How has the market backdrop of the last few years impacted restricted currency execution and custody?
Photo taken with Focos
Local market regulations are constantly changing what custodians and third-party providers are able to bring to market, so this is an ever-evolving landscape. When you look at some of the larger currency control moves such as Malaysia in 2016 or Argentina in 2019, they have certainly placed more eyes on internal processes and external offerings. On that note, we’ve seen a lot more players jump into the third-party FX execution space with restricted currency offerings in the last few years—some in beta testing, some with established client models. Ultimately, we (asset managers) should absolutely continue to encourage more competition in the space as it will drive efficiencies and technology improvements that benefit our end clients.
I’ve been positively surprised with the solutions that many of the larger global custodians have begun to develop, as client concerns about transparency and execution quality have pushed them to enhance their capabilities. With respect to the currency markets, as we look ahead to 2024 with a more dovish Fed and the geopolitical landscape at large, I think that any introduction of excess volatility into the more niche local markets will continue to highlight the need for more transparency and better data quality of restricted currencies. When volatility increases in these markets, we generally have our clients asking more in-depth questions about their executions or about what is happening in a particular local market, so it is helpful to have powerful relationships with our global custodians and banking partners to best address any concerns our clients might have.
Where is there still room for innovation and improvement in restricted currency trading in order to make execution more efficient?
Unfortunately, we are still seeing a large gap across our custodial panel in terms of technology and service levels. As T. Rowe Price uses the custodians where our clients either have an existing relationship or have chosen as their preferred provider, that introduces a vast array of different providers that we deal with. While some custodians have transparent models with SWIFT capabilities and global coverage around-the-clock, we have some niche custodial banks which are somewhat limited in their operational and service models.
Examples include some smaller regional custodians still only accepting fax instructions, to some requiring a bespoke MT599 SWIFT messaging, to others being comfortable with tag 11A instruction and having full transparency and insight into what stage of execution the trade is in. We also have examples of varying levels of standing instruction capabilities, where our custodial panel all have different offerings for non-trade related activity such as income received, and this also differs by currency as well. Looking to the future, the two main areas of concern that need to be addressed by the broader market would be the overall electrification and automation of the trade communication, instruction, and confirmation processes, as well as greater transparency from custodians into their executions – including time stamps and rate captures, spreads being charged, and batching processes.
How can the buy- and sell-side best collaborate to make this innovation possible?
Here is where the future for restricted currency trading looks very bright! We have been having extensive and meaningful conversations with a lot of our partners regarding restricted currency trading, and most of them understand the gaps in the broader market and know that it requires both the buy- and sell-side to push on these global custodians to innovate and move the industry forward. As I stated earlier, there is a need for continued electronification, more transparency into executions and timing, more push-back on trade-away fees, and a move towards a more collaborative environment with custodians.
One excellent example of collaboration that I am happy to share is at T. Rowe Price, we host a standing bi-weekly meeting with our largest global custodian where we go through all local market developments and significant central banking news that might have occurred or been released, discuss how this could affect any outstanding executions we have, and work through any situations that need further review. This has been extremely beneficial, as our portfolio managers have appreciated this proactive approach to monitoring these local markets for our restricted currency exposures, and it keeps our team up to date on important market information.
How can transparency be improved in restricted currencies and what knock-on impact will this have on wider FX trading?
The first item that always comes to mind here is that the transaction cost analysis (TCA) for restricted market currencies still has a long way to go, in my opinion. While freely-traded currency TCA data has made extensive developments and has become significantly accurate over the last few years—restricted currency TCA is still dealing with poor timestamps from custodians and a lack of agreed-upon benchmarking and standardisation from both providers in the industry, and our peers.
In addition, for those who consume custodial data, there are a lot of inefficiencies there as well, as most asset managers need to find creative ways internally for consuming different reporting and technological capabilities across their custodial suite. For the implications against the broader FX markets, I think that we all agree that any progress towards a transparent, fair, and efficient market creates a scenario where a “rising tide lifts all ships”. At the end of the day, as asset managers, we are beholden to our end clients to seek best execution on their behalf, and pushing for both higher data quality and more transparent execution from custodians certainly encompasses that.