Paul Clarke: The WMR benchmarks are a suite of point in time benchmarks that we calculate. We calculate rates every hour on an hourly basis. And then for 25 traded spot currencies, we also publish those rates every half hour. WMR has actually been calculating those rates for over 30 years. We calculate rates for FX spot currencies, for FX forwards instruments, for NDF currencies and also for metals.
Paul Amery: Welcome to Index Ideas from FTSE Russell. I'm Paul Amery, your podcast host. In this podcast we look into how FTSE Russell indices are built and why we explore index ideas that can help you address real world investment challenges. As a reminder to listeners, you can't invest in an index. And so the concepts that we explore in the podcast are not investment advice. Any reference to potential investment strategies is intended for informational and educational purposes only. Welcome back to Index Ideas. This is the first episode of season three of the podcast. And in this episode, we turn our attention to the global currency markets. I'm joined by Paul Clarke, who is head of FX Benchmark Product Management at FTSE Russell. Paul, welcome to the podcast.
Paul Clarke: Hi, thanks.
Paul Amery: So Paul, what are the WMR FX benchmarks?
Paul Clarke: Yeah, thanks. So the WMR benchmarks are a suite of point in time benchmarks that we calculate. We calculate rates every hour on an hourly basis. And then for 25 traded spot currencies, we also publish those rates every half hour. WMR has actually been calculating those rates for over 30 years. We calculate rates for FX spot currencies, for FX forwards instruments for NDF currencies and also for metals. We're very well known for the London 4pm. closing benchmark. And that's largely because of the amount of volume and the amount of interest there is in that benchmark. And we sometimes get called or it sometimes gets called the WMR fix or the 4pm fix.
Paul Amery: Thanks, Paul. And who uses the WMR FX benchmarks and how?
Paul Clarke: So the WMR benchmarks are used by a wide set of market participants. Index firms use the benchmarks and specifically the 4pm London close rates to value international indices both equity and bond indices. Fund managers, if they are operating passive funds that are tracking those indices, use the FX benchmarks to and those rates to minimise tracking error. Active fund managers will monitor and track their performance against the benchmark rates as well as hedge funds. And then they're widely used by corporates, asset owners, wealth managers for doing valuations, reporting, auditing and generally using them as a trusted FX rate. Futures exchanges use the rates for valuing and then calculating settlement of FX futures contracts, and then banks use them for a number of the reasons that I've already explained, including they use them for management of client WMR orders.
Paul Amery: Thanks for explaining that, Paul. For listeners maybe you could summarise the differences between an FX benchmark like the WMR rates and an equity or bond benchmark or index. I'm using benchmark and index interchangeably, but what are the principal differences?
Paul Clarke: I'd say at a high level, many equity and bond benchmarks are generally published daily often near the market close time for the market that the bond or equity is based on, and they're typically built as baskets of underlying instruments. So a number of equity products or of bonds. FX benchmarks vary slightly in that they're typically published through the day, not just once a day. And also they're generally including rates for specific currency pairs rather than being baskets.
Paul Amery: You mentioned the market closed there, Paul. And that obviously refers to trading on equity exchanges, but I know that the FX market is different in that a lot of trading takes place off exchange or as we say over the counter instead of being on centralised platforms. Why is that the case?
Paul Clarke: So the FX market has always been traded over the counter. I think a large reason for that is the fact that it is a 24 hour market. So trading moves continuously between regions and between major financial centres throughout the day. And that means that there isn't one single location or centre where trading would happen like it does in equities and other markets. Also participants need often bespoke transaction sizes rather than just multiples of a lot size. And also FX has always been based on bilateral credit. So there isn't a single solution that allows clients to trade with each other without having a credit relationship. And that's one of the main reasons also why people tend to trade over the counter.
Paul Amery: So let's dig into the nuts and bolts of the WMR benchmarks, how they're put together. First question, how does WMR collect and process the data from the foreign exchange markets?
Paul Clarke: Yeah. So we use multiple sources of data for the WMR benchmarks. That includes FX trade data and orderbook data from two of the primary venues in the FX market, and that's LSEG, FX matching and CMEs, EBS markets. And also we use quote data from a wide set of market participants. WMR has a real time set of feeds for these data sources, and the core WMR system monitors these three feeds throughout the day. During the benchmark window, it samples the data from those feeds and then uses it to calculate rates according to the WMR methodology.
Paul Amery: So how exactly is an FX benchmark calculated? Let's say at the 4pm London Fix, which is the most widely used benchmark window?
Paul Clarke: It varies slightly between different instrument types. But largely there's a lot of consistency in how the calculation works. So if I give you an example of a traded currency, a traded spot currency, then each benchmark windows for a certain time is actually has that time at the centre of the benchmark. So for 4pm, we have a 5 minute benchmark. So it starts at 2.5 minutes before 4pm and finishes 2.5 minutes after 4pm every second during that 5 minute window. The WMR system is sampling a trade if there is one. And also market data for each of the venues and sources that are being used. Each of those trades together with the order book data is used to create a bid and an offer rate for that second. And then at the end of the window, we pull together all the bids and offers across the venues that are being used and then use that to calculate a median bid and a median offer rate independently. The mid-rate is then calculated from those median bid and offer prices. And then finally we apply a standard minimum spread the mid-range to calculate a bid, an offer that's published together with the midway.
Paul Amery: Paul, thanks for explaining that, quite complicated process. Why is the benchmark window five minutes long?
Paul Clarke: So yeah, the benchmark window was extended to five minutes from one minute back in February 2015. And it was done because it was seen that one minute was too short for the market to trade. The high volumes that are done, particularly at 4pm. And also one minute had the risk that there could be a greater market impact from the trading that was being done during the window. And the length of the window has, however, remained a topic that's been debated. It needs to be long enough to ensure that there's good representativeness and allow the trading volume to be done with, whilst minimising market impact. But we don't want it to be so long that rates can be impacted by other factors that could influence the result and then impact achievability. And that could be other things that are happening in the market. So our analysis as well as market feedback tells us that five minutes is currently still a reasonable compromise and is about right. I'll also add a note that change in the window length isn't a simple thing to do because the whole market is geared around when the window starts and finishes, and then there's a lot of processing done afterwards.
Paul Amery: Thanks for going into that, Paul. I guess that a benchmark user would like his or her currency benchmark to be representative of the market, as it is also achievable in trading and robust. But are there, you mentioned that there was some judgement involved in the design of the benchmark. Are there trade-offs between these three qualities?
Paul Clarke: I think, not necessarily trade-offs. I think to achieve these qualities we need to base the benchmark on data sources and liquidity that the wider market can access. And also recognised as being key indicators of the market rate. We also want to make sure that the benchmark needs to allow participants to match it. If they're if they have a business goal to make sure that they want to achieve that rate through their own trading. And that requires both an open and transparent methodology that the market understands. And also using data and trades that the wider market has access to and can achieve. Also for robustness, that's important for a number of reasons. First of all, we need to make sure that the benchmark is robust and resistant to manipulation. Also we need to make sure that it can manage different market conditions that happen through the day and through different trades, through different days that have got different levels of liquidity. And also we need to make sure the benchmark is resilient to technical issues, either in the data sources or in the WMR system itself. So I don't think that there's necessarily trade-offs between the goals and many attributes and many of the attributes and requirements fulfil multiple of those needs. I think the length is an example of that where we have to get a balance there. But again, the balance in terms of the length of the benchmark is helping all of those aims.
Paul Amery: Paul, thanks for explaining that. Why are the standard benchmarks set at particular times of day? For example, the well-known 4pm London WMR Fix?
Paul Clarke: Yeah. So all the benchmarks that WMR calculate all use the same identical methodology. So there's no difference in how we calculate any of these rates. Really, the usage of the benchmarks is based around the external client market need. And it's driven by factors around the external market. So the London 4pm close the usage of that is really driven by the fact that that's the time that the global index providers use as a snapshot to then do their valuations of their indices. It's also obviously end of day for London and Europe, which is a big region for both the equities and the FX markets. Also New York and Boston closed. So Eastern 4:00 PM time is an important period. And for similar reasons that's when those markets are closing as well. We also see other clusters around Tokyo 9:55am and 10am which is a big time where there's other fixings in the local Tokyo market, as well as 2pm CET, when historically the ECB has calculated rates. 3pm London is a key time for the metals market. And then also we have other times that are used by the market based on either when FX futures exchanges are settling or valuing their contracts when there's option Expiries and all sorts of reasons like that.
Paul Amery: And why does FX market liquidity cluster at certain times of day? You mentioned earlier that FX trades around the clock, but clearly there are points in time where there's more liquidity than at other times.
Paul Clarke: Yeah. So traditionally when new markets are coming online. So the handover when Europe comes in is a big time for liquidity as well as when the eastern US markets start up, some liquidity is driven by the need. So for example around 4pm London is a big time of market liquidity. Because of the volume that some participants are aiming to do then. And then also there are other times of day based around economic announcements. So monthly on the first Friday of the month, you've got the non-farm payroll. And then other announcements during the month of important times as well. And then I think another thing that happens is if there are liquid times of day, participants will trade them because they know that's when there is liquidity and they can get volume done.
Paul Amery: Paul, how is the FX market changing? What structural changes are we seeing or have we seen over recent years?
Paul Clarke: Yes, it's a funny question because some specs, you feel like there are conversations and changes that we've talked about happening that are still looking to be happening. Other changes have really in other ways. There have been a lot of changes to the market in the last ten years. So if I think about the wider FX markets, we've seen a lot of introduction of transparency over the last ten years and look at the FX Global Code of Conduct and the changes that's been driving, that's been a key factor. There's been a lot of focus on what best execution means for clients and how banks and participants service clients to help them get the best execution. There's been further increase in algorithmic trading and execution, especially in the spot markets over the last ten years. And also there's been a focus on reducing risk and costs. I think that we expect especially banks to focus more over the next two years in how they reduce costs and also how they continue to service their clients as well as they can. They want to reduce the cost on their balance sheet from doing FX trading and that's a driver towards clearing.
Paul Clarke: And they also want to look at other ways to reduce costs and improve efficiency, things like managing their credit risk. I think on some specific things that we see potentially changing for a long time, there's been talk about when will the forwards market move to be more electronic, but there's been moves over the last few years with different venue operators launching venues, which I think is starting to drive a change there. So I think that's something that's going to happen. Similar to that, there's going to be a focus on more emerging and growing economies. So we see there being a continued focus on trading NDFs in certain currencies as well as cash in those currencies. As well as the obvious thing that a lot of people talk about is the drive to digital assets and tokenization which is obviously hard to predict where that's going to end. It's been talked about a lot over the last few years, but the trends that seem to be getting momentum are central bank digital currencies the use of stablecoins and also the use of distributed ledger technology to improve and reduce settlement costs.
Paul Amery: Thanks, Paul. And are there any key enhancements or changes that listeners should be aware of when it comes to the way we operate the WMR FX benchmarks?
Paul Clarke: Yeah. So one of the things we're trying to do is make sure that we're talking to clients as much as we possibly can to get their feedback and to understand their needs and issues. One of the things that we aim to do is have a regular review of the methodology we use for the spot instruments. In fact, we've recently been running a client consultation on two changes that we're proposing to make to improve the representativeness of the spot rates. We're also looking at additional data sources and potential methodology changes for the FX forwards and NDF rates in order to improve the representativeness of those rates, especially as the market is starting to grow in how they're traded. And then also WMR is, is continuing to invest in resilience because that's such an important issue.
Paul Amery: Paul, thank you very much for taking the time to join me.
Paul Clarke: Thank you. Thanks for having me.
Paul Amery: That's it for this episode of Index Ideas. If you've enjoyed the conversation, then please follow us and give us a rating or review on your podcast app of choice. If you'd like to get in touch with the show, you can do so via the email address
[email protected]. But for now from me, Paul Amery. Goodbye.
