Treasuries shift focus to operational excellence

12 SEPTEMBER 2023

This article first appeared in the SA Treasurers' Journal 

Treasuries shift focus to operational excellence but execution risks remain

By Tim Hutchinson

Over the last few years treasurers in South Africa have invested heavily in execution excellence by way of greater adoption of execution platforms, hedging policies as well as outsourced execution services.

As a consequence, many treasuries are enjoying the benefit of the investment manifesting in better prices and speedier execution.

But we now see many companies pivoting away from pure execution excellence towards operational excellence, which is investment in integrating banks’ settlement and transactional processing capability into the treasury management system, such as SWIFT. There is also a strong demand to automate many of the manual efforts employed in a treasury to give more time back to treasury staff to add value to the business.

We also note the trend that some clients who have historically outsourced execution are bringing the function back internally for many of their vanilla trades. We believe this to be as a result of the ease of in-house execution. The cost of execution is also seen as something that treasuries are happy to forego if they are comfortable to now do it internally.

But while many treasuries now are using the capability set up for execution excellence there are a number of new risks that clients need to be aware of as a result of this that are not as obvious or are often misunderstood.

Most people believe that using the new capabilities, such as executing through a digital platform, immediately unlocks best execution but this is not always the case. There are elements that need to be understood so as to achieve true best execution.

It is important to also have a true definition of what best execution means. We like to take it back to first principles of:

• Did I get the liquidity I wanted? One of the most critical questions in SA as well as broader Africa
• Did I get the best price I could for my execution? This is something that most people solely focus on
• Did my trading have market impact? This is something that has become more critical for clients in the last few years

In terms of getting access to liquidity available, this depends on each market the client is trading in. While SA has historically been seen as a fully liquid currency, we have seen several “flash crashes” in the USD/ZAR market given the reduced number of market makers and as a response to times of volatility.

This trend makes access to liquidity far less easily obtainable in larger sizes. As a result, we have seen a trend of fewer larger sizes, meaning even transactions over $10million can take longer for banks to internalise the flow than have been the case in previous years.

Getting access to best execution is not just about requesting and accepting the best price on a digital platform. We have evidenced a number of clients asking for FX quotes on a multibank portal and are leaving the quote open for many seconds before accepting the relevant price (this time between when a request is sent versus a decision to trade is made, is referred to as the quote-life window). The trend to do this often results from not all banks having the capability to respond to quotes in an automated manner, as such clients need to wait for the banks who are “manually responding” to provide a quote.

What clients fail to realise is that, within the quote-life window, markets are moving in a sub second fashion (as an example, most multibank platforms offer a 4 times a second price refresh feature), meaning that while clients wait for other banks the market is moving through that interaction. Manual pricing typically would take 5 – 10 seconds to put a price on a ticket, meaning that the client is risking 20 to 40 price updates. This is something that clients really need to pay attention to and ensure pressure is put on their banks to move towards automated pricing or at the minimum look to monitor price action within the quote-life window.

Measuring market impact has been something that many clients are now being made more aware of and asking banks for broader Transaction Cost Analysis (TCA) reporting or best execution reports. There are a number of third party providers offering independent analysis on execution and we would encourage clients to explore these broadly. Where costs for such services are prohibitive for clients, we also encourage clients to be curious on how banks are handling the trades given to them.

We typically look to drive the construct of an internaliser of flow meaning that risk is held on the books of the bank and the relevant bank can offload the risk into their client base or passively in the market. Banks measure their effectiveness in doing this as their internalisation rate (i.e. what percentage of their risk are they able to passively trade out with other of their clients), and higher is always better.

We encourage clients to ask questions around banks’ internalisation rates, as well as how banks define internalisation given the fact that many banks now have access to a broad spectrum of liquidity providers, not all equal. What clients should look out for are banks who immediately look to exit risk into the market, as this is a core differentiator of market impact. There is a lot of opportunity for clients to engage their banks on this topic and we would encourage clients to upskill themselves on banks risk management practices as it relates to client flow.

Lastly, an element that is very much in its infancy in South Africa (but mainstream internationally), is the use of algorithmic execution services. These allow clients to transact through automated means through algorithms that have been calibrated for a specific currency, market conditions as well as client need.

These algorithmic execution capabilities seek to offer clients best execution and are typically charged on a per transaction size basis, for example per US Dollars per million, and are excellent for clients wanting to try to optimise best execution.

While sometimes seen as the realm of being too futuristic for some, we have seen excellent results handling many of our own executions. Local banks have been exploring offering these capabilities to clients and we encourage clients to engage with their banks around this capability.

Hutchinson is Head of Electronic Execution, Markets at RMB