Anonymity v transparency in the best execution debate

By Peter Atkinson, FX product manager at smartTrade Technologies The foreign exchange (FX) spot market these days appears to be divided in pursuing a common but sometimes nebulous cause – namely, best execution proof and prices. One side says that the buy-side needs complete anonymity in order to maximise quality. The other side says best …

August 17, 2012 | smartTrade Technologies

By Peter Atkinson, FX product manager at smartTrade Technologies

The foreign exchange (FX) spot market these days appears to be divided in pursuing a common but sometimes nebulous cause – namely, best execution proof and prices. One side says that the buy-side needs complete anonymity in order to maximise quality. The other side says best execution is only possible through the liquidity arising from full participation. This anonymity versus transparency argument is a major theme at present. I believe, however, that there is still room for the personal touch on the financial markets.

The anonymity assumption comes in large part from the equities markets where it has proven very valuable in dark pools of liquidity. But in the FX markets, as in most over-the-counter (OTC) traded instruments, anonymity is not always the best way to get the best prices. Relationships have always been crucial in trading FX, as they are in many things and this hasn’t necessarily changed.

For example, my local independent green grocer always greets me personally and keeps filling my shopping bags with free vegetables. Yesterday it was two large organic portabello mushrooms, and the week before it was a handful of vine ripened tomatoes. As a result I now do all my vegetable shopping with him in preference to the anonymous local supermarket. The relationship strategy works well for my green grocer, and it could on the financial markets too.

Of course FX market making is not vegetable shopping, but it is highly reliant upon the relationship between the dealer and the customer. An FX price is based on the risk and the credit associated with each customer; the customer’s trading style, and his creditworthiness. So if buy-side customers really want price improvement, their relationships with the dealing banks are crucial.

Single dealer platforms can often deliver better price improvement to clients than other trading venues such as ECNs or MTFs/OFTs if you’re in Europe, if the customers are open with them. Not all customers will have the time or the inclination of course – and you cannot deal with an automated algorithmic trading solution – but liquidity providers still need to control risk. If they’re worried that a particular customer will sweep the bottom of the book and wipe out their profitability for the day, they’re less likely to offer that customer prices that increase their risk. If customers work with them to establish and follow some rules of engagement, the dealers will often be able to provide improved pricing.

Transparency can build trust and improve results for both sides by encouraging:

1. Understanding the rules of execution.

2. Understanding the customer’s objectives.

3. Understanding how both sides control risk.

In other words, if the dealers and customers understand each other the buying (or selling) experience becomes more personal. And the dealer can ‘sweeten’ the transaction with the equivalent of a few extra tomatoes in the customer's vegetable shopping bag. In this day and age of anonymous high frequency trading venues, algos, and impersonal-out-of-town supermarkets, it is can still be wise in my opinion and potentially profitable to cultivate direct relationships.

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