Latest updates:
The FX debate – a response from RBS March 2006
Answers to the FX Problem January 2006
It’s the biggest story in the foreign exchange market but nobody wants you to know about it. Six of the world’s largest forex banks are looking at a proposal to create a new spot-trading platform solely for their own use.
Beyond that, the foreign exchange market’s vow of silence kicks in, and it’s hard to find out exactly what’s going on. Some banks say they’re not interested in the proposal (at least for now). Some say they are considering it. Many point the finger at Deutsche Bank and Reuters as the driving force behind the plans (though they are not sure quite what the plan is). Deutsche strongly denies its supposed role, while Reuters won’t comment, even though some bankers say its technology is in place and ready to go.
Some things are more clear. The leading banks have played a big role in creating a system that threatens to do them more harm than good. In effect, they’ve shot themselves in the foot. The proliferation of electronic trading platforms (and no one actually knows how many exist) has increased turnover in the spot market but at the same time cut back spreads to the bone and beyond. Liquidity is poor. Clever traders are taking advantage of the system at the expense of the major liquidity providers.
This intrigue neatly sums up the current state of the foreign exchange market. It is riddled with contradictions. Its participants know this, even if they are loath to admit it. In one breath they’ll tell you forex is the largest market in the world, with a daily turnover of more than $2 trillion a day. In the next they’ll claim it has a liquidity problem. If both statements are true, the market must have deep structural faults that are adversely affecting its overall efficiency.
It’s no wonder the leading banks, having invested enormous sums of money in becoming one of a handful of true liquidity providers to this huge market, want to rectify the situation. The question is this: should they make an effort to pool their own liquidity, or will they create just another platform that has little chance of changing anything?
New solution
The solution that is being touted to the perceived liquidity problem is a new platform that will only allow access to the large trading banks. In effect, this is an attempt to recreate interbank dealing, which has all but disappeared since the advent of electronic trading in 1993. Before that, most major banks traded routinely with each other in larger than market standard amounts either on the phone or via the Reuters direct dealing system. Market sources insist that Deutsche Bank is leading this initiative.
Deutsche Bank denies that it is the driving force behind any bank-only platform initiative, and a spokesman for the bank says that it continues to work closely with many vendors to improve the way that it provides and receives liquidity.
Although Deutsche would not comment more specifically, an insight into the way it, and no doubt other banks, perceive a potential problem in the spot foreign exchange market was provided by Ian O’Flaherty, Deutsche’s global head of e-commerce for global currencies and commodities, in Euromoney last month [see Winners and losers in the FX spread war, November edition].
In the article, O’Flaherty said that he envisaged the electronic market as a pendulum, where at the point of equilibrium both the buy side and the sell side receive value. But, he added: “New technology being introduced into the space could make [the pendulum] swing farther in favour of the buy side. We will have to see how sustainable that is.”
Whoever is behind it, the concept ostensibly appears to have merits; in some ways it mimics the block-trading platforms in the equity market. These act mainly as a complementary rather than a competitive service to that offered by the exchanges.
Few of the banks said to be involved are willing to say anything, at least officially. But if one breaks through the FX market’s omertà, the whispers are loud enough to suggest that the venture might be doomed as early as the concept stage.
Of the eight major banks questioned for this article, only three are prepared to go on the record about the new platform. UBS says simply that it has no plans to take part at the moment, HSBC says it is considering doing so and Deutsche denies leading it.
One of the top six-ranked FX banks according to Euromoney’s latest survey, published in May 2005, which declined to be named, offered the following comment: “We are studying a proposal made by Reuters. How it would work in practice isn’t clear, so it would be wrong to assume we’ll say yes. The proposal is to create a bank-only tier in the market, a closed user group for spot matching for six banks. The people to talk to on this are Deutsche. The idea seems to be to disintermediate EBS.”
This is an extremely powerful statement and, not surprisingly, Deutsche Bank rebuts it, saying it has no intention of trying to disintermediate EBS or any other portal that provides it with liquidity. Reuters, which is EBS’s only real competitor in the electronic broking space, also has little to say on the matter.
Its only response was as follows: “The FX market is an extremely competitive marketplace and it’s natural for participants to look for new ways to access best price and pools of liquidity. Reuters supports the development of the market and is happy to work to support its customers’ business goals. However, as a matter of policy, Reuters doesn’t comment on market rumour and cannot comment on this specific initiative.”