With the foreign exchange markets shaken by the fallout from the 2013 FX rate fixing scandal, Russell Investments saw an opportunity to shake them up even further. While the industry explored ways to restructure the WM/Reuters daily FIX calculation window to minimize the possibility of manipulation by sellside brokers, Seattle-based Russell Investments began exploring a different model altogether.
Early this year, the asset manager began promoting its vision of a new trading model. RFX Network is a buyside-only FX trading platform. Although buyside firms typically trade through dealers, RFX Network, in the context of the recent scandal, could reduce buyside firms’ risks of dealing with profit-motivated brokers by helping them access order flow from other buyside firms that are tapping the $5.3 trillion FX markets simply to settle their securities transactions.
With $275 billion in assets under management, Russell Investments is perhaps most known for the globally recognized Russell Indexes developed by researchers at the firm. The company is currently a subsidiary of London Stock Exchange Group (LSEG), having been acquired from Northwestern Mutual in December, though LSEG announced in February it will retain the indices and sell the investment management business.
RFX Network is not the first time that Russell Investments has bucked the status quo in FX markets. Since 2003, Russell Investments has offered what it calls Agency FX, an agency brokerage service for FX in which Russell Investments acts as a fiduciary, trading on behalf of clients such as pension funds and other investment managers.
“We go to the market and trade competitively with banks, and provide those rates to our clients with a small transaction fee. That’s different from the principal model that’s prevalent in the market, where managers trade directly with a bank as a principal. There have been a number of problems with that model,” Michael DuCharme, head of currency strategy at Russell Investments, told Traders.
The firm’s fiduciary role, according to DuCharme, makes Russell Investments highly accountable to clients in delivering best execution.
“We are accountable for our results, and we back them up with our transaction cost analysis reports. Being on the same side as clients as a fiduciary, our interests are aligned with our clients,” DuCharme said. “There is no other way we are compensated or benefit from clients other than a small transaction fee that we fully disclose. We have no account in which to trade, and we are not interested in flow to analyze trends and pass them on to others. There is nothing we do but go help execute in the market at a better rate.”
THE POWER OF NO TRADING
RFX Network will enable Russell Investments to further leverage its Agency FX business with an automated, algorithmic platform designed with several levels of sophisticated netting and execution. The platform, developed with Palo Alto, Calif.-based Integral Development Corp., offers three layers of algorithms, beginning with netting algorithms to allow firms to explore options for optimally netting their orders internally to reduce the overall size of their trades.
“By being able to minimize the overall size of trades by netting, you are reducing the direct and indirect cost of trading, and that’s why one of the things we say is, the best way to trade is not to trade at all,” said Vikas Srivastava, managing director of business development for Integral Development. Optimal netting, however, is more complex than it may sound, as buyside firms don’t typically come to market with a single trade but a list of trades that may include different currency pairs, different allocations, different settlement dates, or trades where the amounts are expressed in ways that are not easy to net against each other, Srivastava explains. In addition, there are trades referred to in FX as “cross currencies,” where breaking up a trade into two underlying currency trades is more effective because the underlying currency pairs can be more liquid than the cross. The netting part of RFX, which is based on Integral’s InvestorFX platform, allows buyside firms to achieve optimal netting by doing transaction cost analysis on a pre-trade basis.
As an early user of InvestorFX, Russell Investments was instrumental in tailoring netting rules to the needs of the buyside. One of the netting options that the platform includes is the option to match trades at the midpoint price. Normally, when firms net buy and sell orders, the smaller, or non-dominant, order gets the better rate in the match.
“The dominant orders aren’t disadvantaged, but they don’t get any benefit of the match; that’s all taken up by the smaller order. With mid-market matching, we think it makes it fairer for everyone involved in the match,” DuCharme said.
Midpoint matching was a trading issue that Russell Investments had not been able to solve until meeting with Integral. The partnership in developing midpoint matching technology formed a basis from which Russell and Integral collaborated to develop the RFX Network platform.
PEER-TO-PEER TRADING
The next business challenge Russell Investments looked to solve was to take the residual of trades that weren’t netted and execute them on a peer-to-peer platform.
“We were trying to provide a mechanism where asset managers could trade more effectively and efficiently with each other,” DuCharme said. “Instead of having a single bank with which to trade, if they could have streaming prices from 50 liquidity providers, they could have a better chance for enhanced execution.”
As the WM/Reuters rate fixing scandal erupted, Russell turned back to Integral to collaborate on developing a solution to help clients obtain the WM/Reuters rates if they still wanted to do that through peer-to-peer matching, according to Joe Hoffman, director of equity derivatives and foreign exchange.
“We wanted to create a systematic way to net trades internally at a mid-market price,” Hoffman told Traders. “So the netted portion gets the mid-market price, and the residual gets done at the market on the bid or offer.”
In other words, if a firm were buying 100 million euros and selling 50 million euros, the 50 million that could be internally netted would get the midpoint price, and the residual 50 million euros would be executed at the market on the offer, resulting in an average price between the mid-market and the offer, Hoffman explained.
“This is something we talked about doing for years. It’s something we tried to do internally and talked to other providers about. It’s pretty challenging,” he said.
Using this model, the trades that aren’t netted are matched on RFX’s peer-to-peer platform, and if they can’t be matched on the platform, they are sent out to any of a number of liquidity providers accessible through the network, according to Hoffman.
The approach was developed in close collaboration with Integral, and Integral says it gained a lot of insight from its partnership with Russell Investments as well.
“Russell played a role in developing functionality and features that are right for the needs of the buyside,” Srivastava said. “From our perspective, we are partnering with someone who is not only a fiduciary but who actually walks in their clients’ shoes, meaning they themselves are an asset manager so they know intimately the problems that their peers are trying to solve. It gives them a unique perspective.”
ASSESSING THE MARKET
Still, a new model could bring risk.
“It’s an interesting development. Given all the discussions around how prices are determined in the over-the-counter markets, the buyside investors as well as corporations may need a better way of ensuring that the prices that they deal on are not manipulated,” said Larry Tabb, founder and CEO of TABB Group. But he cautioned that circumventing FX traders might not necessarily insulate firms from market manipulation. Due to the inter-relatedness of markets, manipulation on one market could easily spill over to other platforms once pricing disparities are detected.
Aite Group senior analyst Javier Paz suggests that with FX trading, as with other markets, decisions on what to trade on a platform like RFX Network versus going through a broker might in the end be determined by size, with firms still trusting sellside intermediaries for larger orders that might impact the market.
“It’s a noble concept, and I think there might be a sense of community within the buyside that by going to other peers, they might find something meaningful,” Paz said. “Perhaps what the asset managers will do is dip their toes in the water.”
Paz said Aite tracks FX trading platforms, and the FX market has seen a huge growth in the number of platforms compared with the early days. “There is an undeniable amount of innovation in the marketplace, and it’s reflected in the fragmentation that we are seeing,” he said.
Yet, Paz added, while FX volumes have grown and the number of FX platforms has greatly proliferated, the proportion of dealer market share has remained largely consistent.
“We have seen the volumes for single-dealer platforms, which is the primary mechanism for banks to deal electronically with clients, as flat since 2008. Their volume has grown with the market, but their market share has remained the same. They haven’t lost market share, but they haven’t grown it either,” Paz said.
Russell Investments says it is fully aware that habits change slowly in the FX world. “We are looking to make it very easy for them to communicate by inserting the RFX Network into the buyside’s workflow so that it doesn’t look like much of a difference,” said Hoffman. “But change is change, and sometimes it’s a little time-consuming and takes a bit of effort to make that move.”
THE 5-MINUTE FIX WINDOW
Still, Russell Investments sees several opportunities, particularly with the changes to the WM/Reuters FIX, which widened its window from one minute to five minutes in mid-February in an attempt to reduce the risk of manipulation. The possibility of a change in banks’ pricing structure was a key consideration and lo and behold, Bloomberg reported erlier this year that Barclays, Deutsche Bank, JPMorgan Chase & Co. and Citi may start charging fees for trades executed at the WM/Reuters rates, including the 4 p.m. London fix.
While it’s early in the game, and RFX Network pricing has not been determined, Russell Investments expects the platform to be competitive with fees that firms may begin charging under the new, wider FIX window.
“Our observation is that most banks are charging for what used to be free, and that the costs are significant for the major currencies,” DuCharme said. “Depending on the fee structure, those costs at times have been in excess of 5 basis points for U.S. dollar-Swiss franc trades, and generally between 2 and 4 basis points for many euro crosses.
“We think we can be competitive,” he said. “The ability to match at a midpoint price and to obtain not only competitive spot prices but forward points, too, will make the RFX Network’s all-in cost very attractive to investors.”
