Buy side looks to cloud-computing for price transparency

Interest in cloud-based trading technology from buy-side institutions is on the rise as a means to improve price transparency, in the wake of lawsuits brought against US custodian banks over the mispricing of foreign exchange trades, according to market participants.

Speaking on a panel discussion hosted by sister publication FX Week on the subject of cloud-computing in foreign exchange, panellists said the technology, which employs a shared resource model, acts to improve transparency by lowering the barriers to entry.

"The extension of [cloud-computing] is the creation of communities within the cloud, which are communicating and interacting with one another," said Harpal Sandhu, chief executive at cloud-based FX technology vendor Integral in Mountain View, California. "By having a platform available, people can run their own businesses from the various perspectives of
FX markets that exist. And from all perspectives, the barriers to entry have
dramatically decreased."

Sandhu explained that market-makers, for example, no longer have the cost of distribution to clients, who are already present in the cloud. "Customers are no longer dependent on a limited number of relationships - they can actually see the entire market. With the introduction of prime brokers and futures brokers acting as prime brokers, they even remove the credit barrier to accessing liquidity in whatever type of trading model they have," he said.

Joseph Conlan, global head of FX sales at New York-based brokerage FCStone agreed, noting that since joining Integral's FX Cloud in 2010, he has been able to add liquidity providers more easily while diversifying the
mix of providers to non-banks.

"The Cloud [also] enables clients that might have outgrown retail brokers but are perhaps still too small for major prime brokers [to gain better liquidity]. Sometimes they might have been using a major bank but had a drawdown, so had to move their account to a secondary prime like us,"
he added.

There is concern, however, that the establishment of multiple pools of liquidity further fragments the market. Integral's FX Cloud for example has some 200 exchanges. However Sandhu argued that the exchanges
are bespoke, which customers have set up for themselves. "They always existed but are just now elecrtonified and are building up more scalable businesses," he said.

"Fragmentation implies fragmented and separated,whereas we look at it as being distributed. So instead of the liquidity being highly concentrated with a limited number of participants, because of this technology, hundreds of new customers are coming in and building their own liquidity and offering it up to their own customers. But they are highly interconnected as a community,  and that interconnectedness works to overcome people's perception of fragmentation."

He added that Integral is due to release research that shows execution quality is better on a distributed but highly interconnected basis, than when concentrated with a few venues. Similarly, risks of a liquidity mirage are also limited, said Sandhu, as the vendor monitors and can at the request of sponsors of an exchange, systematically eliminate double representations of liquidity.

Sandhu said ultimately validating the quality of execution the buy side is getting is driving interest. "Pension funds and asset manager interest has moved significantly forward with the actions of US custodian banks," he said.

Sandhu cites charges brought by the California attorney general's office in
October 2009 against State Street Corpora Corporation accusing the custodian of overcharging the state's two largest pension funds Calpers
and Calstrs, by $56.6 million on FX trades. "It educated the community. Their investors, their stake holders are asking tough questions, saying ‘we assumed you got best execution' and little did they know that in the OTCmarket, it's whatever execution the counterparty can get away with. So
transparency has to come, transaction cost analysis has to come," he said.

Javier Paz, senior analyst, at Boston-based consultancy Aite Group agreed,
adding however that development is hampered by the absence of a reference point for a price at a single moment, as seen in the equities markets. "But we are seeing much more discussion from vendors and
users to establish a liquidity benchmark to measure the quality of the execution."

To hear the full discussion please click here