What are the hidden costs in FX?

The opaque nature of foreign exchange (FX) execution places great responsibility on asset managers and corporates to put the processes, practices and systems in place to ensure the best result possible, yet they may often be plagued by hidden costs.

Today, many firms may not have access to rates from multiple providers and have no visibility on whether they are getting a good deal.

We believe the current situation is far from ideal as many of these firms are still paying more than they need to – or should do – for foreign exchange (FX). And so, we’re shining a light on the hidden costs in FX and highlighting how technology can help improve competition and transparency, to enable these firms to optimise their FX operations.

Hidden costs

The spread

• Pricing transparency is a recurring problem as FX costs are typically hidden in the spread. The transaction cost on any given trade can be calculated as the difference between the rate traded at, and the mid-market rate at that point.
• For example, if a corporate buys €5m of USD at 1.1890 and the mid-market rate at the time was 1.1860, the transaction cost on the trade would be 0.25%, or €12,500. This is not an explicit cost as the treasurer won’t receive an invoice for this amount; rather, it’s a hidden implicit cost. Let’s make no mistake though: it’s just as much of a cost.

Inability to compare the market

• For asset managers and corporates who trade FX for payment or hedging purposes, FX can be seen as second-order: they transact in FX not because they ‘want to’, but because they ‘have to’ due to international business activities. It is thus often operationally inefficient for them to set up and manage multi-bank relationships.
• This makes it difficult to compare the market – so when executing trades, corporates and asset managers are often beholden to limited sources of liquidity. At any given time, they may not be able to trade at the best available rate as they have no other access points to the market.

Best pricing for bigger firms

• One of the main issues in the FX market, in our opinion, is that clients are provided rates in different capacities depending on what kind of client they are – a concept called “tailored pricing”.
• As a result, the best rates are reserved for institutions that transact the highest volumes, meaning mid-sized corporates and asset managers are often neglected and struggle to get the best possible deal.
• A 2019 paper from the ECB found that banks were overcharging small corporate customers for FX services, charging hedging rates as much as 25x higher than their bigger, more sophisticated customers.

How technology can help

• To get a view on these hidden costs, corporates and asset managers must first understand how much they are being charged for execution. Transaction Cost Analysis (TCA) exposes any hidden costs in the spread, so that market participants can benefit from full transparency.
• Multibank marketplaces, like MillTechFX, enable asset managers corporate treasurers to access a single interface to see live rates from multiple banks and execute at the best rate, all whilst reducing the operational burden traditionally associated with this kind of market access. This type of multi-bank price streaming and execution process was previously the exclusive domain of the largest trading institutions. This is a step forward in innovation, as it increases efficiency, streamlines operations and saves customers money.

By centralising multi-bank comparison and embedding TCA into the process, corporates and asset managers can access the transparency that’s historically only been available to the largest market participants

Get in touch to learn how MillTechFX can help you eliminate hidden costs in FX: contact us.