The evolution of spot foreign-exchange trading to an agency model and electronic trading is accelerating as a result of MiFID II — even though the regulatory regime's transparency and disclosure rules don't apply.
Sources said money managers preparing for unbundling of research and execution costs and increased disclosure in securities trading under the new regulations are asking the question: If we need transparency in equity and fixed-income trading, why not in FX? (The Markets in Financial Instruments Directive II goes into effect Jan. 3.)
And that push for disclosure is dovetailing with requirements implemented in the FX Code of Conduct in May for more transparency in execution quality among market participants. It also coincides with an overall industry-driven increase in use of the agency model, which uses algorithms to find liquidity and price discovery from multiple venues, as opposed to the traditional single-platform process that had been used by banks.
The growth of agency FX services, from both banks and non-bank third-party providers, "has dovetailed in the last six months, with managers feeling under the gun with regulations and FX remaining this opaque area," said Alex Dunegan, CEO and founder of money manager Lumint Currency Management, Boston. "If I'm a money manager and agency brokers can solve this transparency problem, I'd move in that direction ... There's an ever-growing focus on accounting for cost. With more regulations and more business applying technology to this, agency FX is growing."
Added Oliver Jerome, co-founder and director of BestX, a London-based FX analytics provider, MiFID II "absolutely" has had a direct impact on spot FX trading. "With the disclosures that are required with equity and fixed-income trades, investors want that disclosure in FX as well," Mr. Jerome said. "And although spot FX isn't specifically under MiFID II, associated spot deals involving a regulated securities transaction are under MIFID II. That's driving more electronic FX trading to provide the analytics required under MiFID II."
Mr. Jerome said the only way to get that data on spot FX trading — an exchange of currencies between counterparties executed at a specific time — is through electronic trading. "The overall demand for data is a key piece," he said. "That demand will force people to increasingly use electronic trading. We're seeing that already with managers converting more FX to electronic execution."
Radi Khasawneh, senior analyst for fixed income at TABB Group LLC, London, said, "There's a clear lesson from what MiFID II is presenting. With its implications as well as the code of conduct, FX is going more toward the agency model with the eventual move to as full automated trading as possible."