Big investors are growing increasingly concerned that banks are able to decipher their trading patterns, and profit from the information, prompting a hunt for new ways to get deals done.

Some pension funds and asset managers that trade large amounts of currencies every day say the regular patterns in their trades make it easy for banks to anticipate their next moves. “Banks are holding 95 per cent of the cards and we as an industry have 5 per cent, despite us being the ones sending the orders,” said a director at a large UK asset manager.

One way for investors to push back, they say, may be to cut dealers out of their trades altogether, potentially posing a serious challenge to the banks that facilitate this business.

Investors trade several times a day, slicing up large orders into smaller chunks to avoid creating a large exchange-rate move. While the first few slices normally achieve good prices, subsequent chunks become more and more expensive as dealers nudge prices higher.

An analysis of 3,000 trades by one UK pension fund shows that the cost of trading currencies doubles at 4pm, when patterns are the easiest to decipher as a result of a significant portion of the $5.1tn in daily flows passing through the market in just five minutes.

“The bilateral nature of foreign exchange markets naturally leads to significant informational asymmetries between dealers and clients,” said Yazid Sharaiha, global head of systematic strategies at Norges Bank Investment Management, one of the world’s largest sovereign wealth funds.

There are no rules that prohibit banks from scouring the trading behaviour of clients, and banks have always benefited from the edge that large investor flows give them. Banks also have sound reasons for seeking to predict what clients will do next, as it helps with their risk management.

But heavy-hitting investors such as Norway’s $1tn sovereign wealth fund have long advocated steps to reduce the information advantage of dealers, noting in 2017 that “the high cost of intermediation stemming from structural informational advantages enjoyed by dealers and banks is [an] area for improvement”.

One way to avoid showing their hand could be to trade between each other without banks being involved in deals.

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Cracking direct peer-to-peer trading in wholesale currencies trading is tough. Unlike equities markets, where matching platforms have existed since the early 2000s, investors continue to rely heavily on banks for credit to access prices and trade currencies. As a result, similar initiatives in the space have all faltered.

One new project, dubbed Siege and led by ex-HSBC banker Claude Goulet, seeks to disintermediate dealers from as much of these flows as possible, by matching trades with each other before sending them to the market, swapping currencies at a live, regulated reference rate provided by New Change FX.

Instead of paying the so-called spread, the difference between the price where banks are willing to buy and sell currencies, trades would be executed on a midpoint, cutting down on costs.

“We do not expect to net all orders, but achieving even 25 per cent would bring significant savings to our clients in terms of execution costs,” Mr Goulet said.

People involved in this initiative say changes in the way banks process trades mean it has a greater chance of success than previous ventures. “Banks will not like it, but there are plenty of things banks do that I don’t like,” said the currencies chief at one of the funds backing the new initiative, who did not wish to be identified as he is not permitted to speak publicly about the matter at this stage. “I’m not at all worried about damaging my bank relationships,” he added.

Siege faces significant hurdles before its planned launch. For the project to be successful, enough investors need to participate to be able to find matches often enough to generate significant cost savings. A number of investors are also concerned about missing out on good prices as a result of waiting for a match.

“There are circumstances where it might be attractive, but it’s not appropriate for all execution requirements. The most prominent drawback is that you lose control over the market level,” said Stuart Simmons, a senior portfolio manager at Australian pension fund QIC.

But Mr Goulet said the design of the systems meant that investors never lost out on prevailing market prices because of the live benchmark rate. Any unmatched trades can be sent to the usual channels for execution. And as Siege plans to match trades completely separate from main markets, information leakage is reduced to zero.

Investors backing the project say the attempt to cut out banks from a large portion of daily flows will hinge on the scale of cost savings clients can achieve. If these savings are not large enough, clients will experiment with other ways to reduce information leakage about their trades.

“I’m happy to give it a period of time, say six months. But if I’m unable to get significant savings I will find something else,” said one European fund executive who is backing the launch.


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