Panel 1: FX in focus: Risk, efficiency, and liquidity

From regulatory and technological strains to moving payment flows towards instant, the Foreign Exchange (FX) market is evolving quickly and, as a result, facing new challenges.

State Street’s Chris Pizzotti, global head of FX Voice Trading, and a panel of industry experts recently gathered at Sibos 2023 in Toronto for a moderated discussion around the central issues facing the FX market. Below are key highlights of the panel, which included Marc Bayle de Jess, chief executive officer of CLS, and Gemma Laman, managing director of Institutional Sales and Market Securities Services at HSBC.
 

AI and technology
Technology has undoubtedly made FX trading easier, faster and more efficient, helping increase transaction speeds, reducing trading costs and improving transparency. But, as panelists noted, it has also highlighted the need to adopt newer, better technologies, like artificial intelligence (AI) that can help with risk mitigation and operational efficiencies.

“The markets have been supercharged from an electronic perspective, and people have more data in their hands than they've ever had before,” said Pizzotti. “The big question is: How are you going to use that data and how are you going to optimize liquidity? The ones that can do that correctly will minimize transaction cost, improve execution and efficiency, and will be able to minimize their footprint in the markets.”

Given AI’s ability to quickly process vast amounts of data, spot patterns and even forecast trends, the technology is useful at helping identify trading opportunities. And it is also providing clients and banks real-time feedback on their interactions. But, panelists also see its potential for helping them optimize capital and deploy it more effectively. For example, it would allow them to easily see client trade activity and all their relevant research, thus allowing traders to use that information to make faster, more informed decisions about who to distribute that capital to.

Risk mitigation is another area where AI can help the FX market. The Russia-Ukraine conflict and Credit Suisse collapse, for example, underscored the need for quick, easily accessible data and thorough analysis to help traders identify risks and allow them to get out of those risks quicker.

“Getting data from over here, finding data over there and putting that information out can take time. And in that time you are waiting, the markets have moved very quickly,” said Laman.

However, panelists cautioned against an overdependence on the technology, stressing the importance of continuously monitoring and assessing the quality of the information banks and traders put into AI tools.

“It’s accelerating decisions which have an impact on your clients. The function that we put around the quality check for this is critical. So, it can be two-fold. Going too fast, maybe without checking, can be adverse as well,” Bayle de Jess said.
 

T+1 settlement
While a shortened settlement cycle can help reduce the risk of default as transactions are completed quicker, the panelists said the new T+1 requirements – which state that, effective May 28, 2024, trade-related settlements must be completed within one business day after a transaction – are putting pressure on institutions to overhaul operational processes and redesign workflows to ensure they are ready to meet them.

“We are in a world where, depending on the country, the cutoff – which is 6 p.m. in the US – it's already quite late in Europe and even much later in APAC. So, there are cutoff deadlines that have to be respected for a smooth settlement process,” said Bayle de Jess.

The shortened settlement timeframe could create a “rush hour” of liquidity toward the end of the trading day in the US. As a result, some institutions are considering adding trading desks in the US to ensure nothing crucial slips through the cracks when it comes to proper execution and safe settlement.

“It’s kind of forcing the FX market to align with the equity markets in terms of liquidity, leading up to close of business in the US. Where now that's probably one of the most expensive and worst times of day to execute FX,” Laman said.

Certain players, though, could potentially stand out amid the T+1 transition. According to Pizzotti, clients are spending a significant amount of time trying to sort through the impact of compressed settlement times, and that may allow institutions to really focus on their core strengths and invest accordingly.

Liquidity
Worries about the availability of liquidity have loomed over the FX market over the last three years. Volatility from events like the pandemic, the Russia–Ukraine war and global interest rate hikes rattled markets and led to periods of lowered liquidity. And, according to the panel, liquidity remains top of mind among traders who are learning to adopt to the uncertainty.

The rise of non-banking providers in markets is also challenging the sector. These firms leverage technology for high frequency trading to gain a competitive advantage over traditional FX traders, and potentially taking on excessive risks.

“We're also getting non-banking credit providers entering and becoming a bigger share of the market and providing more liquidity and distributing prices in unique ways that we probably haven't seen before,” said Pizzotti.

With some 7.5 million trades a day, the FX market is one of the most active and volatile markets. It is a market that has been transformed greatly by technology and the geopolitical events of the last three years, and it is expected to keep evolving. While regulatory strains (like T+1) are driving some of the evolution, so is the emergence of new technologies, which have put pressure on the FX community to accelerate innovation.

 Panel 2: The evolution of traditional and digital custody in an integrated marketplace

As digital assets become more prevalent, custodians must ensure they have the right processes in place to support clients and offer them safe and reliable solutions, according to a panel of State Street experts at Sibos 2023.

State Street’s head of Custody, Cash and Depositary Bank Services Chris Rowland and Digital Lead for State Street, John Sweeney, sat down for a moderated discussion about the changing and evolving landscape of custody. They also addressed the challenges custodians are facing in the new environment. They were joined by Mike Heffner, Solutions and Industry lead at Appian, a State Street partner. Below are key highlights of the conversation.
 

Technology
Asset custody has evolved significantly over the past two-to-three decades, but most custodians are still battling with legacy technology. And that is leaving many of them behind, unable to meet client expectations, said the panelists.

“We still use faxes in this industry, unfortunately, and have plenty of queries coming in from clients by telephone calls or emails. If we don't start to adopt to digitization and actually improve the user driven experience, then not only do we fall behind expectations, but we don't drive efficiency through the industry,” said Rowland.

Oftentimes, he added, custodians are focusing on adapting legacy systems, “which are reasonably old but are being pushed over time to become more real-time,” to help meet modern world expectations and the requirements imposed by regulators.

According to Heffner, preparing for the future of investing does not have to be an all-or-nothing choice. Striking the right balance is important.

“It’s important to think about how you build and construct an operating model that allows you the flexibility to build toward the future, but in the interim still deal with legacy,” he said.
 

Standardization of data
Another area where legacy technology is constraining custodians is data standardization. Internal legacy systems and a lack of global standards around data collection and management is of concern, said the panel.

“It fundamentally is how we ultimately can move from where we are today into a more digital role,” said Rowland. “If we don't really advance standards around that, then you can’t start to do some of the more exciting things.”

Standardized data is key to generating efficiency in internal processes and it would “ultimately better the broader marketplace and ecosystem,” he added. Though a scarcity of resources and dollars may be what is impeding that change, according to Rowland, the benefits would be immense.

“There would be so much more information, analytics, and less risk, actually, through better data adoption. So that’s why it’s so important to get it right,” said Rowland. “It weighs heavy on people's minds as to whether you can afford to get that done. That’s probably one of the biggest challenges that that we're wrestling with at the moment.”
 

Digital vs. traditional assets
As digital assets such as cryptocurrencies and tokenized securities quickly gain favor over traditional assets such as stocks and bonds, bridging the gap between the two worlds, or potentially combining them, is crucial.

“We're going be living in what at State Street we characterize as a ‘hybrid world’,” said Sweeney. “For example, I'm probably not going to tokenize or digitize a bond with two years left on it. It's costly to actually move it from a traditional platform to a digital platform, and the value that I can extract out of tokenization of a terrestrial bond isn't enough in a short duration bond.”

Traditional assets are not going away anytime soon, though, he said. Instead, in a “hybrid world,” digital forms of traditional assets will be created and exist side by side with original digital assets. As a result, he said, it behooves custodians to figure out how to manage the complexity between the two worlds in one format.
 

Blockchain
The digitization of assets, according to the panelists, not only gives asset owners more independence over their transactions, but also improves transparency and risk-adjusted returns. In a blockchain environment, for example, parts of the ecosystem that normally would be human-based are built into the network and put into a digital format that can be readily moved around the globe, allowing for increased visibility of the process and quicker transfer and sharing of information.

“It’s an ecosystem in which we can all operate and is delivering transparency around the state of what is happening in process,” said Sweeney.

Much like how mortgage payments went from manual, paper transactions to electronic, automated debits, digital assets like blockchain are revolutionizing custody from the administration of assets to the transference of the value between counterparties across the ecosystem.

“You get immediate visibility into the underlying assets,” the Digital Lead for State Street noted, adding that: “We are building a custody system and administration system to be able to record keep and keep track of assets that way.”

With the right investments and proper due diligence, digital asset custody can be safer, more transparent, and more efficient than traditional modes. But to get there, panelists said, custodians must begin to build safe, secure practices and processes so regulators feel confident that clients’ assets are protected and that custodians have full control and visibility of them.