Navigating Volatile FX Markets and the Need to Reconstruct Trades

With August 24th marking 6-months from Russia’s invasion of Ukraine, Oliver Blower, CEO of fintech VoxSmart, examines the growing importance of financial institutions reconstructing trades to protect themselves against volatility-driven risks.

No one reading this article will be a stranger to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, brought in under the Obama administration. One of the key requirements put forward in this legislation was that financial institutions dealing in swaps (which let’s face it – is a great deal of them nowadays) must, within 72 hours of request, produce a time-sequenced reconstruction of their swap trades. This requirement spans the entire lifecycle of a trade, from pre-trade communications all the way through to the swap expiration stages. It is mandatory for a whole host of asset classes, including FX swaps.

FX markets have been choppy throughout 2022, with a defining feature of the year being high levels of volatility in the asset class. This has been largely brought about since Russia’s invasion of Ukraine in February. From a trading perspective, the Russian invasion of Ukraine on February 24th, 2022 led to a plethora of newly sanctioned bodies. What the ensuing market volatility also resulted in was a significant change in the market structure supporting trading in the Russian rouble. Over the course of a weekend, volumes on electronic trading venues (which accounted for nearly two-thirds of rouble ADV i October 2021), dried up dramatically as trading was suspended. What this ultimately resulted in, was a situation where almost all offshore trading of the rouble went back in time, reverting back to bilateral and voice execution Execution Execution is the process during which a client submits an order to the brokerage, which consequently executes it resulting in an open position in a given asset. The execution of the order occurs only when it is filled. There is typically a time delay between the placement of the order and the execution which is called latency.In the retail FX space, reliable brokers always strive to deliver best execution to their clients in order to maintain a solid business relationship with them. This is a common marketing point of emphasis by brokers, whose action execution varies considerably from company to company. When execution prices are not matching the submitted price the client is charged or credited the difference resulting from the negative or positive slippage.Slippage is a very contentious issue among retail traders, which can lead to issues. Many traders view levels of slippage at brokers as a key determinant for their business. Best Execution a Legal ObligationBrokers are required by law to diver to their clients the best execution possible. Some regulators are requiring brokers to submit execution stats in order to assess the quality of their services. Other brokers are regularly posting execution statistics in order to boost the confidence of their clients in the best execution commitment of the company.Best execution has been a point of emphasis in recent years from both retail and institutional players in the FX industry. Negotiating and executing transactions in order to promote a robust, fair, open, liquid and appropriately transparent FX market is identified as one of the six main principles outlined in the FX Global Code of Conduct, which came into effect in 2018. Execution is the process during which a client submits an order to the brokerage, which consequently executes it resulting in an open position in a given asset. The execution of the order occurs only when it is filled. There is typically a time delay between the placement of the order and the execution which is called latency.In the retail FX space, reliable brokers always strive to deliver best execution to their clients in order to maintain a solid business relationship with them. This is a common marketing point of emphasis by brokers, whose action execution varies considerably from company to company. When execution prices are not matching the submitted price the client is charged or credited the difference resulting from the negative or positive slippage.Slippage is a very contentious issue among retail traders, which can lead to issues. Many traders view levels of slippage at brokers as a key determinant for their business. Best Execution a Legal ObligationBrokers are required by law to diver to their clients the best execution possible. Some regulators are requiring brokers to submit execution stats in order to assess the quality of their services. Other brokers are regularly posting execution statistics in order to boost the confidence of their clients in the best execution commitment of the company.Best execution has been a point of emphasis in recent years from both retail and institutional players in the FX industry. Negotiating and executing transactions in order to promote a robust, fair, open, liquid and appropriately transparent FX market is identified as one of the six main principles outlined in the FX Global Code of Conduct, which came into effect in 2018. Read this Term. Of course, it comes as no surprise that financial institutions responded to the macroeconomic shock by altering their trading behaviour to account for the need to reduce exposure to any assets linked to Russia.

The problem now facing these firms is that regulators are beginning to turn their attention to trades that broke from established patterns, such as trades in the RUB, that have occurred since February. When it comes to Dodd-Frank requirements, regulators could specifically ask to see reconstructed trades from swap deals in volatile currencies – especially when a lot of these trades were executed over the phone – rather than more transparent electronic trading venues. The challenge facing banks is that more often than not, their trade information and communication data sit in two entirely separate buckets. The manual process of sifting through these disparate data sets and connecting the dots between trades, particularly in periods where trading activity has been heightened due to volatility, is extremely difficult. Add in the stringent 72-hour timeframe that they have to work towards, and it becomes a vastly more challenging process.

However, by leaning on the support of automated technology solutions that connect communication and trade data, compliance Compliance In finance, banking, investing, and insurance compliance refers to following the rules or orders set down by the government regulatory authority, either as providing a service or processing a transaction. Compliance concerning finance would also be a state of being following established guidelines or specifications. This designation can also encompass efforts to ensure that organizations are abiding by both industry regulations and government legislation. Understanding ComplianceCompliance is a system of checks and balances that prevents fraud and inefficiencies.Additionally, this also ensures cooperation with federal financial regulations with the ultimate goal of protecting the public and provide needed information to governmental agencies to stop fraud, money laundering, and terrorist funding. Compliance in the financial industry offers stability to the markets and serves to protect customers, workers, and taxpayers from ethical threats that are inherited in individual decisions.Many organizations are also obligated to track and store compliance data. This includes all data that is relevant or belongs to a company, brokerage, etc. that can be used for the purpose of implementing or validating compliance or regulatory reporting.Given shifting regulations and the importance of compliance, the use of advanced software is increasingly being implemented to help companies manage their compliance data more efficiently. This cache includes calculations, data transfers, and audit trails.While finance is a globally unified concept, compliance is not. Regulatory compliance varies across both industries and jurisdictions. For example, the financial regulatory structures of one country may be lacking or different in another. Of note, the most tightly regulated jurisdictions in terms of compliance in the forex industry include the United States, United Kingdom or most European Union countries, Australia, New Zealand, Canada, and others. In finance, banking, investing, and insurance compliance refers to following the rules or orders set down by the government regulatory authority, either as providing a service or processing a transaction. Compliance concerning finance would also be a state of being following established guidelines or specifications. This designation can also encompass efforts to ensure that organizations are abiding by both industry regulations and government legislation. Understanding ComplianceCompliance is a system of checks and balances that prevents fraud and inefficiencies.Additionally, this also ensures cooperation with federal financial regulations with the ultimate goal of protecting the public and provide needed information to governmental agencies to stop fraud, money laundering, and terrorist funding. Compliance in the financial industry offers stability to the markets and serves to protect customers, workers, and taxpayers from ethical threats that are inherited in individual decisions.Many organizations are also obligated to track and store compliance data. This includes all data that is relevant or belongs to a company, brokerage, etc. that can be used for the purpose of implementing or validating compliance or regulatory reporting.Given shifting regulations and the importance of compliance, the use of advanced software is increasingly being implemented to help companies manage their compliance data more efficiently. This cache includes calculations, data transfers, and audit trails.While finance is a globally unified concept, compliance is not. Regulatory compliance varies across both industries and jurisdictions. For example, the financial regulatory structures of one country may be lacking or different in another. Of note, the most tightly regulated jurisdictions in terms of compliance in the forex industry include the United States, United Kingdom or most European Union countries, Australia, New Zealand, Canada, and others. Read this Term teams can be empowered to check exceptional trades almost instantly. This ability to cut the manual work out of the process would allow for a complete shift in approach and culture – from reactivity to proactivity. Instead of waiting for the regulators to come knocking, compliance officers would be able to proactively approach regulators to demonstrate effective risk management and governance, building relationships to keep the ship steady during a period of market turbulence. Financial institutions consume and store absolutely mammoth amounts of information – it won’t be a foreign struggle to anyone that getting full use of this data is another story entirely. This is where embracing the benefits of modern technology solutions really starts to show their true worth.

Ultimately, the firms who embrace the benefits of modern technology solutions when it comes to reconstructing trades in FX markets, are the ones who will be able to be proactive in plotting a safe course as the unpredictable trading landscape continues to evolve.

Oliver Blower, CEO, VoxSmart