Foreign exchange (FX) executions are overpriced and inefficient. Discuss. Eric Huttman, CEO, MillTechFX, does just that.
The way the FX ecosystem currently operates is not fit for purpose for many corporates, in our opinion. Traditionally, all but the largest corporates have had little choice but to suffer the dual challenge of significantly overpaying for their currency execution requirements. Additionally, they suffer the operational agony of trying to implement and manage multiple liquidity-proving relationships to try to seek – though often in vain – best execution.
Under MiFID II, best execution has been a requirement for investment firms for some time. They must take all sufficient steps to obtain the best possible result for the client. For too long it has been simply too difficult for most corporates to achieve this level of transparency – that is, until now.
In search of best execution
There are many factors to consider in the quest for best execution, but in our view the most important of those should be the best available price – in other words, the exchange rate at the point of trade. But many corporates can be hampered by the inability to access tier 1 FX liquidity and the best institutional-grade execution terms, meaning they are often reliant on a single custody bank or broker to meet their execution and hedging requirements.
In addition, 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 as a result of their international business activities. It is often therefore highly operationally inefficient for these corporates to go through the significant headache of setting up and managing their own multi-dealer relationships.
This makes it extremely difficult for these corporate treasurers to compare the market – so when they go to execute their trade, they are often beholden to only one source of liquidity. This means 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. Only the largest most FX-savvy organisations have been able to do this.
No transparency: higher costs
Pricing transparency can also be a perennial problem for the corporate treasurer. FX costs are typically hidden in the spread – the difference between the rate at which a market-maker bids to buy a currency pair versus where they offer to sell it. More precisely, 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 treasurer 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.
Unfortunately, the fees corporates are charged to execute FX transactions are notoriously opaque. A 2019 paper from the European Central Bank found that banks were overcharging small corporate customers for FX services, charging hedging rates as much as 25 times higher than their bigger, more sophisticated customers. Harald Hau, a professor at the Geneva School of Economics and Management, said at the time: “The elephant in the room is that dealers systematically and consistently overcharge clients who don’t have currency trading expertise.”
A study from Accourt on the same issue concluded that there is no straightforward way for a corporate treasurer to decide which one is the most expensive when comparing costs among banks.
The good news is transaction cost analysis (TCA) was created specifically to provide transparency on these hidden costs. But the issue is many corporates still don’t have access to this kind of analysis.
New approach to old problem
Corporate treasurers deserve better quality FX execution. They need a simple tech-enabled solution that cuts costs, reduces operational burden, and improves their FX workflow.
The seemingly straightforward premise of accessing competitive, executable quotes from multiple liquidity providers in real time is critical for treasurers to gain a transparent view of their execution set-up, enabling them to streamline their operational workflows and execute FX trades at the best possible rate.
Simple aggregation may not be enough – treasurers should be able to execute on these prices and have banks compete for their business. Some platforms aggregate prices from multiple banks but still require a treasurer to go through the operational nightmare of negotiating ISDA [International Swaps and Derivatives Association] agreements with each counterparty to transact with them on the platform. For many corporates, this remains an insurmountable barrier to entry. For a treasurer, going beyond aggregation and gaining actual access to the world of comparative multi-bank FX execution through a platform such as MillTechFX can be the first step towards supporting further international growth, adding real value to their business, and driving future success.