FX Trading Portal
Dr Cameron Mouat, CEO of Aoraki Advisors
In recent years there has been an increase in an individual’s rights to personal data protection via the European Union’s General Data Protection Regulation (GDPR) and the UK Data Protection Act (DPA) 2018. This legislation gives the public greater confidence in how businesses will handle personal information passed to them. In a similar vein, we should expect our trading businesses to treat their client’s information with a comparable set of standards. Segregated execution desks is one way to achieve this, at least, within the realms of client execution, by reducing potential for conflicts of interest within a trading business. In this article we discuss these information protection principles and how trading businesses can adhere to them by using segregated execution desks. In order to do this, we loosely refer to a segregated execution desk as a trading desk which manages execution of FX orders without information slippage or taking principal positions.
The UK Data Protection Act and Principle 19 of the
FX Global Code
The DPA legislates how personal information can be used and sets a high bar on protection principles. It includes principles that information must be used:
• fairly, lawfully and transparently;
• for specified, explicit purposes; and
• in a way that is relevant and limited to what is necessary.
For example, the transparency principle ensures an individual has the right to know how their information is used and the relevance principle ensures information is only used for what the individual intended it to be used for. It is also a requirement to have robust breach detection, investigation and internal reporting procedures. Firms are liable for substantial fines if they breech these data protection principles. In the FX Global Code, Principle 19 refers to how confidential information, for example client fixing or algo orders, should be handled. It states that confidential information should be clearly and effectively identified and access should be appropriately limited. Disclosure should also be limited to internal parties who have a valid reason for receiving information. These requirements mean there is significant responsibility on participants of the FX Global Code to ensure client orders are handled in an appropriate way. Unfortunately, there is not a lot of information that defines what “valid reasons” are which leaves room for interpretation. A note on what best practice looks like would be a useful addition to the FX Global Code and would help clients qualitatively compare different FX counterparts. However, we can take principles from the DPA and GDPR, such as relevance and transparency, and apply to where the FX Global Code leaves a gap. For example, the relevance principle might imply that confidential order information should only be visible to a trading or sales desk that explicitly needs to handle that order. The transparency principle would ensure banks inform clients how their information is used. One solution to these problems is to have a segregated desk to handle orders that should not be visible to a traditional trading desk.
Why are segregated execution desks needed?
Although segregated execution desks are not new in FX, we have recently seen more formalised segregation pressure in response to changes in how banks manage fixing and/or algo orders. This has resulted in segregated execution desks interacting with clients more like an agency execution desk in futures or equities, enabling them to provide market colour as well as discussing different execution scenarios with clients. There is a natural similarity between the handling of algo orders and fixing orders, as both order types require automated processes to handle flow effectively and have a need for segregation of information. From a bank perspective, firstly acknowledging and then putting processes in place to ensure that trade or order information is accessible only on a need-to-know basis, reduces risks for both the client and broker. Principal traders are protected as they cannot obtain order information and the risk of accidental conflicts are significantly reduced. For algo orders, the purpose of many executions is to work large interest into the market with “minimal” impact and signalling risk. This usually involves executing over a longer time frame and means any information slippage about the order could be detrimental to the execution. For example, prices could be skewed or hedging behaviour changed. Additionally, once an order has completed there may be similar follow-up orders, so ensuring information is segregated posttrade reduces any potential impact on these. Even a simple post-trade operation could change the internal visibility of an order in front office systems. Fixing orders are a large focus for many segregated execution desks. The information that these, potentially market moving orders contain, provide trading opportunities for market participants. It is therefore worthwhile understanding how large fixing orders are managed from an information and risk perspective. A bank may manage fixing orders by initially netting with other client orders, followed by matching against offsetting fixing interest from other banks (through brokers or electronically). Then any residual risk could be traded via an algo around the fixing window. This order information needs to be kept segregated from principal desks to reduce any accidental or real conflicts of interest. For example, a principal desk, by coincidence, might be in a similar trading position as the residual fixing risk and trading in the same direction at the same time. Some banks, however, might prefer to pass the fixing residual directly to another bank to manage. In this scenario, even if a client gives a fixing order to a bank who has robust information segregation, there is a chance that important order information might be forwarded to another bank, with lesser information controls. It is therefore important to understand how fixing risk is handled as each bank will have different policies, procedures and segregation models.
What to expect from a segregated execution desk?
From a buy-side perspective, understanding the interpretation and implementation of Principle 19 of the FX Global Code and consequently how information slippage is reduced is important due diligence. Some banks will be severely limited in how they can restrict information between internal areas due to legacy technical systems. Historically, many order management systems (OMS) and risk management systems (RMS) have not had the technical capabilities to meet the confidentiality requirements that the FX Global Code or DPA would require. For example, trading books in an RMS might be viewable across business areas. Changing an OMS or RMS or even developing the segregation rules can be an expensive and difficult project. This means that for FX firms with smaller fixing and algo businesses, the setup and running costs can be prohibitive, although some measures can be taken to achieve at least part segregation. At a minimum these businesses should ensure that trading books and order information flow are segregated. An additional step could be designating an employee to have sole access to the segregated order flow from a physically segregated desk. Being open and transparent about these policies is likely to be appreciated by clients. Below are some points to be considered when talking about segregated execution:
In this article we have discussed some of the benefits of segregated execution and how data protection
principles can be applied to client execution. These qualitative factors can be hard to measure but are useful to benchmark different providers.