FX and Banking: A bad year to have a good year

Although few banks strip out the results, Euromoney believes that most of them have recorded bumper profits form their FX activities in 2008. Coming on top of generally solid performances in 2007, many will now be hoping that repeat performances will be seen in 2009.

If ever there was a bad year to have a good year, it is likely to have been 2008. With most other departments suffering badly, the bumper results produced by many FX units are likely to prove a sideshow in what will be a year of write-downs and general value destruction. The chances are that many FX participants will find they have not been rewarded as they think they should. Although this will obviously prove disappointing, in the longer term it should cement the reputation of FX as a proper asset and a realistic business line.

This year might well prove to have been a watershed in FX for several reasons, some of which are not yet fully apparent. Market participants have long believed that FX is an asset in its own right and while it remains true that the currency aspect is often ancillary to a cross-border securities transaction, the market’s overall liquidity should continue to attract new players.

Consistent prices

The reality is that there is almost always a price in FX and that price is accessible to virtually everyone. What remains to be seen is whether the new breed of FX service provider, specifically those catering for the retail sector, can evolve into more significant participants in the overall market. At many times in 2008, the prices quoted by these companies, once derided as bucket shops, have been far tighter and more consistent than those of the supposedly dominant banks.

But the continuing importance of the banks should not be discounted. Of course, most of the big players have faced big problems in other areas of their business. Therefore, it should not have come as a surprise that, as December approached, activity in FX was starting to drop off quite rapidly. After all, few banks will have been ready to gamble their FX profits in the present climate.

What is telling, though, is that at the same time as volumes have started to drop off, the market’s major liquidity providers have, according to several buy-side sources, started to tighten their spreads. Royal Bank of Scotland’s quant solutions team sent out a note at the end of October that highlighted how sophisticated the banks have become at trying to quote in accordance with the underlying market conditions.

Attractive assets

RBS compared the spreads and volumes on EBS and Reuters in September and October 2007 and 2008. This shows that spreads did widen when volatility became excessive but that tellingly the number of transactions did not decline. RBS points out that an increase in transactions does not necessarily equate to an increase in liquidity. But, as the evidence from EBS last month suggests, volumes have not yet fallen off. The anecdotal evidence is that now they are, spreads are coming in again, which ultimately bodes well for the market’s health because it ensures that FX is the most attractive of all assets to trade.