Inflation in the UK reached a 40-year high of 9% in April. Meanwhile, the International Monetary Fund has reduced its forecast for UK economic growth in 2022 from 4.7% to 3.7% in recognition of higher operating costs.
The outlook for the rest of the year is pessimistic, with the Bank of England suggesting that Britain could experience double-digit inflation for the first time in 40 years. And despite raising interest rates in March, the global nature of the causes of inflation mean that rate hikes are unlikely to have the desired impact.
In addition to the double whammy of lower growth and higher inflation, there is also rising volatility due to geopolitical events and disruption to global trade and supply lines, making it difficult for finance decision-makers to effectively manage their FX risk.
All of these factors are contributing to higher operating costs and forcing companies to search for savings where they can.
The first stop on this search for savings should be the easiest to tackle: FX transaction costs. Corporates continue to overpay for their FX requirements and suffer from a lack of transparency.
The FX market is the largest financial market, with a daily trading volume of $6.6 trillion. A growing proportion of this volume comes from corporates.
But despite their increased participation, many businesses can often be treated like second-class citizens in what remains a frustratingly opaque and often unfair market.
The first problem is the lack of transparency, especially when it comes to pricing. Transaction costs (which are very real costs to a business) are hidden in the FX spread, typically calculated as the difference between the traded rate at the point of execution and the mid-market rate at that time. This is something that is easy to calculate through transaction cost analysis (TCA), but all too often firms don’t even know this is possible.
In addition, unless they are very large, corporates can have limited choice on which and how many counterparties they trade with. They tend to work with only a small number of banks for their FX because of the operational complexity of setting up multiple banking relationships. This makes it harder for them to compare prices in the market because they have fewer access points and a smaller number of liquidity providers.
The second big problem is that brokers and banks give different rates for different clients depending on the type of client that they are. The most competitive rates (ie, those with the lowest spreads) are typically reserved for those with the largest trading volumes.
This is not a secret. The European Central Bank produced a report in 2019 that found that banks were overcharging their smaller corporate customers for FX services with hedging rates as much as 25 times higher than for their larger and more sophisticated clients. The report’s author likened it to walking into a used-car dealership and paying £50,000 for a car that others can buy for £5,000.
The lack of transparency, limited number of counterparties and discriminatory pricing all increases the difficulty for corporates to achieve – let alone demonstrate – best execution.
Fortunately, there are alternatives to the traditional single bank-based approach on which so many firms have been forced to rely. Technology and the advent of electronic trading has enabled new entrants to offer an alternative way to transact in FX that addresses the inequalities and inadequacies outlined above.
The first step is to get more transparency on pricing. The use of independent TCA exposes any hidden costs in the spread and enables firms to see exactly how much they are being charged for their execution.
The next step is to get access to a greater pool of liquidity. Multibank marketplaces offer corporates access to multiple liquidity providers from a single interface. This enables them to see live rates of institutional-grade quality on a single screen and to automatically execute at the best available rate.
The final step is to provide all of these benefits from a single location, providing streamlined workflow and regulatory reporting for best execution in addition to TCA, drastically reducing operational overheads as well as execution costs.
By looking beyond their traditional brokerage or banking relationships, businesses can get access to the kind of liquidity normally reserved for the largest trading institutions along with associated cost savings, plus the transparency to prove it.
By choosing a partner that offers a level playing field for FX, firms may be able to make sizeable savings at a time when cutting costs is critical.
Eric Huttman is CEO of MillTechFX
