TCA: Bridging the Gap Between Equities and FX

March 7, 2016 | By: Flex Advantage


Transaction cost analysis has been the Holy Grail of best execution in equities trading, but the evolution of TCA in foreign exchange trading must consider the OTC nature of currency markets.

While FX trading is becoming highly electronic, the OTC nature of FX trading creates difficulties since the market is fragmented across multiple ECNs and FX trading platforms. Participants also rely on their relationships with liquidity providers for obtaining the best price, which can vary across venues.  The common theme amongst all participants is to trade more effectively, reduce transactions costs and minimize market impact under a cohesive execution framework.

“Philosophically, the new generation of TCA is a misnomer,” said David Ullrich, SVP of Foreign Exchange at FlexTrade. The real-time FX-TCA product is now live and available to any firm that uses FlexTrade’s EMS.   At its heart, the new breed of TCA will help develop effective trading strategies while continually monitoring market conditions and the quality of the executions in real time.

By definition, TCA itself is an effective measurement of execution price relative to a mid-price, said Ullrich. But in the principal market of the FX world, this can be complex since there is no consolidated tape, and practices such as ‘last look’ allow market makers to delay or reject trades after the customer has agreed to the quoted price. As most current TCA is historical in that its reports and analysis are delivered at the end of the day, traditional TCA is subpar because it’s not able to accurately capture information about the market at the time of the trades, said Ullrich. FlexTCA gains its value from trading through an EMS, which captures all the current trade and market data, and allows for real-time evaluation of the currency process.

With the buy-side trading currencies through FlexTrade’s EMS, the firm is expanding and redefining its existing product, FlexTCA, to become more of a ‘trade evaluation process’ or TEP, that looks at the quality of the execution as one component of a broader currency framework.

More importantly, TCA is evolving from measuring the execution quality at the point of contact to looking at the overall execution process, explains Ullrich.

The enhanced system will encompass the three components of best execution and help establish an effective currency process:

  1. Post-trade, which is the quality of any execution.
  2. Trade – Examining the factors that influence the style and performance of any execution, relative to operational constraints and internally derived benchmarks.
  3. Pre-trade, which are the factors that go into making the currency decision.

“TCA really speaks to the best execution process. It’s evolving beyond the scope of evaluating any trade at the point of contact — that is the quality of the execution from the liquidity provider — and it’s expanding into the realm of how an asset manager looks at its currency process on behalf of its underlying clients.”

FlexTCA will allow for continually evolving feedback mechanisms along the entire trade cycle.

At some point, the buy-side will want to examine how their internal currency traders are managing the process. FlexTCA allows a portfolio manager to look at whether their currency traders are taking on too much risk relative to internally derived benchmarks. “Additionally, if the underlying funds aren’t FX risk seeking, then the ideal is to achieve their relative benchmark,” said Ullrich. There are a number of benchmarks out there including ones based on the midpoint of the price at the time of execution, momentum implications after the trade, arrival price of the order in the EMS, as well as OMS and pre-OMS derived benchmarks. (FlexTrade is developing customizable benchmarks with asset managers based on their underlying currency rationale.)

Best Execution in FX versus Equities

Measuring best execution in FX is different from equities. In the equities world, a broker is not allowed to add spread to an execution, said Ullrich. Given that FX is a principal market, there is no true agency format and each trade is a relationship issue.

“As FX is still an OTC marketplace, you need to evaluate the quality of the execution and this is achieved by trading through an EMS, creating time stamps and gathering information on the market conditions,” said Ullrich.

The problem is that prior to 2010, it was difficult to match time stamps and price stamps and capture price spreads effectively, especially for the buy-side, which didn’t have access to those analytics, according to Ullrich.

Buy-side traders were not able to gauge enough information about the market at the time of their trades, explains Ullrich.  What’s changed? First, the buy-side is exerting more control over their FX execution more than previously, and secondly, the EMS is gathering a wealth of information, which is giving rise to new metrics to help manage that process.

As an example, the system shows a complete summary of the parent orders with a complete breakdown of individual orders with trade dates and time stamps, counterparties, type of trade (i.e., a spot, forward or swap) and notional amount.  In addition, traders can also look at trades by methodology, whether it was by phone, by request for stream (RFS) or request for quote (RFQ), and what impact this had on TCA. “It’s the aggregation of data through the trade process that is being employed into the newer TCA systems,” said Ullrich.

Traders can easily customize the system by adding and deleting columns of data and attributes that are pertinent to their FX execution rationale.

Best Execution in FX at the Fund Level

As an example, a fund manager responsible for best execution at the fund level could be executing trades for three different funds. The EMS provides a breakdown of any parent order into child orders with subsequent allocation details for each fund. The child orders need to be averaged, including spot rates and forward points, and rolled up to the parent order, notes Ullrich. Details of each unique transaction slice will roll up into an overall TCA cost so that FlexTCA tools will be applicable to any subset of allocation details, he emphasizes.

Evaluating Counterparties

One area of buy-side interest is evaluating counterparties to build the quality of execution from a sell-side perspective. A buy-side firm could assess the types of trades executed with broker A versus broker B. “We can look at summaries by currency pair, counterparty, latency, drop rates and transaction size in real time, for example. This is only available from an EMS,” said Ullrich.  Even further, FlexTCA can examine execution price smiles created when a liquidity provider shows the best initial price for a given amount, but underperforms its peers on subsequent slices.

Perhaps a fund manager might want to look at which liquidity providers are good at executing Canadian dollars with a given volatility and a given trade size. “We’re going to be able to look at their information and help the traders understand who their best liquidity providers are in certain currencies, volatility levels and at certain times of the day,” said Ullrich.

There is also seasonality in currency trading in that FX liquidity varies according to time of day, day of the week, and day of the month or month of the year.  Participants need to make sure they know about all of these factors effecting currency trades before they formulate their own process, he said.

Internally-Derived Benchmarks in TCA

Eventually buy-side firms are going to want to use TCA to identify if their currency process is adding uncompensated risk. Take an asset manager that has an EAFE mandate, who purchases Japanese equities during Asia-Pacific’s morning and then funds the currency execution at 11 am New York time.  “So you’ve got 12 hours of currency movement that you are just leaving out there,” said Ullrich, creating the uncompensated risk. “It does point to the fact that risks are out there and asset managers take them on implicitly, but are not always paid nor wish to do that,” said Ullrich.

Similarly, if a firm is buying European stocks in the morning, that’s when their currency exposure is created, says Ullrich. In December of 2014, the Swiss National Bank pulled back from supporting the Swiss franc against the euro. Those who bought Swiss equities in the morning, but waited to fund the equities purchase by buying Swiss Francs and selling dollars in the WMR Fix, paid over 20% more given the currency move that morning.

This volatility also underscored the interplay of the FX execution and the underlying equity trades and the currency movements themselves. Through the integration of FlexTrade’s EMS with FlexTCA, traders can analyze the interplay of the equity executions with the currency volatilities, FX liquidity times, which vary during the day, and execution strategies.

Traders could also add a column measuring momentum after five seconds, 30 seconds, five minutes, 30 minutes or at customizable intervals, to identify their currency trading impact and potential information leakages.  “We’re going to help buy-side traders establish a better way to access the markets if your trades are seeing higher momentum shifts in the markets,” added Ullrich.  One of the new concerns for asset managers trading electronically will be spotting patterns in their executions. “Information leakage is going to be a new buzzword going forward,” predicted Ullrich. Additionally, FlexTCA will examine if the impact is liquidity provider-based, or potentially if the trade is incorrectly sized for the market conditions.

In fact, FlexTCA is aimed at both the buy-side and sell-side to focus on problems that confront the both of them. “This is not intended to disintermediate the sell-side,” said Ullrich.  As a broker-neutral provider, FlexTrade’s intent is to provide the tools equally to both sides of the equation so they can benefit from deeper, more meaningful relationships, he said.

Since FlexTrade’s EMS provides direct connectivity from the client to each liquidity provider, sell-side firms could utilize FlexTCA to better understand how their clients are using their electronic trading venues. The sell-side could see which electronic protocols their clients prefer and for which currency pairs they are not attracting flow. For instance, suppose that an institutional customer   requests streams in Hungarian Forint (HUF), but the bank isn’t winning any trades. If the bank is interested in that currency pair, it could improve its spreads.

Algorithmic Trading

The system also enables traders to analyze algorithms. While the typical algorithmic trade today is VWAP or TWAP, ongoing information on market volatility and market spreads captured by the EMS creates the potential for conditional types of algorithmic orders akin to equity market algorithms. “You’re going to see more hybrid and conditional algorithmic orders opening up the dynamics of how you access the FX market in a more informed way,” said Ullrich.

With the wealth of data employed by FlexTCA, FX trading will be transformed into an evaluative process that gives buy-side traders insight into factors such as latency, reject rates, and counterparties. The end result is that traders will look beyond the quality of a single execution and instead use these TCA tools to improve their access to liquidity as well as their entire FX trading process.

How FlexTrade Can Help

For a complete review of your firm’s TCA requirements for FX and a demonstration of FlexTCA, please contact us at

Other TCA-related posts:

A Hard Look at Last Look in Foreign Exchange

Best Execution FX: A Shifting Landscape

FX Liquidity and Technology — An Ecosystem in Flux

Advanced Trading Analytics: A Look at TradeMap Execution Strategy Designer