The need to settle closer to execution as the shift to T+1 looms is set to exacerbate the need for automation in future FX transactions, as the GFMA claims that only those with sufficiently high levels of automated processes will succeed within the new state of play.
The GFMA’s Global Foreign Exchange Division’s (GFXD) educational report recommends that impacts and dependencies of current and future pre- and post-trade process be thoroughly evaluated in order to continue to successfully execute.
Speaking to The TRADE, James Kemp, managing director of GFXD, explained: “When analysing the impacts of faster settlement, it is important to consider FX both as an asset class in its own right and also in its role in cross border securities transactions and the corresponding FX-funding transactions and operational processes that need to be completed to support those transactions.”
According to the report, despite current functions being well-established, widespread adoption of more efficient processes and new technical solutions is limited unless these are available to affect settlement as near to execution as possible.
“This is especially important when considering FX transactions which involve multiple third parties, such as trading venues, custodians, prime brokers or clearing houses, all of which will need to be in sync to ensure that the agreed terms of the FX transaction can be met, and the transaction settled on-time.”
Future FX transaction functions are set to be markedly different, exacerbated by the need to settle at – or close to – execution. The GFMA highlighted the fact that initially it may only be those FX transactions with high levels of automated processes which will be suitable for T0 or for timed settlement.
Technology, and by extension automation, will clearly influence the success rates of market participants. The GFMA explained: “Technology could play an important role here through the creation of immutable ‘golden sources’ of transactions as these too will enable the reduction of the time taken to perform any post trade processes.”
Furthermore, the association emphasised the relevance of increased fragmentation, stating that as it is unlikely a single provider will be adopted by the entirety of the market, operational risk would increase and thus the pace of adoption decrease.
Recommendations from the GFMA includes harmonisation and futureproofing of FX regulations and supervisory guidance across jurisdictions and market participants, as well as private-public sector dialogue regarding the concept of a global ‘Settlement Date’.
In addition, the GFMA underscored that technological progression, public sector developments, and “a desire to improve operational efficiencies and reduce settlement risk” works to increase the options participants have in relation to execution and settlement for wholesale FX transactions. This increase in options is set to drive T0 volumes, it said, as well as increasing choice regarding timing of when a wholesale FX transaction is settled.
The report affirmed that post-trade (including settlement) processes will be impacted either by changes to T0 volumes, or by changes to today’s flow of settlement liquidity.
Specifically, the GFMA reenforced that impact would stem from the ability of the market to empirically perform post-trade functions within a reduced timeframe, and whether market participants can successfully adopt technological solutions to achieve automation.
Both factors hinge on successful communication across the FX Value Chain, said the report, adding that information sharing between trading, operations, credit and treasury divisions is also key.
“A big challenge to overcome will be the ability to perform these new functions in conjunction with today’s existing processes, as there may be a reduced desire to support multiple trading and settlement models (with very different timeframes and requirements) as standalone units,” said the GFMA.
Whether there is a commercial market desire to move at scale, or the capabilities in place to do so, remains unclear, with the GFMA highlighting cost and coordination as the main barriers.
Kemp told The TRADE: “We can clearly see the trend towards faster settlement cycles across different assets, driven by operational and cost considerations.
“[…] The industry continues to reduce operational and settlement risk and we clearly do not want to take any backward steps. This latest GFXD paper looks at a number of the key building blocks for any further acceleration of FX settlement and seeks to identify a number of areas where the whole industry is likely to need to collaborate to enable any transition.”