The story goes that when asked whether he used electronic trading, an Australian corporate treasurer replied, “Yes, I trade electronic, I use the telephone.”
But that was then and these days all across the region banks, institutions, corporates and smaller businesses are doing more than just playing catch up, they are becoming as sophisticated in electronic foreign exchange trading as anyone on the planet. Given its relatively modest 22 million population making it the world’s 55th largest country Australia’s currency bats well above its weight. According to the 2010 Bank of International Settlements Triennial Central Bank Survey, turnover in AUD ranked 5th in the world. The USD / AUD ranked as the fourth most commonly traded currency pair accounting for 6% turnover.
What drives the market popularity of this currency is the country’s, until recently booming exports of iron ore, coal and other commodities, especially to Asia, its exports of meat and agricultural products and the carry trade. The AUD has been drawing in foreign deposits in huge amounts and only now, as the AUD has come under some pressure, the Reserve Bank has started cutting its benchmark interest rate. It still stands at 2.5% though various pundits are predicting another quarter point cut before too long, but this compares favourably with the other major currencies.
Surprising then perhaps that the take up of e-trading in Australia was, until now, a little slow. “Electronic trading in Australasia has historically lagged behind other markets such as the US and Europe,” explains Paul Tivnann, Bloomberg’s Global Head of Foreign Exchange and Commodity Electronic Trading. “But in recent years FX e-trading in Australia has expanded to meet the demands of the developed markets and perform as a new Asia trading hub. Australian banks are leading the region with their price distribution technology, embracing multi-dealer channels and investing in single dealer platforms to reach their customers more efficiently.”
Chris Daley Global Head of Markets e-Commerce at Commonwealth Bank of Australia (CBA) adds that recent surveys place levels of online dealing by institutions and corporates at the top end of the market in Australia and New Zealand at around 57%. “This compares with 75% in Europe, 82% in UK and US. This statistic likely goes some way to explaining the perception of Australasia as a hotbed of innovation. As the appetite for e-FX in the region grows, it does so with the benefit of ‘last look’ at innovative technology. Banks in Australia and New Zealand recognise they are in a position to enhance the cross asset functionality they can now provide to meet the expanding needs of their clients. FX Businesses must understand that if they do not make e-FX a key priority, they will be left behind.”
Indeed, arch rival National Australia Bank (NAB) is aiming not so much to catch up but to leapfrog the competition. Drew Bradford joined two years ago bringing with him his experience from other firms. He in turn brought in Justin Geaney as head of fixed income, currencies and commodities (FICC) digital, from Citi where he had worked on the development of Velocity. “18 months ago I’d agree that Australasia was behind in e-FX but if I look where NAB is today and where NAB is going we are definitely pushing the boundaries of innovation,” says Geaney.
“The types of electronic product that I think the market is going to see out of Australia over the next 18-24 months will really take us to the forefront. Drew has a vision about simple solutions for clients so that they can self-service in commoditised vanilla products. We’ve seen all the global banks coming up the curve in what they are doing in the electronic space. Our aim was to learn from the curve of other banks and design and build something that is better. We are building a platform that is truly multi-asset. A single point of access for all products that are FICC that clients can access where they want to access it, on whatever device they choose to use,” says Geaney.
According to Graeme Edie, Westpac’s Managing Director of foreign exchange, investment in high performance infrastructure is paying dividends. “We have taken that journey to build out the entire eFX function over the past 18 months and have seen a dramatic response from our customers,” he says.“To deliver to our clients we have taking a holistic approach from price construction, distribution, automated portfolio approach to risk management, liquidity aggregation and pre and post trade services,” he says. “Having this stronger, cross border connectivity and coordination across our global FX client base as a result, has increased our volumes by over 25 per cent this year.”
Buy side demand
Fighting talk but this is very much in response to client demand. On the buy side the larger corporates such as the major mining groups are as sophisticated and knowledgeable as any. Among the institutions Australia’s superannuation funds and other large financial sector firms have global reach and experience of the best e-trading capabilities. This has forced the pace of change.
“Up until 3-5 years ago virtually all the buy-side operated via human contact,” says Steve White, a director at Noah’s Rule, a Sydney based consultancy specialising of providing buy side businesses with risk management and forex strategy advice. “The sophisticated operators with an internal treasury would have had an electronic capability. Below about top 50 on the ASX they were generally dealt with directly by their bank or their banker. This has changed as the banks have developed their platforms and made things more user friendly for those buy-side corporates. Clients now have better access to the markets and in some cases better transparency to the pricing they’re receiving. They know what they’re getting. So that’s a good thing but many clients do not have the knowledge or experience to know what the right strategy is.”
At the same time buy side clients are recognising that they can be more efficient across their treasury, liquidity and currency management. They know that the tools are available to help them to do so and that providers are competing to provide them with those tools.
“The different client segments in Australasia have had very different demands, but we see that they are now starting to converge. Asset managers and institutional investors have generally been using a combination of trading on platforms – single or multi-bank – chat systems and the telephone for many years and larger corporates are now also recognising the benefits of aggregation and straight through processing achieved in eTrading. Process and work flow are critical to the institutional segment so bi-directional integration with their order management system is very important as is electronic confirmation matching with their banks. As the institutional space increases focus on performance measurements for their investors such as proof of best execution and transaction cost analysis (TCA), we are seeing more participants considering trading on true multi-bank electronic platforms like 360T which provide an efficient and cost-effective tool for doing this,” explains Sally O’Keefe Australia/NZ Sales Manager at 360T.
“Since 2007 movements in the AUD have opened up people’s minds to the foreign exchange risk,” according to FXall’s head of Asia Pacific, Jonathan Woodward. “For importers, exporters, investors and the large superfunds with a spread of international assets, FX is a much hotter topic these days. Asset managers have been leading in this. They had the best execution requirement of MiFID come through from Europe but for them it is all about workflow, straight through processing (STP) and risk reduction. They are looking to reduce their operational risk as well as their actual currency risk by doing things more efficiently. And when you’re trading on behalf of thousands of accounts you can’t risk having things being re-keyed incorrectly. Asset managers need to execute efficiently, then confirm the trade immediately and have links to a custodian as well as taking advantage of connectivity to CLS to reduce settlement risk. There is a need to be able to show and report all these things to your investors who need transaction cost analysis (TCA).”
“Our TCA tool, known as Execution Quality Analysis (EQA) has been in great demand from investors in Australia. If you can show to a CFO or CIO that he can prove that he’s trading at the right time of day for liquidity in that currency pair and help him analyse which of his banks are offering him the tightest spreads he gains a better insight into his performance. You can then break that down by account so that he can give detailed reports to his firm’s customers. Once the CFO has seen that he knows that he needs to use the system to generate that report automatically,” continues Woodward.
As with other regions around the world, pre- and post-trade functionality and now TCA are proving to be the battlegrounds on which increasing competition is being fought. Best price and low latency are no longer enough in Australasia as elsewhere. Moreover that battle is not only being fought within the buy side firms but also on the sell side.
Rob Hodgkinson’s technology firm, First Derivatives, based in Sydney specialises in providing TCA to the banks themselves as well as TCA tools that banks white label to their clients. “As a result of the fragmented trading model, identifying how good the prices are that you are getting is relatively difficult – there is no central venue and therefore no central price. That opacity makes analysis of trade costs and prices all the more valuable. TCA involves V x 3 on data - volume, velocity and variety. We specialise in high-velocity market data capture, and the building of large tick time series databases. TCA involves real-time analysis of incoming tick data; for a large bank it will involve comparing that with their own books - possibly published - and identifying if the bank is competitive, within the best spread across all liquidity providers and ECNs. TCA additionally often involves detailed book analysis (volume weighted spread and/or skew analysis) along with a ‘what if’ analysis to compare actual trades against possible alternate markets/times to establish if the bank is achieving best execution. This real-time analysis can really pinpoint how competitive a bank is in FX trading. Consequently, Australian banks are now able to benchmark their own performance against others in the e-trading space, demonstrating that they can compete with the big international players while bringing their niche AUD and NZD expertise to market,” he says.
FX prime brokerage and currency derivatives
The development of prime brokerage services and e-trading of currency derivatives in Australasia is following a path familiar in other regions of the world. Regulation is becoming their key determinant. Graeme Edie Westpac’s managing director of foreign exchange succinctly summarises the position. “Prime brokerage is moving away from the provision of credit and towards clearing house access and administration / compliance solutions,” he says. “The extent of changes to the FX prime brokerage model will be determined by the final split of FX products between OTC and regulated platforms / clearing houses.”
Jonathan Gencher who heads State Street Global Exchange, Australia & New Zealand adds, “Given the increasing cost of capital to the banking sector and the banks needing to show or at least illustrate a return on equity, I would not be surprised to see a decrease in the level of FXPB providers as banks seek to optimize their balance sheets. That said, there is certainly room for those banks with strong balance sheets to step into any void created. As for currency derivatives in the region, with the ongoing regulatory changes and the need for banks to move away from the more commoditized vanilla type products (outrights and FX swaps), we are likely to see an increased level of derivative and sophisticated tools being offered. The rationale for this is likely twofold. Firstly the banks are going to look to offer products and innovations that will differentiate them from the peers and secondly, the banks will be looking to deliver higher yielding solutions.”
Meanwhile it is worth noting that as the Australian banks were largely unscathed by the financial crisis as compared with the global majors, they are being sought out by institutions and smaller asset managers. To these they are in a good position to offer niche currency expertise that may involve provision of credit and/or currency derivative products. However it has tended to be on the retail side of the market where there has been greater innovation and development in e-trading in both Australia and New Zealand.
Retail FX trading
“The retail margin FX market in Australasia is the one clear market where I think the region could possibly be considered a hotbed of development, although not specifically on the technology front, rather in increased activity,” says O’Keefe at 360T.
“Investors in Australasia, as elsewhere, have been looking for alternative asset classes to equities post the global financial crisis and given the rapid increase in marketing by the many retail FX brokers in the region, many “mums and dads” are moving into trading retail FX. These firms run huge marketing campaigns via Internet, TV, radio and in the press in the sports and financial pages. They offer both free and paid training programs and forums and also via introducing brokers – and they also offer very tight spreads and leverage to their clients,” she notes.
The growth has seen many large offshore platforms from retail mega-markets such as Japan apply for local licences. On the regulatory front, retail FX in New Zealand is not regulated which sees it as a very popular destination for new entrants. However, in Australia ASIC is strengthening regulation with the introduction of capital requirements for local firms.
From January 2013, retail brokers offering leveraged FX trading were required to hold net tangible assets of at least AUD500k or 5% of average revenue. This amount will increase to AUD1mio or 10% of average revenue by January 2014.
From a company perspective, 360T realised the global growth in retail FX and moved into the space via their sister company FinBird that provides technology developed by retail brokers for retail brokers which additionally enables the provision of 360T’s wholesale liquidity panel to the brokers.
Derek Mumford a director at risk advisory Rochford Capital in Sydney adds, “Demand for personal currency services is also being impacted by the growth of immigration into Australia, especially from Asia. People have businesses to launch and run, houses to buy and so forth, so they’re looking to transfer funds. Likewise immigration from Europe and the UK particularly is also growing. And up until recently people were switching currency back the other way from the strong AUD. That looks to be underpinning the market. We are hearing about lots of money coming from China in particular. The attraction of online currency platforms is that they are transparent to see where the markets are, as opposed to just using a bank’s rate, which may have a large spread in it. That’s left the market open for companies like HiFX, OzForex and many others to come into the market and these will each have an on-line platform.”
Whether retail FX trading in New Zealand will become regulated in the foreseeable future is a moot point. It is difficult to imagine that it will remain outside the increasingly global regulatory net, as this spreads to encompass more or less every type of financial sector activity across all geographies. But Regulation is definitely the hot topic in Australasia as elsewhere at the present time.
As local banks develop their own tools and capabilities, watching what is going on in regulation in Europe and the US is vital. Westpac’s Graeme Edie points out that pre-trade transparency is a key focus of the G20. “This has manifested itself in the development of SEF legislation in the US and MiFID2 in the EU. Australia is still in the market assessment phase and monitoring developments in other jurisdictions before determining appropriate trading venue and platform designs. However, in the interim, market participants are being encouraged to increase utilisation of electronic platforms. The interplay between the yet to be finalised G20 margin regime and capital requirements will affect market participant behaviour. Penal outcomes will encourage a greater use of electronic execution and clearing solutions.”
So for example at NAB this approach is a central pillar of their soon-to-be-launched platform. “Regulation is often a driver to build these platforms in a certain way,” Justin Geaney explains. “Our FIC operation has a large offshore footprint. We’ve approached this from the point of view of where the most stringent regulations exist and working out how we can cater for those. So we feel if we can do this for example for the most stringent regulation for clearing and reporting, we should be able to reuse that technology as regulations change locally or in other jurisdictions where we work. So if you think about the swap execution facilities (SEF) under Dodd Frank we need to be ready for that and for when similar regulations arrive in Australia as well.”
Sally O’Keefe of 360T adds, “A deputy governor from the RBA said recently that Australia would not be able to “cherry pick” which reforms to implement or not and the Australian regulator ASIC has also said that to ensure that global markets remain accessible to Australian participants and technologies, they will endeavour to ensure that their reforms are consistent with their foreign counterparts. Again, I see Australasia as following what happens in the major markets. As the G20 has stipulated that OTC derivatives are required to be traded on electronic platforms, the evolution of eFX trading will continue and at rapid pace as the regulatory regimes are implemented across all regions.On the clearing front, ASIC is yet to release rules for the clearing of OTC derivatives although the local ASX has established OTC clearing and LCH Clearnet recently received their licence to operate OTC clearing of interest rate swaps in Australia.”
For all parties it seems to be a game of regulatory wait and see but meanwhile there is likely to be plenty more going on across Australasia as e-trading gathers further momentum. Investment is already paying dividends at Westpac and both CBA and NAB are rapidly developing their proprietary platforms, knowing that for clients e-trading is a must have but that it also ties clients to their banks to a greater or lesser degree. “Technology has also brought a new wave of competition to the traditional way of servicing and extracting value in the FX market,” says Edie.
FXall’s Jonathan Woodward sees the Australian banks expanding their services further into Asia as a next stage.“E-trading will aid the Big 4’s expansion into Asia; they are all looking to move north. Singapore is also better from a time zone perspective and also from a latency one.” He also points out that the Australian Big 4 have invested considerably in their e-capabilities and will be able to leverage these as they expand into Asia and internationally.
However the route into Asia is a two-way street and the current malaise surrounding the AUD has a great deal to do with economic uncertainty in China. For all its popularity as a traded currency and the increasing ability to trade it by electronic means, the fundamentals of Australia’s economy look likely to be a major factor. If demand for coal, iron ore and other minerals from China and other Asian countries falters, buy-side clients’ revenues will be bound to suffer which will in turn affect those firms that provide them with FX services, chief among which are the Big 4. To that degree the multi-bank platforms have global reach and greater stability to their business models. The Australasian banks have a great deal to play for but also a good deal of financial risk to shoulder in order to compete on the global e-trading stage.