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Tackling Hidden Costs in FX Management

Tackling Hidden Costs in FX Management

All investors experience significant – and often hidden – performance erosion as a result of routine FX trading, whether it’s carried out directly or via external parties. What’s the true cost, and how much can investors save?

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Tackling Hidden Costs in FX Management

IN THIS PAPER

Leakage: the known unknown. Spread costs are often inaccurately calculated; market impact costs are largely invisible. New research estimates the true size of investors’ currency trading costs at $140 per million transacted. With routine FX trading often reaching multiples of the investor’s AuM each year the figures add up rapidly.

The rise of peer-to-peer netting. Recent years have seen the emergence of various ‘peer-to-peer’ solutions for off-market FX trading, in a bid to reduce leakage. A study of just 11 buyside entities indicates that 26% of their FX trades could be netted over a one-hour window.

Implementation challenges.Savings are hugely dependent on the details. This paper includes a brief implementation checklist for investors to use when considering peer-to-peer netting. What rate is being used? How is order information used? What rules govern the pool and who gets to be in it?

Tackling Hidden Costs in FX Management

WHY DOWNLOAD?

Investors are typically spending considerably more than they realise on FX transactions. The subject, typically viewed as an administrative back-office function, often receives limited attention from pension fund trustees and investment seniors in an institution. While FX is a highly liquid market it is also opaque, fragmented and lucrative for its operators, creating challenges for even for the most sophisticated asset owners and managers.

Transaction costs, comprising spread and/or fees plus market impact costs, have received greater attention in recent years. Transaction cost analysis can help investors to understand the extent of losses. Yet it must be robust: spread costs are often inaccurately estimated; market impact cost is even harder to quantify.

It is one thing to understand leakage and quite another to reduce it in practice. Manager selection, custodian arrangements and direct trading arrangements can all play a role. Some interesting solutions have recently emerged that enable investors to net their FX trades against each other before going to market. Evidence demonstrates that this can produce substantial savings; a $60 billion pension fund, for instance, can save $1.3 million per year when netting with just 10 other entities. Yet benefits are hugely dependent on the method of implementation.


Important Notices

This commentary is for institutional investors classified as Professional Clients as per FCA handbook rules COBS 3.5R. It does not constitute investment research, a financial promotion or a recommendation of any instrument, strategy or provider. The accuracy of information obtained from third parties has not been independently verified. Opinions not guarantees: the findings and opinions expressed herein are the intellectual property of bfinance and are subject to change; they are not intended to convey any guarantees as to the future performance of the investment products, asset classes, or capital markets discussed. The value of investments can go down as well as up.