Changing in the way currency benchmarks are calculated has seen FX trading transition to a more agency-style model, according to research from Pragma Securities.
In February this year, WM/Reuters adopted a new five minute window to calculate its 4pm currency benchmark rate, know as the Fix.
Pragma claims this change and the increasing adoption of automated handling around Fix orders are changing the way banks offer FX brokerage and leading to new patterns in currency trading.
Prior to 15 February 2015, Fix was calculated during a one minute window around 4pm London time, typically leading to order being submitted before the window and bank spot desks would guarantee clients the benchmark rate, with trading happening just before and during the window to manage the associated risks.
However, as a result of the scandal around some banks manipulating the Fix, the new methodology for calculating the rate was adopted.
Pragma’s analysis reveals this has had a significant affect on the way currency pairs are traded around the fix. Prior to the new benchmark volatility would gradually rise as the calculation window approached and taper off shortly afterwards.
After 15 February, however, trading volume and volatility rise more abruptly and remain flat during the five-minute window before rapidly dropping again afterwards.
Pragma suggests this is evidence of a broad shift to using TWAP algorithms to trade around the FIX. It adds that anecdotal evidence suggests many banks have shifted Fix trading from their spot desks to their e-commerce groups, using an algorithmic, agency-model approach to trading around this key benchmark.
This creates some issues for the banks, it adds, as one side clients are demanding orders benchmarked to Fix despite the risk of adverse trading results there are exposed to, while regulators are demand they handle these orders in a more systematic and transparent manner.
Banks and their clients need to weigh up the tradeoffs between tracking errors and execution quality when participating before or after the Fix window. Pragma said firms will need to be able to track and respond to the ongoing evolution of this trading pattern, and the potential for some market participants to try and exploit it, if they are to achieve best execution.