FX poll 2009: Staying power in troubled times

ALTHOUGH IT IS too early to say whether the profound changes that have altered global financial markets over the past two years are structural or cyclical, one outcome is that foreign exchange is now regarded even more widely as the proper asset it has always been.

FX, like other markets, had to face big difficulties in 2008. The fact that the turnover reported in the 2009 Euromoney FX poll, which covers the 2008 calendar year, was only marginally higher than in 2008 – $175.3 trillion compared with $175 trillion – might cause some concern and lead some to ask if the growth of FX business has reached a plateau. Realistically though, volumes, which have soared from just $40 trillion in 2005, simply could not have kept increasing at the same rate indefinitely. Encouragingly, the number of buy-side players voting this year has again increased, surging nearly 24% to 12,150. The suggestion is that while increased volatility has led to a reduction in the notional size of positions put on by some risk takers, more people now realize that they have a duty to manage their FX exposures. Ultimately, this bodes well for the market.

The top-five banks in the 2009 poll are the same as in 2008, which seems astonishing given the amount of money they have written off between them as a result of the sub-prime crisis. Although they have collectively lost more than $180 billion and raised more than $225 billion in fresh capital, they appear not to have been punished in any meaningful way by their FX clients.

Deutsche Bank continues to lead the pack, with a market share of just under 21%, down fractionally from 21.7% in 2008. UBS is still in second place, although the gap between it and Deutsche has widened, and Barclays consolidates its third place. RBS, which so nearly went bust in 2008, has actually managed to increase its market share to 8.2% – and that is excluding the vote that went to ABN Amro – and climbed above Citi into fourth spot. Between them, the top five account for 61.5% of the reported volume, which is a small increase on their share in 2008. The expected challenge to their hegemony from those banks whose balance sheets have not been so severely challenged by the sub-prime crisis has failed to materialize.

Overall, the market share of the top 10 in the poll has risen to 79.7% from 76.3%. A far larger vote for Credit Suisse (3.05%) moved it up from 14th to 9th, while the top five are certain to have noticed that although JPMorgan remained in sixth spot, it increased its market share by nearly 2.25 percentage points. BNP Paribas is another significant player that is moving up the rankings, breaking into the top 10 with a 2.26% market share. Slightly further down, there are also better showings for State Street and Standard Chartered, two banks that have at times failed to translate their profitability into a strong showing in the poll.

The resilience of the FX market and the performance of its larger sell-side players means that currency trading is increasingly seen as a core competency in many banks. Even a year ago, most senior FX figures would not admit openly that their standing within their organizations had gone up. Now they are less reticent.

“We get a lot of attention from senior people in this institution,” says Jeff Feig, global head, G10 FX, at Citi. “When the CEO comes down to 300 Greenwich he always comes by FX and asks how we’re doing, what we’re up to, what we are thinking and what our clients are thinking. Jamie Forese, the head of markets, and John Havens, head of ICG [institutional clients group], are down on the floor at least a couple of times a week. That would not have been true in the past.”

Another senior FX figure puts it more bluntly: “I don’t even think the previous CEO knew who I was. The current CEO knows who I am, and if he comes on to the FX floor and I’m not around, he asks where I am. The management is now interested in our market views, because we are a macro product and have strong macro views.”

Low balance sheet business

Reto Stadelmann, global head of FX trading, FICC, at UBS, points to another obvious attraction of FX. “In the current environment, any businesses with low balance sheet usage and a revenue stream that is more client driven is likely to be more attractive,” he says. “Within UBS, the strength of the FX business model had been evident, but its attractiveness really shone during the financial crisis.”

“The secret here is how to be consistent when consistency is required and how to change when change is required. We have never taken our leadership position with clients for granted” Zar Amrolia, Deutsche Bank

Zar Amrolia, Deutsche Bank’s global head of FX, agrees with this. “Flow businesses have firmly re-established themselves at the core of most banks’ sales and trading operations,” he says. “FX has a great return on economic capital due to the short-dated and liquid nature of the product, and minimal balance sheet consumption, and the industry has worked together in minimizing systemic risk. It has fantastic risk-adjusted returns as well as genuinely reflecting client needs, and as a result will see focus and continued investment.”

Brad Leek, global head of financial institution FX sales at RBS, explains why the market has become even more attractive for the banks to be in. “The FX story is a compelling one,” he says. “It has a high risk-adjusted return on equity, low usage of risk-weighted assets and low credit utilization – all from an annuity-based business. FX is now truly an asset class, and banks that want to provide a full service need to have scale to meet the needs of their core clients. It is also one of very few markets since the credit crunch started that has remained open for business and liquid.”

Such comments make it clear that credit is an important issue, even if it appears not to have had such a big impact on FX as on other assets. “Credit exposure, as a story for 2009, is a concern for both banks and clients alike,” argues Leek. “With increased need for in-house due diligence of banks and monitoring of those relationships and exposures on the client side, flows will tend towards the bigger banks that continue to offer both the core liquidity as well as all the value-added services that differentiate them from the pack. Banks need to make the extension of credit worthwhile, as capital is a limited resource.”

Feig has a more simplistic but no-less valid view: “The G20 has been clear in saying that no systemically important financial institution will fail. That helps with issues about counterparty risk.”

Amrolia puts it slightly differently. “Pre-Lehman, I don’t really think most of the FX industry focus had been on credit risk and settlement risk,” he says. “But I think the intelligent pricing and risk management of second-order credit risk will be the differentiating factor between the winners and losers in the next five years, whether that is gap risk associated with prime brokerage or a corporate client doing a vanilla forward – credit risk that has been mispriced or, even worse, not priced at all, and this will fundamentally change over the coming years,” he says.

Fabian Shey, joint global head of distribution, FICC, at UBS, argues that such issues are already very much a concern. “It [credit] is a significant issue with all client segments. Risk appetite has fallen globally, so counterparty exposures are being monitored closely,” he says. “This will impact the selection process between providers and clients, but it will also increase the robustness of the FX industry – a development for the better.”

No easy way to the top

This raises another issue. Banks with better balance sheets and credit ratings might well be looking on at the success of the top FX banks with envy but it is not a given that they can simply replicate the success of the top five, or even the top 20 for that matter, on the basis of their good names alone. FX history is littered with the corpses of banks that made this mistake.

“FX is a relationship-based market. It always has been and this shows no sign of change,” maintains Leek. “Clients use e-commerce tools to fulfil one part of their needs, while in a volatile market, direct contact with a trusted counterpart is invaluable. The nuances, ideas and colour that cannot be delivered over a platform mean that the professionalism of your sales team, the wider ancillary services and innovative solutions that you can deliver really are vital.”

He adds: “The biggest banks that have had the scale and long-term investment strategy for electronic trading platforms will benefit. It take a long time to build up this infrastructure and the barriers to entry after years of significant developmental and infrastructure spending by the big players are a huge challenge to any meaningful potential new entrants on the bank side.”

The 2009 Euromoney poll is proof of the strength of these relationships. Credit is part of the story but overall service levels, including the provision of research, are also important. After all, for the vast majority of the time there is not a huge differentiation in the prices quoted by the banks. “There was a huge flight to quality during the crisis and we actually witnessed a large inflow of business from clients whose traditional counterparties were unable or unwilling to quote during the fourth-quarter volatility,” says Amrolia. “I think the secret here is how to be consistent when consistency is required and how to change when change is required. We have never taken our leadership position with clients for granted. We have worked hard each and every year to improve our offering – sometimes incrementally, sometimes in quantum leaps. Markets change, clients’ needs change and we change to reflect that.”

Ultimately, the main section of the Euromoney poll is a measurement of flow. Of course, other factors are important but FX has increasingly become a volume game and Amrolia is keen to stress that managing flow is more complex than many realize. “Don’t assume that flow has less intellectual property and sophistication than the so-called complex businesses,” he says. “We believe the ability to differentiate by applying intellectual capital to the way we do flow has been absolutely central to our success.”