BBH: Spotlight on FX: a new era of choice and transparency

BBH: Spotlight on FX: a new era of choice and transparency

Jeffrey Scott is a managing director and global head of client strategy for Brown Brothers Harriman Foreign Exchange. Jeff’s primary responsibilities include managing the relationship management, sales and product development disciplines globally. He has 25 years of industry experience, joining BBH in 1991 as a foreign exchange trader. A year after joining BBH, Jeff launched the firm’s Fx sales desk to focus on servicing global investor clients. Since then, he has managed BBH’s foreign exchange products and electronic trading, and has been responsible for currency strategy and product development. Jeff has a BA in economics from Rutgers university, and an MBA from the Columbia Business School.

What major trends are affecting investment managers when it comes to management of FX?
First and foremost, the level of focus investment managers are putting on FX is far greater than ever before. Whether they execute FX actively or through more of an outsourced or low-touch model – it does not matter. They are talking about it and spending more time understanding it, and this was not always the case several years ago.

In the past, many viewed FX as an operational necessity or burden, so there were fewer questions and less rigour around how to measure competitive execution or the process being used to ensure competitive rates. This has absolutely changed because the reality is that FX is not just an operational necessity, it is often an important part of an investment strategy.

Investment managers have what BBH would refer to as a continuum of FX needs depending on their investment strategy, and they need a continuum of products that meet those needs. Basically they need choice, and as they have increased focus on FX, their requirements have evolved – the range of products available five years ago is just no longer sufficient.

Clients want integrated, end-to-end solutions that cover a variety of trading requirements, not just a solution to address one piece of the trade lifecycle.

Lastly, more investment managers are looking to achieve “effective” execution, but we are also seeing some begin to look beyond execution at the other factors that impact FX performance. Their implementation parameters, the level of operational efficiency, and of course further downstream the reporting matters too. Evaluating executions requires transparent reporting and there are now more options in the industry that help provide this.

How are you responding to the shift in what clients need from FX providers?
I would say that we are not just responding, we have been proactive in identifying the varied execution needs of our clients – I am comfortable saying that BBH embraced choice and transparency before the industry demanded it, and I think this is because of the way we have approached our client relationships.

We found that an effective approach starts by working with individual clients to understand what they want to achieve. Each global investor has a different set of priorities and needs, and I think it is our job as their provider to spend time understanding what those are.

As an example, seven years ago we built a product called InfoFX to give clients the choice to execute FX away from their custodian while providing cost efficiencies. And then we embraced transparency as the backbone of that product, giving clients a view into their execution quality.

What does transparency really mean for FX?
Transparency in FX is generally used when discussing execution rates, but it should really be discussed in the context of the entire FX process. There has been a marked increase in the range of execution routes for FX, and this has meant a change to process as well.

In response to the execution piece, there has been an emergence of transaction cost analysis (TCA) firms devoted to measuring the quality of execution, but this industry is still evolving.

I would guess that in a couple of years it might look very different. We are still a long way away from a ticker that provides precise information about a volume-weighted price. But, as the amount of data increases, becomes cleaner and – with the help of the TCA firms – easier to measure, clients are able to get closer to being able to compare the execution rate with the market.

From a process standpoint, I think this is really a new concept, but in our view it is about providing clients a view into what is involved and how we are going about it.

The results of Global Investor/ISF’s FX survey showed that less than half of respondents use benchmark pricing or pre-negotiated spreads for their execution. Does this square with what you are seeing?

These figures marry with our experience: we do not have many investment managers who want to do all of their foreign exchange based on a benchmark rate, and we find it is because the level of transparency has improved and has allowed the focus to shift towards not only rate but also measuring execution quality. This comes with the ability to evaluate rates more effectively.

Speaking for BBH, we focus on ensuring clients get high quality data, where possible in real time, which they can then evaluate in-house or with a TCA firm.

Going back to InfoFX, when we execute trades for a client, we provide them with a time stamp as appropriate, and the functionality to compare execution rates and determine implied costs. Though a time stamp is best, if investment managers cannot get one, they can use tools like midpoint analysis. With these options, clients have the confidence to execute at market rates and can still validate executions.

Getting back to choice – what does this mean in practice?
In its simplest form, choice in FX can sometimes just mean investment managers not being captive. Clients want options, for example the ability to send some flow directly to a custodian, some to another provider, and use an ECN alongside it.

Using BBH as an example, we aim for our products to be open architecture – our clients can elect to use one or several of our products, they can decide the size of trade to do with us, and they can turn certain programmes on or off whenever they want. They can trade with us as custodian or trade away.

Clients also want choice in execution, for example to execute at market, at WM, or even through a multi-bank or agency offering. BBH has recently started offering multi-bank execution for certain products, which solves for specific requirements and allows clients to use our expertise to diversify access to market liquidity.

On the surface, it might sound risky to encourage customers to use alternative execution routes but no client wants to be captive, and if you are confident in your rates and the quality of your products, it works for you. It is the ultimate stamp of approval when someone deals with you when they have the option to go elsewhere – it provides the market validation of what you are doing.

The question of standing instructions was obviously the subject of much discussion several years ago. Do you think the industry has evolved to where it should be?

There are three levels to this question. At an industry level, I think we all benefit from the fact that people are talking more about FX. At the next level, for investment advisors, the concerns around standing instructions caused them to evaluate their process and in turn, demand more from their providers. Finally, from the point of view of providers the question became: What opportunities do we have to improve what we are offering?

As a custodian, this gave us an opportunity to go back and validate our standing instructions programme and our capabilities in providing transparency. I cannot speak for other providers, but from a BBH perspective we are happy with where we are, but we are also committed to continually evaluating our programme for improvement as our clients’ FX needs continue to evolve.

What regulations have the most impact on the FX industry and how are participants responding to change here?
Although EMIR is on the horizon, the major challenge at this stage continues to be adopting the rules contained in Dodd-Frank regulations. A lot of the rule changes have an impact on FX but there are a number of issues that have not yet been resolved. Participants still have a lot of questions and staying on top of updates is a real challenge.

A speaker at a recent conference I attended summarized the situation well by saying that, with so many rules to be determined, the one thing everyone can agree on is that there is still a great deal of ambiguity for our industry.