A new era in structured FX trading at Vontobel

Electronic, competitive, efficient—Vontobel’s new trading platform for FX OTC derivatives

The foreign exchange (FX) market, the world’s largest and most liquid financial market, continues to evolve rapidly, driven by technical advancements and the need for operational efficiency. Cash and forward FX markets went from being predominantly voice-powered to full electronification in less than a decade. An early mover in the race for new opportunities within FX through technology, Vontobel introduced the eFX platform in 2013, which allows both our clients and Vontobel itself to access global FX liquidity in a highly efficient, automated manner (see our article Foreign Exchange at Vontobel for more details about the Vontobel eFX platform).

«Automation and efficiency are integral parts of our DNA and fundamental to our structured FX business initiatives.»

Olof Andersson
Head of FX Platform

The rapid and successful electronification of the cash and forward FX market can largely be explained by the relatively simple products involved. Spot FX is a trivial transaction—a single cash flow on an agreed date for an agreed amount at an agreed rate. Forward outrights and swaps have additional parameters but remain easy to manage electronically. But what about more complex FX derivatives? Is it possible to achieve similar efficiency gains and electronic market reach for, e.g., FX options and even second-generation derivatives? As technology platforms supporting structured FX are slowly beginning to enter the marketplace, Vontobel is again at the forefront, having introduced a best-in-class trading platform for highly complex FX OTC derivative products.

Higher quality through technology and operational efficiency

FX OTC derivatives take many shapes and forms, and product complexity varies greatly—from trivial vanilla options to multi-year target redemption forwards (TARFs) with potentially hundreds of fixings and corresponding cash flows. One common denominator is that the products are tailored to client needs—this inherent myriad of product possibilities and combinations makes it challenging to standardize the price discovery mechanism.

In a real-life trading scenario, this typically means that the price discovery process is highly manual—either using voice/chat or (best case) electronically using the market maker’s single-dealer platform. A significant drawback of this manual, labor-intensive process is that it is extremely hard to get any real sense of market depth: in a normal scenario, only two individual market maker quotes will likely be available for comparison before a decision is made on execution.

This limitation is one key area we aim to address with the new trading platform—by introducing an open architecture multi-liquidity-provider trading hub, we can structure bespoke products and request live pricing from multiple market makers on a single, consolidated trading platform. The ability to efficiently source liquidity and systematically identify optimal quotes from a curated pool of providers leads to significant improvements in overall pricing and execution quality, directly benefiting our clients and setting us apart from the competition.

Automation and operational efficiency are integral parts of our Vontobel DNA and thus a fundamental component of our extended business initiatives around structured FX. Where lifecycle management and subsequent back-office workflows are often highly manual for this complex type of products, we are aiming for full automation to achieve scale and reduce operational risk. By leveraging and extending systems and workflows already in use for Vontobel’s market-leading structured products offering, deritrade, we are including FX OTC derivatives in battle-tested, fully automated trade processes, allowing for full STP trade booking and lifecycle management. By avoiding manual intervention, we are significantly reducing the potential for errors while at the same time enhancing the speed and accuracy of the overall trade management process.

Vontobel—a gateway between clients and the global FX market

A key aspect of our structured FX initiative and the new trading platform is to replicate the successful model we implemented for the aforementioned eFX platform, where Vontobel acts as a gateway between clients and the global, interbank FX market. Clients are able to leverage Vontobel’s extensive trading network and relationships with tier 1 market makers and tap into a curated pool of top-quality liquidity, but without incurring the operational overhead needed to maintain relationships with each individual liquidity provider. Instead, Vontobel is the sole trade counterparty and the only trading relationship required from the client’s perspective.

Vontobel acts as a pure agent between our clients and the global FX market, and the trading platform ensures this is done fairly and transparently through automated, immediate risk transfer of all client requests and orders. At no point are client pricing and trading workflows in any way impacted by Vontobel’s own risk position or view, meaning that we can provide our clients with true best execution for even highly complex products.

From a liquidity provider perspective, the benefits are the same but in reverse—the open architecture platform allows market makers to compete for business originating from a client base that was previously unreachable, while at the same time needing only to maintain a single trading relationship with Vontobel. This effectively opens a new (and highly cost-effective) distribution channel for connected liquidity providers. The agency model and guaranteed risk transfer of all client orders, along with fair competition on the platform based solely on price, make it highly attractive for liquidity providers to actively participate on our platform.

Structured FX use case—target redemption forwards

One of the most popular second-generation FX derivatives is the TARF and variations thereof. While this type of product can be a very powerful tool, a TARF is a complex derivative product, and it is therefore essential to understand all intricacies and potential outcomes when considering this financial instrument in the investment decision process.

At Vontobel, our client-centric approach is one of our core values, and we take pride in actively engaging with our clients to form strong, long-lasting partnerships. During the investment process, we routinely educate and advise on portfolio positioning for FX derivatives. When considering any financial derivative instrument, we believe it is paramount to understand all associated risks and limitations as well as the benefits. Any derivative that the client does not fully understand is a dangerous derivative.

A TARF is a series of forward contracts that allow the holder to buy or sell a currency (or precious metal) at a pre-determined strike price on a specified set of future dates. Unique features of a TARF are the target level, which allows for early termination in case of favorable market movement, and the leverage, which increases the notional traded should the spot trade unfavorably to the agreed strike price on a fixing date. Although it is decidedly more complex and has more upfront uncertainty than a regular FX forward, a TARF makes it possible to capture favorable market movements, often resulting in enhanced yield. Conversely, if the market moves against the contract holder, the downside risk is that the client is still obligated to transact the leverage notional on the relevant remaining future fixings.

A TARF can be a suitable tool for cash management purposes (e.g., to manage future FX cash flows) but can also be used to adopt a more speculative strategy, for example when taking a clear view on the future market. One major reason that TARF products have gained in popularity is they can be structured flexibly to meet a client’s exact needs—direction, currency pair, notional, duration, strike, etc. can be fully tailored to the client’s needs and strategy outlook. Additionally, due to the target feature, which introduces an additional implicit leverage, it is often possible to create strategies that look more appealing than comparable alternatives using first-generation option strategies.

Clients who traditionally use FX OTC options or DCNs for cash management often expand their strategies to include TARFs once they understand the benefits of this product category. This addition allows clients to outperform the markets by capitalizing on their regular currency transactions involving, for example, annual dividends, foreign trade, or other large cash events.

Conclusion

Our current initiatives involving FX OTC derivatives are a highly collaborative effort spanning multiple Client Segments and Centers of Excellence within Vontobel. At present, demand is mainly originating from our Private Clients unit, while trading and advice is managed in the Structured Solutions & Treasury CoE. The Transaction Banking and Structured Products Platform teams within the Technology and Services unit are responsible for liquidity management and automated trade lifecycling, respectively.

The introduction of a bespoke, best-in-class technology platform dedicated to FX OTC derivatives represents Vontobel’s commitment to meet the continuously increasing demand for this product segment and to take our capabilities to serve our clients’ needs to the next level.