Capitalizing on the cloud in a fast-changing FX market

Foreign exchange is the largest financial market in the world, with more than USD 7 trillion traded daily. It continues to evolve through increased electronification and automation, higher trading volumes, and greater complexity of products, while new participants and business models transform the competitive landscape.

The financial crisis of 2008 gave rise to a wave of regulatory reforms that aim to cut systemic risks and bring more transparency to markets. Reporting requirements are tightening, leading in some instances to jurisdictional divergences, higher costs, increased market fragmentation and less liquidity.

This momentum in volumes and regulations comes as financial technology use cases grow exponentially, giving market participants in the complex and decentralized foreign exchange industry little choice but to adapt.

FX teams are known for using a patchwork of platforms, spreadsheets and manual interventions to perform their functions, which brings management risk, but with a financial ecosystem that requires greater efficiency and interoperability, a more holistic approach is required to optimize straight-through processing rates.

Software solutions based on cloud computing could be one of the strategic allies that the FX industry needs. The technology is a gateway to greater innovation, automation, and seamless connection between trade execution and post-trade processes, and endows firms with the agility to remain compliant with changing regulatory pressures.

Digital transformation gathers pace

According to Nasdaq’s head of capital market solutions, Gil Guillaumey, in a Waters Technology article, a perfect storm of regulations and accelerated technological developments is forcing modernization.

Cloud-based applications, which can be up and running with limited time and effort, help firms scale their level of automation to meet the requirements of faster-moving markets. Instead of investing heavily upfront on physical infrastructure, a cloud environment demands less capital expenditure and enables firms to rapidly innovate, with focus on business outcomes and competitive advantage.

The cloud’s on-demand usage and subscription-based pricing model allow firms to focus resources on clients and business value by stripping away time and spending on what AWS calls ”undifferentiated heavy lifting”, such as data center and infrastructure related operations.

Back-office workflows, risk management, regulatory reporting and other data processing operations are obvious areas that can be moved to the cloud, and an increasing number of firms are transitioning to off-site infrastructure.

But while new players and start-ups are cloud natives, larger and more established institutions might opt to switch gradually, first moving less critical business operations while maintaining on-premise or co-located infrastructure, adopting a hybrid approach.

NASDAQ, for example, has been moving services to the cloud gradually over the past 10 years. In November it completed the migration of the core trading system of one of its six options exchanges, Nasdaq GEMX, to Amazon Web Services (AWS), delivering up to a 10% improvement in latency. Nasdaq GEMX is its third market to move to AWS.

Regulators too are seeing the benefits of technology to enforce compliance and detect fraud. FINRA, the US financial industry regulatory authority that oversees 3,400 broker-dealer firms and 620,000 individual brokers, uses cloud computing, artificial intelligence (AI) and big data analytics to protect market integrity. It processes a peak volume of 600 billion transactions every day to detect potential abuses, ‘making it one of the largest data processors in the world.’

Cloud benefits in data processing

Data is everything and quality data has always underpinned the best trade executions. What’s different now is the exponential growth in volumes, harmonizing the different formats by which it arrives, and leveraging data in real-time.

Data fragmentation is one of the biggest challenges towards the availability of clean, consistent, and high-quality data. Investing in a modern and unified platform, which allows for flexible yet secure data, is more critical than ever.

Firms that deploy cloud-based solutions are better placed to more effectively manage risk due to their ability to analyze mass data and streamline and automate decision-making processes.

Many organizations, however, are not yet fully leveraging the technology and are still extracting benefits from onsite systems they have built and adapted over the years. For front-office trading solutions, one constraint is the availability of critical mass in FX liquidity at low latency on the public clouds. This should be resolved in time as more liquidity and venues become available on the cloud and, in any case, should not hold up other areas of the FX ecosystem migrating to the cloud.

In any debate about the merits of cloud infrastructure, other factors must be taken into consideration, including its capacity to act as a secure, global and interoperable platform, where services and a collaborative marketplace, well beyond infrastructure, can readily be tapped.

Regulatory changes add pressure

Market-changing events force firms to leverage technology for risk management and adaptation. A key event is the transition to T+1, requiring US securities transactions to be settled in one day instead of two from 28 May. This change, primarily targeting equities, has significant global and FX implications, especially for Asian markets due to time-zone differences.

Currency sourcing becomes crucial in cross-border securities trades due to the compressed settlement period. Participants may need to source dollars before knowing the exact transaction cost, potentially leading to failed trades and penalties due to internal inefficiencies.

Transactions with an FX component carry increased risks and costs, which can be mitigated by integrating order management and execution systems on the securities and FX sides with the back office.

Risk also derives from the bilateral nature of most FX trades. The Basel Committee’s new rules recalculating such risk have increased banks’ capital requirements. The implementation of the standardised approach for counterparty credit risk (SA-CCR) and changes in uncleared margin rules (UMRs) have also increased costs and pushed more FX trades towards central clearing.

As regulations become more complex, firms need a technology-based architecture for efficient risk and compliance control.

AI brings us to the tipping point

Cloud technology will increasingly form part of daily operations as legacy systems are squeezed out, and any reluctance to exploit its transformative capabilities could be on the verge of tipping with the development of AI.

According to a report by McKinsey, generative AI could speed up the cloud return on investment and adoption with its ability to ‘unlock new business and tech use cases’.

The Bank for International Settlements said back in 2018 that the increased use of machine learning in high-frequency FX trading could improve market efficiency. The use case has gained even more traction since then as the transformative and revolutionary nature of AI generally has become clearer. Its ability to synthesize masses of data accurately and quickly and generate price predictions helps traders make better informed decisions.

Increasing numbers of firms have embarked on the journey towards digital transformation, adopting a spectrum of technologies, ranging from interactive web and mobile applications to APIs, real-time processing, cloud solutions, and data analytics. Throughout this transition, technology assumes a pivotal role in generating and delivering value. Those market participants who have not yet embarked on this modernization journey risk losing out.