SO IT WASN’T a blip. When UBS scored a rare victory over Citigroup to be recognized in our poll last year as the bank with the largest market share in foreign exchange, some rivals sought to convince themselves it was a statistical error. This year, though, not only has UBS won the top spot again; it has also increased its market share. What is more, Citigroup has been shoved squarely into third place in the market share rankings by Deutsche Bank. After over 20 years of consistently leading in this poll, Citigroup has seen its dominance of the market crumble.
The sample size for Euromoney’s 2004 poll is significantly larger than it was last year, when 1,901 valid replies represented $17 trillion in annual turnover. Out of the $24 trillion that is transacted by the 3,501 valid respondents to the poll this year, just $40 billion separates UBS and Deutsche. That kind of difference can be wiped out by a single vote.
Neither firm thinks its period of growth in this industry is over. “It is still a top-line strategy to grow our business,” says Fabian Shey, global co-head of FX distribution at UBS. “We still believe very firmly in our strategy to be a comprehensive FX provider … and we think we have the platform to continue to grow our market share, broaden our research and deepen our relationships.” Shey adds that the bank is serving many more clients than it was a year ago.
Meanwhile Deutsche Bank is understandably disappointed to have missed the top spot by such a narrow margin, and indeed the firm’s global head of FX and commodities, Jim Turley, offered to lend Euromoney’s research team a calculator to re-count the results. But Deutsche’s jump in market share of nearly 2.5 percentage points is impressive by any measure. “The result shows a big change in our market share, so I am delighted,” says Turley.
Citigroup misses out
Citigroup’s market share has changed only slightly year on year. It is down by just half a percentage point to 9.37%. So it seems that UBS and Deutsche Bank are finding new pockets of clients and ways of doing business that are not necessarily stealing business from Citigroup. Instead they are creating and maintaining flows that Citigroup is simply missing.
UBS and Deutsche Bank share a lot of clients and compete directly for a large proportion of their trades. Our research shows that nearly 60% of the turnover that the two banks handle comes from clients that list them both as counterparties.
The result is that UBS and Deutsche are breaking away from other banks and consolidating their global role. Predictably, and unlike other firms, they welcome this concentration of liquidity. “It sets a standard that is healthy for clients, because they must be getting a better service or they would not be dealing with those banks,” says Turley. “If that prompts the other banks to up their game to that standard, that is good for the market.”
Similarly, Shey at UBS describes this concentration as natural evolution. “For the banks, there are, we believe, two valid strategies in FX,” he says. “One is to be a full-service provider, where you have a large fixed cost base, and the other is to focus on service and to outsource the liquidity to other banks.”
UBS was the first bank to spot this trend for liquidity outsourcing. It is not a lending bank, so when it decided it wanted to be big in foreign exchange, it couldn’t turn to a large corporate client base and build on existing lending relationships. Instead, it provides liquidity to smaller regional banks, and they pass on FX products to their clients. Up to now, UBS has done the best job of promoting its services in this way. Among non-market-making banks, its market share is over 19%.
The success that UBS has had with this client group is viewed with a mixture of envy and admiration by other banks. As one head of FX says: “If a bank decided that it wanted to be big in liquidity outsourcing, it would be like someone turning up in London and saying they wanted to set up a nice little chain of coffee shops. They would soon realize that a firm called Starbucks had already cornered that market.”
Nonetheless, several other banks are making the investment to compete with UBS here. Goldman Sachs has increased its coverage of those clients, and Deutsche Bank has almost doubled its market share to 15% this year.
Banks that are lower down the overall market share rankings are quick to insist that they are more profitable than UBS and Deutsche, both of which have spent heavily on technology to secure outsourcing flows and other business. But while profitability rankings may look substantially different from market share rankings, the key decisions for each firm are how much it is willing to spend, and how important it feels that foreign exchange is for the rest of its business. “We are committed to a cost base that other people would not want to be committed to,” says Turley. “And we are going to continue to invest in the infrastructure.” He is not referring just to technology here; many banks are not comfortable with other costs that Deutsche is willing to bear, such as maintaining offices around the world.
It is never wise to write off Citigroup. After all, it has extended its lead with corporate clients, winning a market share of over 13% in that segment. But a gradual drop in the overall rankings from first place to third does look worryingly like a trend. If it falls further over the next year or two, it will be especially clear that it has serious issues to address. Jeff Feig, the bank’s new global head of foreign exchange, is determined not to let that happen. Feig took over from Richard Moore, who moved internally to the role of co-head of global rates and currencies in early 2004. “We are not trying to be number one just in FX,” says Feig. “If we try to be a niche player that will limit us. It seems that nobody competes with us in as broad an arena.”
Other banks are always keen to offer reasons for Citigroup’s fall from the top. One suggestion is that while Citigroup has some excellent and unusual electronic execution tools, the core technology lags behind what others have to offer. It concedes this point to an extent. “It seems that electronic activity has been increasingly important in winning volumes. We are beefing up there,” says Feig. “I think we have emphasized value-added products as a way to increase the volumes we do as opposed to just putting plain vanilla in front of every customer.”
Stifling bureaucracy and politics
Another possible reason is that Citigroup has been too focused on its corporate franchise, so has not capitalized on the growth of other client groups. Feig disagrees. “No, I don’t think so at all,” he says. “The corporate segment is important to us but I don’t think we have stressed it over others.” Over the past 18 months, the bank has set up new teams to address the needs of non-market-making banks and hedge funds.
But the suggestion that appears to rattle Feig the most is that Citigroup has slipped down the rankings because it does not hire and nurture the best staff. Anecdotal evidence suggests that some people who have left other firms and gone to Citigroup have quickly returned, saying that they found the environment was not conducive to creative thought. Another senior FX banker says he regularly interviews lots of people to fill new positions, and the candidates he sees from Citigroup are certainly not the brightest. The external perception is that while Citigroup may have many more people working in FX than other banks, those people are stifled by internal politics and bureaucracy.
“We absolutely have the best people,” says Feig. “We do offer people a lot of opportunity to develop new ideas and skills and to further their careers.” However, he does concede that different areas of the bank have not worked together in the past as well as they might have, and this is a situation that has improved.
Citigroup’s volumes may be lower than those of the two leading banks but it received hundreds more client votes, highlighting its strong corporate franchise. These place it at the top of most of the service categories of our poll which are not volume weighted. Corporate FX volumes are, as a whole, lower than they were in the late 1990s. Big-ticket M&A business has fallen, which removes a small number of very large trades. And new regulations such as IAS39, which forces corporates to mark to market FX options and other products, has dampened corporate appetite for a range of FX products. This has hit some of the banks that are more reliant on corporate business particularly hard.
Thankfully for them, the impact appears to be short-lived. “It is something we expected through the third quarter of ’03,” says Bob Gotelli, global head of FX sales at Bank of America, which performs significantly better with corporates than with other types of clients. “But we saw a pick-up which began in the last quarter of ’03 and continued through the first quarter of this year… There has been a very obvious turnaround.”
Wooing hedge funds
Bank of America is looking to boost its foreign exchange business globally, and it has invested in people and technology to achieve that. According to the results of this poll, it is clear where the areas for improvement are for the firm. It ranks ninth with corporates, for example, but fourteenth with institutional investors. “Where we rank lower is where we started to focus over the last five months,” Gotelli says. “I think we know our strengths as a franchise and when I look across what we have done in other asset groups and what we have done with the corporate clients, we can use some of the same things to grow our institutional business.”
But perhaps the most interesting example of a bank that has been wrong-footed by shifting patterns in foreign exchange is BNP Paribas, whose overall ranking slipped from thirteenth to eighteenth this year. The bank ranks tenth with corporates, and nearly 50% of its votes came from corporates, which is an unusually high proportion. Those clients clearly value the relationship, advisory services and structured products that the bank has to offer. And its FX business remains profitable, which is a key aim for senior management.
But it misses out on the rapidly growing hedge fund volumes, because it lacks prime brokerage services and it does not give funds to those types of clients to invest. And it decided to hold back on technology spending until it had a clear view of the types of execution tools that would emerge as the most popular. Now appears to be the time for it to tackle issues such as these.
The bank is reviewing its technology and working on ways to target hedge funds. “That will not mean just hiring one person. You need prime brokerage activities. You need a trading platform. If it is so important, we will start moving into that area,” says Ligia Torres, the global head of FX sales. And even aside from efforts such as those, a big push into new types of clients would require new client coverage models. “Our sales people cover cash and options,” she adds. This is natural for a firm that focuses on corporates. “Now I think the bank needs more specialists in, for example, options, for the hedge fund community.”
Prime brokerage continues to be an important way to secure hedge fund business, and the banks that can offer it on a cross-product basis are in the best position. “We started with equity prime brokerage, which was a core product, and we didn’t think we could transfer it to FX,” says Mike Burton, head of institutional FX sales at Goldman Sachs. “But since we did that, it has led to more client loyalty.”
That experience is mirrored at JPMorgan. “Most people do not change their prime broker very easily,” says David Puth, the bank’s global head of FX. “It is a relationship business, and we provide a service beyond just FX.” Indeed, it is just about impossible to find any sizeable FX bank that does not already offer prime brokerage or is not thinking about doing so.
The new challenge in catering for hedge funds is defining who those hedge funds are and working out how to cover them. This sounds straightforward enough, but as all types of foreign exchange clients increase their levels of sophistication – a trend that all large banks have identified – suddenly everybody starts to look like a hedge fund client.
And as bankers continue to move into hedge funds, they are taking with them a good idea of the products and services that they can demand from banks, which can make them difficult to please.
Institutional investors are moving away from using conservative currency overlay simply as a way to smooth out risks from currency shifts. Instead they are shifting resources into seeking alpha from currencies. “This is the first time that currencies are becoming recognized as an asset class,” says Rashid Hoosenally, managing director and head of client strategy and product innovation at Deutsche Bank which, according to this year’s poll results, is the number one counterparty for institutional investors and for hedge funds. Hoosenally adds: “From currency managers, overlay managers, hedge funds and across the investment management community, 2003 was the biggest year of inflows into FX that we have ever seen.”
Capital introduction
And as established fund managers set up their own in-house hedge funds, the distinctions between clients become even more difficult to handle.
As part of its effort to develop its foreign exchange business, Merrill Lynch is trying to capitalize on this trend, offering capital introduction and advisory services to funds, and developing total return strategies for asset managers and even central banks. It is also successfully linking institutional and retail business, by building FX funds of funds.
In general, and despite the recent announcement that global head of FX Michael DeSa is to leave the firm to pursue other interests, Merrill Lynch’s FX development project is going better than the gossip among other bankers would suggest. It has moved to number 10 in the overall market share rankings, which is an improvement by one place, and which forms a clear contrast with the last time it quickly rose up the market share tables, then rapidly fell again the following year. If it is to progress, then it will need to improve its standing with corporates, and it will need to build consistent performance to attract clients such as pension funds. It is also considering going into prime brokerage.
The trick for the full-service banks such as Merrill Lynch is to hold on to institutional clients as they become more demanding, rather than letting them run to specialists such as CSFB and, possibly the most successful niche player of them all – State Street. That Boston-based bank manages to consistently appear in the top 20 rankings overall despite essentially having no corporate coverage at all – it ranks below 50 for those types of clients.
State Street, which describes its analysts as “high bandwidth”, is a good example of a firm that attracts volumes on the back of its research and advisory services – a relationship that is often difficult to prove and even more difficult for banks to enforce. No firm wants to feel as if it is providing the strategic advice but not getting paid for it, just as no firm wants to provide just low-margin electronic spot execution.
But if banks’ enthusiasm for developing their research and advisory services is anything to go by, some sort of link with flow must exist. In addition, prices are now so tight in terms of the bid-offer spread, so homogeneous across all firms, and so readily available through electronic channels, that clients have more freedom to reward banks for advisory services. If a fund manager knows that the last several hundred times it sought five different prices on a transaction from five different banks it got five almost identical prices, then the issue of seeking the best rate becomes less important. That means that the fund manager can justifiably give 60% of its FX flow to just one bank as a reward for good advice. And large flows from a diverse client base create good data, which in turn creates good research. And so the cycle of market concentration continues.
HSBC aims for top three
This makes it difficult for banks outside the top tier to develop a foreign exchange business. Nonetheless, some are trying. HSBC’s rise in market share and ranking in this year’s poll reflects a general development of its investment banking and capital markets business. The firm is ranked fifth this year, after dragging its way up from twelfth in 2002. In the early 1990s it regularly featured in the top seven but after the emergence of the euro exposed its continental European weakness it found it difficult to compete globally. Its technology lagged behind that of other banks.
Now HSBC has transferred Mike Powell from Asia, where he was treasurer and head of global markets for that region, and brought him to take on the same role in Europe for Stuart Gulliver’s global team. He is frank about HSBC’s long period of weakness. “I don’t make any bones about that,” he says.
“It often happens. Those people who are at the front end of a product are not the ones to move quickly.” He plans to add 1,000 clients to the bank’s e-commerce platform this year, and he is hiring, taking staff from firms such as Deutsche Bank and Goldman Sachs to build a sales team in all the main client groups and products. “We will be very difficult to compete with,” he says. “My expectation is that next year we will be in the top three – that is the aim.”
To get there, though, Powell will need to barge past not just Citigroup but also JPMorgan. This will not be easy, especially as JPMorgan is about to gain 20,000 new clients through its acquisition of Bank One. In Europe alone, JPMorgan has hired 11 new sales people over the past year. It has also integrated its FX and commodities businesses, which gives it an unusual advantage in corporate advisory services as well as electronic execution.
Barclays Capital has risen by two places to rank seventh this year, and it has shot up from fifteenth to fifth with corporates. Its head of foreign exchange, Ivan Ritossa, hopes to win a full view of the market by building a diversified client base. In a move reminiscent of UBS and Deutsche Bank, it overhauled its back-office systems about two years ago, and can now boast some of the best execution technology available anywhere. “We are a high fixed cost, low variable cost business,” says Ritossa. “The real barrier to entry is the fixed cost.”
The same is true of Royal Bank of Scotland, which offers cutting-edge execution tools for small payments and for trade matching, as well as robust standard executable streaming rates and some advanced options pricing facilities. RBS’s global head of FX, Peter Nielsen, says: “It [good technology] is a very important part of what top-tier clients will demand. We have made this investment.”
But of course a bank cannot build a business on technology alone. “The differentiation is in the people,” says John McCormick, global head of sales, marketing and structuring at RBS. “We have added back human beings, especially in the middle and back office.” The firm is also capitalizing on its lending relationships.
What market shares RBS and Barclays Capital will have in 12 months’ time is anyone’s guess. With their sizeable lead at the top, UBS and Deutsche Bank appear secure. But if HSBC can deliver on its promise to penetrate the top three, the order of the other big foreign exchange houses could be unsettled.
The market share level at which banks are now becoming second tier is rising. Smaller banks must decide now whether to copy aspects of strategies that have worked for other firms; build a niche; or to give up.
