That the market is feeling the gravitational pull of a few big names has been one of our favourite topics for at least six years. But perhaps we are wrong. The very biggest banks have so far failed to become supernovas: the market share of the top five, according to Euromoney’s FX survey, was stable at just over 60% between 2007 and 2009 and dimmed to 54.6% in the 2010 survey. Perhaps last year’s result was a kink in the fabric of the FX space.
Yet I can’t help thinking that the laws of FX and physics are inescapable, especially after Mike Bagguley’s comment, quoted in last week’s theweeklyFiX, about the immense expense of preparation for, and speedy compliance with, new regulation. It seems that talk of FX provision having ‘barriers to entry’ at the highest level is not an accurate observation: the phrase ‘barriers to survival’ may be more appropriate for smaller bodies in FX’s expanding universe.
At a Citi presentation this week of its Velocity platform and the bank’s general approach to FX, I was impressed by how difficult it will be for most banks to accelerate with, let alone catch up to, the leading five or six.
I was already aware of Citi’s philosophy after speaking to Mike Page, the bank’s FX chief operating officer, last year. Page said: “FX has always been taken seriously here, but now it has a much higher profile. Both profitability and customer penetration has continued to grow consistently, regardless of problems in the wider financial markets. If CitiFX [as the Citi FX business has been re-branded] was a stand-alone company, it would feature in the Fortune 500; if profit per employee was a measure, it would feature very close to the top.”
At this week’s presentation it was claimed that Citi is “the most profitable bank in FX”. Page told theweeklyFiX that the focus is not particularly on revenue, rather it is on the efficiency and development of the business: “The first essential is to get the current processes, systems and support areas working optimally. The second essential is to have a vision of the future of FX and to plan to align the business with that vision; projecting our vision to the supporting areas, and our strategy to meet it, enables us to get total buy-in throughout the process.”
The over-arching vision comes from Anil Prasad, the bank’s global head of FX and local markets. Prasad insists that the provision of the fullest range of FX product to the fullest range of client segments is crucial: “You need e-commerce platforms tailored to each segment – we have one tailored towards the corporate sector, one tailored towards high-frequency users, an e-commerce platform for retail investors. You need auto-trading capability – something that is very difficult to build – so that it is profitable and efficient, you need algorithmic execution suites (even corporate clients use algos to transact in today’s market) and you need quantitative investor strategies – your alpha and beta models”. And each product group is complementary to another: client segments differ in their profitability and in the value of the flow information.
The last two words of Prasad’s job title – local markets – is significant: Citi’s footprint covers 83 countries, rivalling ‘the world’s local bank’ HSBC, and Citi claims to have FX traders in every emerging market country. “The fact that we’ve got traders on the ground that know the central bank, that know other market participants, that know the local client base, that are aware of the local regulations and what the sentiment on the street is gives us an enormous edge,” says Prasad. The cost must also be enormous, not least because the technology is fundamental to the business and its development.
Prasad says: “Using technology to create an information highway is absolutely vital; having a large footprint is not of itself enough to get ahead”. Citi says it executes around 75% of all FX trades electronically; all flow information, as well as financial data, research and commentary is collected, processed and distributed within seconds.
“For this business model to work well, a trader sitting in Thailand or Brazil must know as much about the situation in Egypt as our traders in Cairo or London,” says Prasad. “Leveraging information into knowledge.”
One, perhaps minor, indication of the power of such leveraging became even clearer in a post-presentation discussion. The major single-bank platforms often transact as much as $100 billion of spot per day; about 30% of that is EUR/USD. If during a day it is identified that order flow has favoured EUR purchases by say 54%, that the spot price is hardly better bid, and that the majority of the buyers were speculative accounts, the obvious conclusion is that some liquidation is likely later in the day. Such information and analysis is routinely distributed both internally and externally to clients.
The top players are differentiated by their scale – in terms of geography, product and technology, and have now reached a critical mass in terms of flow internalization and flow information. Those who haven’t yet reached such critical mass may find the costs of doing so prohibitive. For smaller stars the option of relying on geographic or product niches is also disappearing as the top tier expands across all dimensions.
We may be witnessing the separation of the FX sell-side into the top tier and the rest. Technology – rather than making distances smaller – is making the gap bigger. Prasad says: “The business is consolidating into fewer players; partly this is because of the footprint and product suite that is required. But it is also because of the technology – unless you have cutting-edge technology, it is not possible to truly compete in this business.”
And the cost of that technology is getting beyond the budgets of most players. Alex Jackson, Citi’s head of European investor sales, sums it up: “10 years ago we would have seen a medium-sized bank as a competitor, now we see them as a client because the technology spend required is significant.”
