TCA: Bridging the gap between Equities and FX
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:
- Post-trade, which is the quality of any execution.
- Trade – Examining the factors that influence the style and performance of any execution, relative to operational constraints and internally derived benchmarks.
- 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.