Cash & Liquidity ManagementInvestment & FundingEconomyFX E-Commerce & Beyond: Providing the German Financial Markets with More Than Just Execution Tools

FX E-Commerce & Beyond: Providing the German Financial Markets with More Than Just Execution Tools

The Global FX business is a mature market. A substantial level of automation and the subsequent price transparency have led to ever-thinning margins for the sell side. Combined with improved liquidity, the influence of price has diminished, and the FX providers, desperate for volume, are aware that business is increasingly won by offering value-added services. E-commerce has a big role to play in this strategy. Fortunately for the FX providers, there remain significant market entry barriers to the high-scale FX market place. Standard minimum volumes of €1m, as well as processing requirements like CLS, present hurdles for corporate treasurers which many can rarely overcome, thereby limiting their access to advantageous inter-bank rates.

In order to improve client retention, thereby countering market transparency and simplified market access, FX providers have started to extend their service offering both horizontally, by including value-added services, and vertically, by extending the scope of financial instruments being covered by these services. This has become possible principally because e-trading has matured and technology has progressed – widening the choices available to both German corporate treasurers and the German savings banks.

Three main areas of services can be identified:

  • Domain services that extend the service offering of FX providers with the intention of limiting their client access to the FX marketplace to their own products and services.
  • Domain markets that are targeted at well-defined market segments in an attempt to tie clients to a service by providing access to near-market rates without imposing the market entry barriers mentioned above.
  • Public markets that provide near-bank prices and services by maintaining a high market transparency with a number of different banks offering competing prices.

An example of the latter is the increasing number of prime-brokerage infrastructures, where a number of potential prime brokers have combined forces to offer FX services to a target community. Usually the margins in such environments are very small, with turnover generated through add-on services surrounding the processing of the resulting transactions rather than from the transactions themselves.

These services have one thing in common: they require state-of-the-art technology to be provided in such a way that clients can use these services regardless of their internal infrastructures and networking environments. The most prominent example for such services is the growing number of Web portals providing predominantly FX price discovery and semi-automated FX trading. These marketplaces, as well as the banks’ own proprietary solutions, provide the corporate treasurer with an instant market price and the ability to instantly execute a transaction either through the RFQ (request for quote mechanism) or using ESP (executable streaming prices).

However, until now, the product coverage available within e-trading systems and the associated ‘value add’ functionality has been limited. As competition to attract revenue via e-trading within the sell side community becomes more intense, a number of banks have been looking at providing an e-platform to customers and branches that can provide far more than just FX price discovery and execution.

Ideally, such a system should be highly user-friendly, creating a ‘one-stop shop’ for all the different products. This will entice treasuries to go online and stay online for all stages of the trade cycle, i.e. research, price discovery, deal execution, settlement and post-deal analysis. ‘Intelligence’ technology, defaulting relevant pages and information accordingly to customer ‘profile’ and ease of configuration can all simplify the use of such a system, allowing treasuries to have a higher comfort level with using the system. Equally important, of course, is the ease of integration with the buy side’s existing systems so that data is easily transferable in real-time to facilitate straight-through-processing and to minimize market and counterparty risk.

Only recently, one such German bank has begun launching a new Web system aimed at its customers and branches. This system provides flexible trading and order management across a variety of different products spanning FX (including emerging markets), money markets and derivatives. Customers access the system via the bank’s corporate portal and may view live executable prices for a number of different financial products, all of which are immediately tradeable via a click and trade mechanism. These live rates cover all currencies and instruments traded by the bank, each adjusted with a client-specific mark-up where applicable. This has become possible owing to the tight integration of the internal trading environment with the rather externally oriented e-platform provided for the clients.

By relying on de facto standards for modelling the resulting transactions, namely the use of XML and middleware components, seamless integration into both the bank’s internal position-keeping systems as well as the clients’ processing infrastructures has been ensured.

As with current real-time trading systems, the e-system displays streaming executable rates based upon customer profile, the type of product being traded, and the requested notional. These are based upon core rates, which originate from the bank’s global rates engine, which provides sanity checking, spreading and market management for all currency pairs traded. Such core rates are all provided with a time-out period for execution, dependent on market volatility, dealer intervention and pre-settings configured for mitigating market risk. Credit checking is automated by integration with the bank’s credit and limit system. Furthermore, trade processing is performed by transferring all resulting transactions into the bank’s core trading infrastructure, thereby ensuring a fully managed trading position. By implementing a web interface using a component-based approach on top of a standard FX and MM trading system, the bank has maintained a high level of flexibility for introducing new products and derivatives without the need to change the entire system architecture.

Functionality and Flexibility Paramount

The buy side can now have access to an extensive toolkit of treasury management strategies which allow the practical adoption of most of the sophisticated methodologies previously considered too academic, esoteric or only applicable to the realms of investment banking. There is now an array of options available to mitigate exposure to treasury risk and running costs incurred in trading or hedging positions. This evolution has been primarily facilitated by technology innovations that have pushed e-commerce to the forefront of most of today’s treasury activities and forms part of an ever-more common business model.

The flexibility now available to treasurers through the use of e-commerce ranges from some of the more traditional budgetary aspects such as ‘slippage reduction’ (where the access to electronic exchanges, portals, etc. significantly increases the quality of market data and in turn allows for a more expansive approach) to benchmarking, coupled with realistic fine tuning of rates, thereby enhancing the use of execution tools.

An effective benchmarking strategy can help reduce bid-offer spreads and, dependent upon volumes, can make a significant contribution to reducing trading costs. As a logical extension the growth in e-commerce has spawned a market in crossing orders, with participants reducing the transaction costs, most notably in the less liquid currencies, by matching transactions and negating exposure to the bid-offer spreads. In parallel, there is now an extensive range of risk management tools available over the Internet, with extensive cover both in terms of the range of products and the number of solutions offered. These range from the more basic concepts such as VaR and back-testing flow analytics, through to the more sophisticated modelling tools. This means that, whether a one-stop shop approach is adopted or a portfolio of best of breed solutions is employed, the corporate treasurer has at his disposal a sophisticated armoury of solutions for identifying and managing his exposure across the asset classes.

In conjunction with the business drivers, there have been major regulatory demands such as the adoption of IFRS, with the focus primarily on IAS 39. Here again there is a variety of internet-based solutions that accommodates all shapes and sizes, but very much with the corporate treasurer in mind. As with trading and risk solutions, it is possible to obtain a comprehensive solution that matches requirements in terms of flexibility, volumes, product coverage and degree of sophistication. This is complemented by speed and ease of adoption, with little of the heartache experienced with traditional implementations.

Treasurers can process individual hedge clusters or run extensive portfolios dependent on their specific needs, with all of the regulatory requirements addressed in terms of fair value hedge accounting, plus the associated documentation, disclosure, etc.

As a by-product of the varied interpretations of regulatory initiatives and the increased demands for good corporate governance (not least as a result of Sarbanes Oxley), there has been an upsurge of interest in the centralised treasury model and the implementation of the ‘in-house bank’. This results from a need to improve controls and reduce operational risks, but also offers business benefits through economy of scale, improved cash management, netting, decreased volatility, reduced country exposure etc and ultimately can lead to a reduction in transaction costs. However these business benefits are only available to corporate treasurers as a result of the e-commerce initiatives of the last few years. Without the flexibility and reduced cost of ownership on offer through the Internet, whether it be hosted solutions, portals of exchanges, the more sophisticated treasury and risk management strategies would be prohibitively expensive for most corporates.

Integration is Key

For the buy side to fully maximise the efficiencies of e-trading, it is essential that there be seamless integration between existing treasury management systems and the portals used. With the development of XML-based real-time interfaces, reliable and relatively low-cost connections can be established between systems with different strengths in functionality. As a result, companies can realise efficient system support for their varying operations by implementing a limited set of well-designed interfaces. This avoids the eternal search for one system that covers all functionality needs for a longer period of time and its corresponding costly implementation. Both companies and their banks have an interest in realising low-cost integration across organisational boundaries to achieve better trade execution, settlement and controls.

The Future

It is the natural evolution within the financial markets that technology and functionality is adopted first by the inter-bank and core trading market before finding its way to the corporate community and other buy side users. This was true of the FX markets where banks were trading in a transparent ‘live’ marketplace years before the introduction of auto-trading was extended to the corporate community. Web-based fully-functional multi-product auto-trading has arrived. The buy side via one point of access can view market information, view live prices for the different asset classes, manage orders, execute transactions at the click of a mouse button, monitor the trade via trade lists and reports and with seamless integration view the trade instantly in their existing treasury management systems. With flexible web technology, the banks are now able to react to customer demand and add more functionality to support the treasurer. Increased price transparency and liquidity for all traded products, instant trade execution, better management and control of risk and exposures, significant reductions in trade processing costs, improved audit trail – the benefits of online trading and analysis to the buy side are now far too great to be ignored.

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