TF: Does the creation of the multiple currency curves mean the creation of multiple sub-liquidity pools and order books at the exchange?
RK: No. Although there will be the ability for the same security to be listed and traded in multiple currency denominations, there is still only one liquidity pool and a single order book in the security’s native currency. The best bid price in, say a U.S. dollar virtual order book, will be able to match with the best offer price in, say a British pound virtual order book, on perhaps a Japanese yen-listed security.
Yet in this model, neither the exchange nor the investor are taking on any FX risk and at the same time, the participating FX banks will not be taking on any additional risk apart from their regular flow business via FIX APIs.
TF: So what is the M-DAQ model?
RK: Multi-denomination Automated Quotation, or M-DAQ, aims to enable listed securities to be tracked, bought or sold in an investor’s local currency rather than the currency of the country where security is listed. This disruptive technology solution would allow exchanges to provide securities in multiple currencies on a tradable basis within a single native currency order book, thus enabling them to benefit from FX transactions when overseas trades are purchased in the local currency.
Since this is implemented at the exchange level, the combined securities and FX blended price is deemed to be an exchange price and would satisfy a fund manager's fiduciary duty for best execution in seeking the “all-in” best price. With the M-DAQ model, FX conversion is performed at the exchange level and at the exact time of equity trade execution. With the exchange acting as a counterparty to the FX banks supplying the liquidity, the FX trade is done at a much more favorable (almost wholesale) rate, which ultimately benefits all end investors.
This also has the effect of creating an infinite number of “right curves” where the securities now has a number of foreign currency curves – which is local to the investor, thereby removing the uncertainties and complexities of the two constantly changing and independent variables.
TF: How does this work in markets that have multiple exchanges, dark pools and trading platforms?
RK: For any exchange that we work with, their alternative trading venues would not have access to these new multi-currency symbols. That’s because these alternative platforms would not be able to process, match and clear these new multi-currency symbols without an M-DAQ engine implemented within. However, let's say they do have access. The NBBO requires that the underlying security price be the best price in all competing market centers and the M-DAQ-enabled exchange would be the only venue with a comingled price and the best comingled price. The reason is its ability to manufacture the best bid/offer FX rate from its panel of global FX banks, often better than interbank rates.
TF: Is M-DAQ targeted at the retail market?
RK: Though FX price compression is often seen as the obvious benefit of this product (particularly for the retail guys), the real point is to trade the right curve, which is for every investor, regardless of trade size, institutional or retail.
Let’s take an example of an Australian-based investor who wants to buy shares in Hong Kong’s MTR Corp. Over the course of 2009, the right time to buy in Hong Kong dollars would have been in March while the right time to sell would have been in October.
However, with M-DAQ, the same investor would be able to track the Australian dollar-based graph of MTR and figure out that he would be better off selling in August instead of October.
The entire equity research industry needs to change. Investors make the wrong investment decisions because they all trade off a single [benchmark] currency chart. Seeing equity prices in your home currency would represent more value-added price data.
TF: What about the broker community? Aren’t they resistant? Don’t they take this FX pain away from investors today?
RK: First of all, as a product launched at the exchange level, a broker cannot effectively limit its clients to “not trade on any securities over another.” However, there really should not be any broker resistance as the current FX conversion revenues are not even made by the exchange’s community of brokers.
For example, say NASDAQ adopts the M-DAQ platform and quotes Baidu in U.S. dollars alongside Baidu quotes in JPY, AUD, etc… As things stand, U.S. brokers do not see the FX conversion transactions today since it happens offshore, so a U.S. exchange adopting the system would not be doing so at the expense of any brokerages in the market where the exchange is located. It is the offshore brokers who are going to lose out on the FX margin.
However, to look at it from another angle, if Google is to list in Asia, then the offshore brokers are not going to worry about losing 3 percent FX commissions since they will be making it up in extra trading volume.
TF: Why now?
We see it not a case of why now but why it has not been done already. It offers all investors the option to seamlessly buy and sell foreign securities in their home currency without explicitly performing an additional currency conversion trade and the ability to track their foreign holdings in their home currency.
From the exchange’s perspective, besides opening its door to encourage more overseas investors to participate in its market, increasing volume and velocity, a multi-currency capability is an obvious advantage when attracting secondary listings from overseas. If you consider which exchange a company would choose for a secondary listing – it comes back to multi-currency. Numerous factors are involved in choosing a location for a secondary listing – from the potential for increased investor diversification to the greater ease of using a security listed on an international exchange as an acquisition currency. In other words, exchanges need to differentiate themselves or it would be a “race to zero” – the inevitable cutting of fees and costs.
TF: What are the challenges to adopting M-DAQ?
RK: Many people in the industry have talked about marrying exchange-traded securities with over-the-counter FX for some time. However the biggest hurdle is a change in mindset to the current investment process, to trade the right curve.
Think about the development of online brokers in the retail market. A lot of people said it would mark an end of equity broking when online brokers came in offering $10 trades, but volumes increased to such a point that it is still a commercial business and every broker has an online offering.
All in all, not all cross-border trades will go M-DAQ for a variety of reasons. Today, there is no framework for comparison and that’s an easy excuse to say no.
TF: Why haven’t exchanges developed this technology on their own?
RK: Since FX is an OTC model that’s unchartered water for the securities exchanges, there’s a lack of intimate knowledge and details how to tie the two together into one product. And not just on the technology front but specifically on the clearing and settlement side. M-DAQ is not merely a technology solution, its uniqueness lies in the sustainable ecosystem it has built among exchanges, brokers and FX banks and how it weaves the intricate clearing and settlement workflows between them seamlessly. To an exchange, why reinvent the wheel?
TF: What about regulatory and tax considerations?
RK: These remain business as usual. M-DAQ does not impact any regulatory and tax considerations. If an investor can trade cross border today, he can continue to do so the M-DAQ way bounded by the same regulatory and tax regime.
M-DAQ merely changes the settlement currency of the cross-border transaction; instead of the currency conversion taking place between the investor and his broker or custodian, it will be performed at the exchange level (between the exchange and an FX bank), which then allows the investor to simply settle his trade in his preferred currency seamlessly from the onset.
TF: Thanks Richard.