Apples to apples FX pricing: A critical market service

According to the Bank for International Settlements (BIS), turnover in the global FX market regularly exceeds that in the global equity market by more than an order of magnitude: in April 2022, over-the-counter FX trading volumes averaged $7.5trn a day, compared to average daily turnover of “only” $551bn in global equities^[1].

But whereas equities are largely traded on exchanges, with the associated fixed trading hours and official daily closing prices, the FX market is diverse, trades 24/7 and lacks any concept of a closing price (or time).

In the presence of such high fragmentation and under conditions where most trades are conducted bilaterally, benchmarks play a particularly important role in reducing information asymmetries. Everyone conducting an FX trade needs some reference point for prevailing exchange rates—otherwise they are trading in the dark.

It’s important to remember that foreign exchange market participants have a choice of benchmark provider—and they also retain the possibility of calculating FX rates themselves: for example, it’s possible to snap a streaming contributor quote from a data vendor at the same time every day or to pull in the official FX rates published by central banks.

While credible, such approaches may fall short in fully managing the risk of exposure to sudden market movements, data anomalies and potential delays caused by delivery mechanisms. Anyone calculating and administering a benchmark must also bear in mind the increasingly stringent regulatory requirements in this area.

WMR FX benchmarks were first introduced in 1994 because asset managers lacked a standardised way of reporting foreign exchange rates, making their performance hard to measure. This is still one of the main use cases of FX benchmarks—active asset managers need them so they can compare themselves against other managers in league tables. 

But the user base now goes far beyond this original contingent. Corporations need FX benchmarks for internal and external accounting. Passive (index-tracking) funds worry about tracking error, meaning their managers want FX market counterparties to offer the ability to trade at WMR rates rather than just at the best available market price. 

Index firms use WMR spot and forward rates in the calculation of multi-currency equity and fixed income indices. Trading platforms, fintech companies, websites and web applications use foreign currency rates across their business activities and require a standardised way of calculating and reporting FX.

And, returning to active managers, it’s increasingly hard to generate performance, especially in developed (vanilla) markets. FX exposure and transaction costs can have a big impact on returns and more and more managers and pension funds are paying attention to that cost element.

What should an ideal FX benchmark look like? It should be robust, attainable and representative. Guaranteeing all three attributes simultaneously may be impossible, since there’s a trade-off between robustness and attainability (see below)—but the benchmark should target those objectives simultaneously.  

Modifications in FX benchmark design during the last decade (in particular, the widening of the 4pm London fix “window”) mean that high-quality benchmarks now have enhanced governance controls, safeguards against potential conflicts of interest and limited discretion in the benchmark-setting process. 

In summary, a reliable FX benchmark is:

• Consistent – It is widely available, timely, and delivered using a transparent methodology.
• Representative – It accurately reflects FX market prices throughout the day or at a specific time, where necessary respecting the dynamics and operating rules of local FX markets.
• Liquid – It represents a liquid market, with the potential to improve liquidity through the amalgamation of trades.
• Attainable – Asset managers wishing to ‘trade at the fix’ to minimize tracking error should be able to attain that FX market price.
• Robust – It should be constructed with built-in roadblocks to potential manipulation (the benchmark’s methodology should be well-designed and it should consolidate multiple data sources, having plans in place to ensure adequate data sourcing in times of market stress).

Created in 1994, WMR FX benchmark rates are the global standard for tracking currency movements, whether your need is valuation, comparison, reconciliation, hedging or transactions.

WMR FX benchmarks are based on three core principles: (1) Quality data inputs and benchmark oversight; (2) Data sufficiency and integrity; and (3) Tailored methodology. 

We apply multiple validation techniques to capture and calculate rates, ensuring accurate spot and forward rates at each fix throughout the day. Our process is designed to produce benchmarks which are resilient to third-party attempts to influence FX rates.

There are always trade-offs in benchmark design, for example when it comes to the time window during which trades are captured. 

In less liquid FX markets, a shorter trade capture window provides less underlying data for consideration and could make the FX benchmark less representative or more prone to being skewed. But in very liquid FX markets a shorter window ensures the most accurate rate at that time of day.

WMR benchmarks aim to balance these potentially opposing objectives to provide the optimal benchmark design from the perspective of the whole user base. And if a currency market sees disruption, we work with stakeholders to find creative and credible solutions to value their FX exposures.

The foreign exchange market evolves continuously and benchmark oversight and design must cater for changes to market infrastructure. For example, last year’s switch to next-day (T+1) equity settlement in the US, designed to increase efficiency and reduce risk in US domestic markets, put some strain on longstanding FX settlement processes, with possible knock-on effects on FX trading practices.

In recognition of their importance to the global financial markets, WMR FX benchmarks (4pm UK), which are administered by FTSE International Limited, have been designated as “critical benchmarks” under the UK Benchmark Regulation since November 2024. 

As an FCA-regulated Benchmark Administrator, FTSE Russell has the robust governance structure and control framework in place to manage the WMR FX benchmarks effectively and in accordance with regulatory requirements. 

It is important to emphasize that benchmark regulation and administration are now activities requiring significant oversight. FTSE Russell, a London Stock Exchange business, has over 60 years of history in index management — 30 of those in FX benchmarks — and it has both the business model and the support structure in place to meet the high standards required for market use.

Learn more about WMR FX Benchmarks and how they can meet your reporting and valuation needs. Our WMR Metals Benchmarks extend the WMR approach to the precious metals markets.

1. OTC Foreign Exchange Turnover in April 2022, Technical Report (BIS), World Federation of Exchanges data.