Regional e-FX perspective on Canada
Mar 27th, 2017
Richard Willsher reports that although Canada is set to see increased adoption of electronic FX channels, voice trading continues to account for a surprisingly large proportion of turnover in the regional FX market.
Successive e-Forex regional perspectives suggest that trading on electronic platforms is steadily increasing across the global FX market as a whole. In some cases e-adoption is taking off rapidly. Yet research suggests that in Canada, voice continues to account for close to half of trade execution.
This conclusion arises from statistics released annually by The Canadian Foreign Exchange Committee (CFEC). An industry forum whose nine members are the largest foreign exchange banks in the country, CFEC includes: BAML Canada, Bank of Nova Scotia, BMO Capital Markets, CIBC World Markets, HSBC Bank Canada, National Bank of Canada, RBC Capital Markets, State Street Canada and TD Securities. The Bank of Canada chairs the group and co-ordinates its annual surveys. The breakdown of execution methods over the last four reporting periods, based of volumes transacted, splits out as seen in table 1 overleaf.
The numbers may be skewed because some banks report related party trades under “voice”. Nonetheless the high volume of voice transactions does seem to stand out.
Why there is an apparent stasis in the growth of e-execution in Canada we shall explore. Meanwhile it is worth reflecting that the Canadian banks are the major liquidity providers in Canadian dollars (CAD) and CAD crosses. CAD is the sixth most traded currency according to the Bank for International Settlements’ latest Triennial Central Bank Survey of foreign exchange and OTC derivatives markets.
In April 2016, the average daily turnover was USD260 billion, a market share of five per cent, slightly greater than that in Swiss Francs, the next ranked currency. While small as compared to the top three major currencies, CAD plays a significant role in the FX theatre. Matt O’Hara 360T’s CEO Americas says that the larger CAD liquidity providers tend to harness electronic means to reach out to the international market.
“Electronic channels have allowed the Canadian banks to be CAD liquidity providers on a global basis which they might not have been able to do with their own, physical footprint. Typically they are North American focused, very focused on Canada, with a presence in the major risk management centres around the world – London and Asia – but not geographically dispersed everywhere like the global mega banks,” he says.
“The electronic venues also help them to access liquidity from the global marketplace in their non-core currencies. They have been proactive when it comes to using electronic channels to manage their own risk and positions which are typically generated off the back of their client flows. They were reactive initially in those early pioneering years of e-commerce when other banks were setting up single bank portals and investing large sums in their proprietary trading platforms for internal risk management, then price construction and distribution.”
Canadian banks have tended to be slower adopters of e-commerce. Market participants do expect to see further growth in the use of electronic FX trading channels as CIBC’s MD and Head, Global E-Commerce Solutions Group, Takis Spiropoulos explains, “Canada is set to see more growth in the use of electronic FX trading, although not at the same pace as in other jurisdictions. Key drivers are increased automation to reduce risks and costs, more transparent and auditable execution processes driven by increased regulatory requirements both on the sell side and the buy side, and keeping up with competition from other global banks.”
At Royal Bank of Canada, the country’s largest bank measured by assets and stock market capitalisation, Geoff Jones, Global Head of eFX at RBC Capital Markets points out that, “RBC Capital Markets has provided electronic solutions for Canadian clients for over 15 years through our award winning single-dealer platform, RBC DX. Multi-dealer platforms have been widely adopted by Canadian institutions as they help simplify some important pre- and post-trade activities. These institutions require an ever-evolving portfolio of eFX products and services where realtime analytics, reporting and transparency make up part of the core solution.”
He goes on to say that “RBC Capital Markets’ global footprint has helped to keep the firm at the forefront of the global evolution in execution services for its clients. This experience and success is continuously being leveraged across other asset classes for all of our clients to utilize. Algorithmic execution continues to gain in popularity among Canadian institutions and RBC Capital Markets has been well positioned to support this demand with a suite of intelligent FX execution algorithms along with robust TCA reporting services to meet our clients’ demands for performance and transparency.”
360T’s Matt O’Hara says that the buy-side in turn was slow to adopt e-execution and that the banks have carefully tracked the needs of their clients. Unsurprisingly, the needs of the Canadian buy-side clients are the key focus of the larger Canadian banks. Some of those buy-side firms are significant in size even if their names are not as familiar as many of the US based corporate and institutional clients.
For example in an October 2015 piece of research, Boston Consulting Group drew attention to the domestic and international influence of the ten largest Canadian public pension funds. Led by the CPP Investment Board, Caisse de depot en placement du Quebec and Ontario Teachers Pension Plan they had over USD 1 trillion in assets under management.
Their overseas investments, in such areas as infrastructure and real estate, give rise to large in flows of foreign currency likely to require hedging and FX risk management. Similarly, corporates with interests in food production and distribution, automotive engineering, energy and power generation have substantial overseas revenues.
RBC’s Geoff Jones says that, “We are working more closely than ever with our buy-side clients, helping them stay on top of developments in market structure and liquidity conditions. We have a duty to educate our clients on the changing OTC landscape and guide their selection of tools to manage their risk and meet their regulatory obligations. Our global markets structure means that we are applying experience and best-practices cross-asset and RBC Capital Markets has a world-class equities algorithmic platform to build upon. Our FX electronic trading is no longer limited to the provision of principle execution services. We recognize one size does not fit all and provide principle and agency executions on a quoted and algorithmic basis; this is unique within the Canadian banking market. Our team of experts at RBC Capital Markets helps clients achieve the best possible results from the broad range of execution tools available.”
Yet for all the increasing sophistication of their buy-side clients, 360T’s O’Hara believes that the Canadian banks listen closely to their clients who still “very much value the relationship of speaking to a voice at the end of the phone for advice and research and for pricing in more structured derivatives trading, such as options, while looking to multi-bank eFX trading venues to automate vanilla FX flow.”
Takis Spiropoulos echoes this view. “Unlike commoditised products that are increasingly being traded over single dealer and multi dealer platforms, more complex products such as options and structured notes, require a closer engagement between the sales people and clients, in order to understand the requirements, identify associated risks and discuss possible structures and transactions for mitigating those risks. We are continuously reviewing which derivative products are appropriate for electronic execution to create efficiencies for our clients and satisfy the evolving regulatory landscape. As with FX spot, offering derivatives electronically will leverage investments in pricing and risk management capabilities, and will be subject to the same safeguards and fail-safe switches.”
Readers of Michael Lewis’s non-fiction work Flash Boys will recall that it was RBC’s Brad Katsuyama who harnessed research and technology to expose and combat predatory high frequency trading in the US equity markets. Although he left the bank some time ago, and FX is a different market, this example does illustrate the sort of technology talent that the Canadian banks are able to attract, whether home grown or migrating from other banks.
RBC, among others, attaches considerable importance to technology. “Canada is fortunate to have some of the best technology schools in the world,” says Geoff Jones. “Banks continue to attract many talented graduates in a very competitive market. As a result, RBC Capital Markets is committed to providing a dynamic environment for its technologists by investing in everything from innovation labs to outreach programs. We have also invested meaningfully in several other initiatives including cloud computing, machine learning and block-chain technologies. Our Teaching Kids to Code program, where RBC Capital Markets employees help school children learn the basics of software development, has been extremely successful and something we are very proud of. RBC Capital Markets is thoroughly committed to advancing the customer’s end to end experience through technology, evidenced by the scheduled release of the award winning RBC DX platform later this year. The new version will offer clients access to our product suite through a range of mobile devices, reflecting the evolution of user habits.”
Technology extends across the full waterfront of offerings from corporate to retail. CIBC’s Spiropoulos draws attention to the growing use of mobile for example, particularly in the retail and SME segments.
“Over the past couple of years, a mobile offering has become a key differentiator for the retail and discount brokerage businesses, and is becoming more important for small to medium size corporates. For example, our corporate business banking clients are currently benefiting from a dedicated app linked to the cash management system that enables FX payment transactions to be done over mobile in a secure manner. Our retail clients are benefiting from our partnerships with fintech firms to send money abroad in new, faster and cheaper ways, via web applications or using mobile phones linked to their CIBC bank accounts. Applying such innovations to institutional trading is far more complex however due to market risk and the size of committed balance sheet, so it will take longer.”
Canada has a number of companies that provide extensive foreign exchange services that are bringing state of the art technology skills to FX. One of these is independent, Toronto based broker-dealer Velocity Trade. Simon Grayson, the firm’s CEO says that as the buy-side demand for e-commerce solutions for FX is evolving rapidly firms like his have an important role to play.
“At Velocity we have taken the view that we enable the client to interact with us on their terms. This can be via API, proprietary platforms or via a multitude of other secure access points. The banks are also evolving their solutions with the added focus of upgrading their client franchise solutions.”
“Many large banks and institutions are starting to leverage companies like Velocity to take advantage of our focused technology investments and international footprint,” says Grayson, “This allows enhanced international trading capabilities while deepening regional and franchise business lines. In terms of evolution one can find competitive electronic pricing in NDFs/NDSs of Asia and South America, streaming or request for stream in a plethora of pricing venues. The strongest institutions are those that are platform agnostic.”
Specifically he notes that agile firms like his are assisting large ones to keep pace with changes in regulation. “With developments such as Central Trade Repository (CTR) reporting for example Velocity has taken a proactive approach and has invested resources to automate required reporting functions.”
FREE OF DODD FRANK
In the context of regulation, what may or may not happen to the Dodd Frank Wall Street Reform and Investor Protection Act in the US, now that the new President has set his sights on reducing regulation, remains to be seen. But for the time being Canada has an advantage over the US, in that trade in OTC derivatives is less regulated there. There is no requirement to trade certain types of products on a swap execution facility (SEF) for example.
Consequently, overseas banks, such as those in Latin America or Asia for example, who seek to trade with a North American bank, can forge a bi-lateral relationship with a Canadian counter-party to provide CAD liquidity and execute NDFs for Latin America currencies. In addition, some of the Canadian banks have a significant presence in Latin America as well having expertise in commodity finance and trade, which is common ground with some Latin American counter-parties. Currency hedging has an obvious role to play that Canadian banks perform, often, though not necessarily, on electronic platforms.
However, the steady growth in regulation impacts the Canadian market as everywhere else. “As a large financial institution, subject to increasing reporting, registration and clearing requirements, we are well-versed on the evolving regulatory landscape and we engage clients regularly on the implications for them,” says Takis Spiropoulos. “We are ensuring we are appropriately resourced to deliver the right client solutions in different regulatory regimes, and customizing our systems to meet client needs. A recent example is the introduction of margin rules for non-cleared derivatives, that vary by jurisdiction,” he continues. “This had implications for which clients could trade NDFs, options and FX swaps electronically, and our e-commerce systems had to be configured appropriately. We engaged pro-actively with our clients on CSA agreements and to receive appropriate out of scope self-disclosures. Also, we discussed with our real money clients topics such as the potential implications of collateral requirements on capital currently deployed for investments, or for rebalancing portfolios and hedging, and what that may mean to volumes and overall liquidity.”
Whether the steady creep in regulation will extend its inexorable grip on the FX market could now be a moot point, in light of the avowed intentions of the Trump administration. Canadian firms meanwhile are moving with the flow and look likely to develop their own compliance and assist their clients to comply in line with whatever regulatory demands come their way.
BEST-EX AND TCA
In this regard demand for best execution and transaction cost analysis is high up real money clients’ agendas and is therefore reflected in new offerings across the market place.
“As both an agency FX and Equity broker TCA tools are something we support in order to provide accountability and transparency across asset classes,” says Velocity’s Simon Grayson. “Late last year we partnered with the TMX to become a data provider to their analytics tool. TMX Analytics is a product that synthesizes vast quantities of trade-by-trade data to provide analysis that enhances transparency in the FX and Equity markets.”
Geoff Jones at RBC Capital Markets reiterates his firm’s commitment. “Trading analytics are an important part of the algorithmic trade cycle but more important is helping clients understand the tools available to them before they start using them. We believe in educating all our clients in the use of these tools and research across a range of metrics show that these clients achieve better trading results as a consequence.”
At CIBC Takis Spiropoulos says, “While current demand for algorithmic execution in Canada is still relatively lower compared to other forms of trading, electronic or voice, as a “hybrid” execution model prevails. Any credible robust offering on algorithmic execution has to be accompanied by a level of transparency (trading venues, timing of orders and fills obtained), as well as analyses on relative market movements to assess the quality of the execution and market impact. Even though there isn’t a standardized TCA approach to FX, TCA and other pre- and post trade analytics can be used to support arguments for best execution. Appropriate analyses of executed trades over time help build a picture to better understand the appropriate balance between instant risk transfer pricing versus algo-execution.”
Ultimately however, Canada’s leading FX market players are not wedded to technology, e-execution TCA and so forth for the sake of embracing the latest e-fad. On the contrary they are highly focused. 360T’s Matt O’Hara provides a useful overview of the landscape from the vantage point of a global multi-bank platform. “When I think about the Canadian banks I see very well run, profitable institutions that are primarily focused on their own domestic market place and serving the Canadian businesses and branches of their Canadian clients, who might be all over the world. They run a tight ship, ensuring that their risk profile is within balance and that they are profitable. They are not trying to be the global mega-banks. They understand who they are and the place that they have in the market.”
This may explain the apparent relatively slow growth of electronic execution in Canada versus voice trading. But we should not read too much into the numbers. There is a considerable push to electronic trading going on in Canada that statistical radar does not adequately pick up and Canadian banks and their clients are among the most advanced in the world, even if they are not necessarily leading the charge.