The definition of best execution in foreign exchange trading goes beyond the notion of best price. For buy-side firms with the infrastructure to actively manage FX trading through third-party dealers, best execution is a function of finding the liquidity provider that will offer the best rate for a currency pair at a given moment.
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Highlights
TowerGroup estimates the contribution to daily FX turnover from investment management institutions is approximately US$150 billion, about 12.5% of the total value of FX trading for a given day. Of the more than US$20 billion in daily electronic FX trades, almost two-thirds are executed through multidealer platforms. Today the total percentage of buy-side FX trades negotiated and executed electronically is approximately 14%.
Many buy-side firms define best execution in FX trading by looking at the total cost to execute, allocate, and settle an FX trade, including the potential for operational risk inherent in moving cash between accounts and counterparties. The analysis considers the trade-off between the competitive rates offered by third-party FX dealers and the operational efficiencies derived from procuring foreign exchange through custodian banks.
Effective treasury operations can be defined as the management of liquid assets against liabilities, financial risks, and bank relationships in such a way as to maximize performance of cash as an asset while minimizing operational error and the monetary penalties associated with settling FX transactions.
The inherent value of electronic FX execution for buy-side customers will induce a steady increase in the volume and value of transactions that will flow through multidealer platforms. However, questions still remain concerning the longevity of the business model, how many portals can be sustained, and the commitment of liquidity providers over the long run.
Challenges to the sustainability of multidealer platforms will come from the supply side not the demand side. Questions remain regarding the profitability of running an FX trading venue and how liquidity providers can maintain FX revenue by trading through a multidealer portal.
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