Total Transparency

Not everything that can be counted counts, and not everything that counts can be counted.
Albert Einstein

The demand for transparency within the execution process has increased significantly over recent years within the FX market. Indeed, BestX was founded to try to help meet this demand and we have adopted this theme within everything we do. We set out to build a market-leading set of analytics and ensure that all of our clients have total transparency around the workings of these models. Such analytics can only add real value if they are powered with the highest quality market data. Transparency around the market data inputs used is therefore also critical and we have invested significantly in order to build a comprehensive view of the FX market. This article explores some of the thinking behind our approach and why we believe it is important to generate the most broad, independent and representative view of the market.

In an OTC market such as FX one of the biggest challenges when trying to compute accurate execution metrics is gathering a data set which fulfils the following criteria:

-          representative
-          clean
-          independent
-          normalised
-          timely

Below are some of the common themes and challenges in building such a data set.

·       Breadth and independence of data

One of the most common topics when discussing market data and benchmarking is the breadth of sources used and the independence of such sources. Independence and the complete absence of any bias is critical in delivering a market standard for FX best execution metrics. Computing a mid based on such a broad array of liquidity providers globally is far more valuable than generating a potentially skewed mid based on a specific sector of the market. For example, if a mid were computed based on liquidity sources biased towards to non-bank high frequency traders, this would clearly be inappropriate for use in estimating costs for large institutional asset managers. BestX takes market data from over 100 liquidity providers, supplied to BestX through a number of pipes, one of which is the Thomson Reuters pipe in addition to ICE and EBS. Thomson Reuters is not the only source, and even if it was, it is not a single price as data from all of the individual liquidity providers is accessed.

·       Generating benchmarks based on client specific liquidity providers

This is an interesting point and one which we debate frequently. Aside from the fact that regulations such as PRIPPS stipulate gathering data from as representative set of sources as possible, we believe that for the institutional market it is important to portray a view of the total market. To simply compute costs based on a client’s specific liquidity sources is self-reinforcing and could be argued is not satisfying best execution as perhaps there are other sources out there that a client could access but currently doesn’t? In addition, there is a growing demand for one level playing field to compute costs across, that could be used to meet demands for, for example, peer analysis. If the market data set is tailored for each client in this universe then we would always be comparing apples and oranges.

At BestX, we do also provide the ability for clients to submit their quote data, which we will use as additional benchmarks if so desired, as some best execution policies require this. However, we provide these metrics in addition to the spread to mid costs based on the full market-wide data set.

·       Internal pools

We would argue that, even if it were available, would data from liquidity provider’s internal pools add any value when trying to assess price discovery and generating a market mid? The price forming data and flow is available via the lit electronic marketplace, where liquidity providers risk manage the ‘exhaust’ of their inventory. The activity of internal pools is interesting, although would not add value in determining the market mid at any one point in time, e.g. having offsetting trades match and internalise wouldn’t necessarily change where the external market is trading.

There is clearly significant value within the overall best execution outcome through internalisation, and we measure this via other factors to demonstrate this value (e.g. through post-trade market revaluation and impact metrics).

·       Timeliness of data

There is a lot of focus on market data sources and independence, and rightly so. In addition, however, there is also a requirement to ensure that data is timely, especially in the FX market. Using stale data, for example, snapped at 1 or 5 min intervals or worse, can obviously potentially generate erroneous cost and slippage metrics. It is imperative to be gathering data on a millisecond frequency and in real-time to allow for immediate transaction analysis if required.

·       The FX Tape and other potential sources

The recent announcement of the launch of a tape for the FX market is an interesting development. Clearly, this is an initial step and there are many questions still around exactly what will be available, at what cost and with what lag. It may be that it could provide BestX, and all other providers, with an additional ‘official’ source of traded price data, although for it to be truly representative it will require all of the large liquidity providers to participate fully. This would, obviously, be extremely valuable and could be used in addition to the broad market data set we already consume and aggregate.

Equally we will be following the evolution of what trade data becomes available via the APAs once MiFID II goes live. It is unclear at this stage exactly what will be available and how timely the data will be, but it could provide an additional source. The trade data that became available following Dodd-Frank disappointed to some extent as it wasn’t rich enough to use for rigorous analytical purposes, so we are reserving judgement on the potential data riches that may flourish from MiFID II until we can actually see it.

·       Credit

We don’t generate pools of liquidity adjusted for different credit quality or capacity. The philosophy is to generate a representative picture of the institutional market that can be broadly applied to compare and contrast performance and cost metrics.  Additional benchmarks can be customised on a bespoke basis to service specific liquidity pools if required.

OTC markets make the provision of representative, accurate TCA metrics difficult. FX doesn’t have a National Best Bid and Offer (NBBO), there isn’t a source of public prints and there is little consistency across the industry in terms of what data is made available. The current situation may obviously change over the next few years, for example, via the FX tape or a shift to an exchange based market structure, but it seems unlikely to happen in the medium term. We have taken the pragmatic, and rigorous, approach to gathering as much high quality data that we can and use it in a thoughtful way across a suite of analytics. One of the core tenets of BestX is the delivery of an analytics product that is totally free from any conflict or bias. Independence and total transparency is therefore critical, both in terms of the analytics and input market data.