worse prices for investors.

Anecdotally, it is estimated that 80% to 90% of fixing flows reference the WM/R 4pm rate. This makes it the most liquid benchmark, but also the one that is most widely used because it underpins the majority of investment mandates for vehicles such as index funds.

It is understood that buy-side participants can end up paying a quarter of a basis point for every $1 million traded on spot fixing transactions. Fees for these trades have compressed in recent years from $25-$50 per $1 million to $10 per $1 million, depending on the bank. There are concerns that another race to zero may be taking shape.

Moore believes WM/R benchmark spot trades are a prime example of the kinds of orders that introduce operational distractions and risks. He says FX HedgePool’s new model aims to reduce these hidden transaction costs by compressing as much liquidity as possible within the buy-side community. That, he adds, should minimise the amount of liquidity needing to go for execution in the market, where market impact risk and pre-hedging risk could negatively affect the outcome of the transaction.

“There’s a more efficient way to support the buy side in this space,” says Moore. “The concept of having a pre-defined future price point in peer-to-peer is unique, and the technology we built to support this feature is ideal for benchmarked trades.

“The only way to eliminate the potentially much larger costs of market impact is to avoid the market altogether with peer-to-peer.”

He says FX HedgePool’s ethos has never been to provide a much cheaper alternative for liquidity but to provide asset managers with another option to automate much of their non-strategic operation flows, such as quarterly and monthly rolling hedges.

“Let’s be honest, traders are insanely busy and have more important trades to focus on, and we can help them do that,” he says. “Passive orders like rolling hedges and spot fixing orders offer no upside, so if we can eliminate the migraine of these trades with a more efficient alternative, then everybody wins.”

One head of distribution at a global bank believes FX HedgePool’s spot offering could benefit the buy side by preventing a resurgence of the kinds of incentives that caused some banks to engage in misconduct when trading benchmark orders. Before the scandal became public in 2013, these banks would be guaranteeing fixing rates they could not be certain of achieving since no one knew the future direction of the benchmark.

“It takes a lot of those tensions away and in fact just tries to look at it from a different vantage point,” the source says. “If you can match the risk to begin with, then you don’t even need to seek the offset. I think that’s really helpful.”

Banks could also benefit from the new offering by being paid to use their credit more strategically, since FX HedgePool is looking to book the trades in the same way it does with its swaps model. “If you think about management in general, what you’re supposed to do is try to control what you can control,” says the head of distribution. “I think that this helps and provides a good service to the buy side, a guaranteed service that helps with being able to assure and confirm that your credit lines are sufficient for dealing, while removing other operational hurdles and thus making the process smoother.”

The source adds that the spot offering could be useful when there are skews in the market, such as more sellers than buyers. Any trades that could be matched at mid would help to alleviate such a skew.

“Then whoever is in the seller’s camp is going to end up with a better price, because there’s going to be less of that skew,” the head of distribution says. “In that sense, it should mean a better price overall for everybody, hypothetically.

WM/R is the natural next step after FX swaps. These are passive flows. These are massive flows. They’re happening on a daily basis. They’re mostly in major currencies. There are some imbalances where some flows tend to go one way. I think the peer-to-peer matching helps with that stuff.”

When FX HedgePool’s new service launches, it will increase the level of P2P competition in the market. In February 2021, Siege FX completed the first P2P transaction on its platform, giving buy-side traders another way to reduce the market impact of such large orders.

Siege FX has since connected with Bloomberg FXGo and FactSet Portware, while integrating with the algorithm channels at Credit Suisse, Morgan Stanley and NatWest Global Markets. According to the firm’s website, it is in the process of onboarding more banks and trading platforms.

Editing by Daniel Blackburn

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