Asset managers must adapt their operating models to account for evolving needs including increased operational complexity, T+1 settlement cycles, greater engagement with emerging markets, fund structures such as exchange traded funds (ETFs) and separately managed accounts (SMAs), and management of expanding distribution channels.

As they seek to tackle these dynamics with finite resources, managers should look to reassess how foreign exchange (FX) activity is managed and determine opportunities to leverage a specialized FX provider.

While managers have historically been hesitant to outsource FX operations, technological advances now allow them to retain as much control as desired – especially with regard to operational FX – while focusing on their main areas of expertise.

By differentiating between two distinct types of FX activity – strategic FX and operational FX – and addressing them individually, asset managers can optimize their FX programs. This means they can deliver enhanced execution quality while maximizing operating efficiency, mitigating uncompensated risk, and gaining data-driven transparency.

While neither example typically adds to performance, if handled poorly, both can erode the alpha generated by a fund manager. A lack of focus on this type of FX activity has historically led to operational and executional inefficiencies which can hurt fund performance and prompt inconsistencies.

Firms handling operational FX in-house are challenged with the costs and risks of managing the entire FX lifecycle.

Managers using automated custody-FX programs may be concerned with a lack of true rate transparency masking excessive FX costs and/or inefficient and inconsistent execution across funds and investors. As a result, operational FX draws increased scrutiny from institutional clients, fund boards, and even regulators.

Where to focus

Pre-Trade Activities:

While reviewing their approach to operational FX, many managers focus solely on the execution stage, neglecting important pre-and post-trade activities.

Accurate pre-trade calculation is critical to meet the fundamental requirements of trade settlement FX and fund-associated security activity. Defining pre-trade parameters to meet each fund’s specific needs drives a manager’s ability to make decisions on netting opportunities, which can stimulate compelling efficiency gains and minimize transactions costs in a well-calibrated FX program.

Execution:

When executing, managers need to consider the ‘when?’ and ‘how?’. The ‘when?’ is about balancing access to liquidity and maximizing netting opportunities while minimizing time to market (i.e., latency). The ‘how?’ is about understanding appropriate trade execution methods and benchmarks. Execution considerations include whether to use single or multi-bank platforms, sophisticated aggregators, or electronic communication networks –creating further complexity for asset managers.

Managers who use in-house trading desks to handle their operational FX flows increasingly evaluate the lifecycle of their FX executions, including if the risk and resource requirements of strategic FX are equally appropriate for operational FX. Concerns over inconsistent treatment and uncompensated risk for investors have prompted many managers to move toward a more automated, rules-based approach for this non-core activity.

Post-Trade Transparency and Control:

In the post-trade environment, timely and accurate settlement for third-party trading is paramount. Clear and informative post-trade reporting is necessary to demonstrate to all stakeholders the effectiveness of the execution process. All parties involved in a trade need access to real-time, transparent oversight to:

• Easily track mandates over time
• Evaluate historical order and execution data alongside market spread data
• Review trading costs at the time of execution
• Provide full transparency for cash management

Accurate and timely post-trade reporting supports reconciliation and FX Transaction Cost Analysis (TCA). Delivering best execution is a competitive necessity for asset managers in today’s markets. TCA allows managers to assess both the implicit and explicit costs associated with trading while providing an analytical framework to measure execution quality against benchmarks.

By leveraging TCA, managers can minimize trading expenses and enhance execution performance, ensuring trades are executed at the most favorable terms available and unlocking greater value from every trade.

To implement changes based on the insights gained, managers should ensure they have extensive, real-time control of the trading process, including the ability to:

• Deviate from trading parameters
• Amend pending trades
• Assess FX exposure
• Evaluate execution rates in real-time