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When banks released first quarter 2017 results there was a focus on the recovery in broad fixed income revenues, compared with the same period in 2016. This was driven by strong performance in rates and credit products, however, which masked chronic weakness in FX and commodities.
Most banks do not disclose detailed breakdowns of revenue splits within fixed income (or equities), but the Coalition survey of first-quarter income for the 12 top investment banks revealed that G10 FX revenues fell 25% from the same period last year to $1.8 billion, which was the lowest level since the survey began in 2006.
Predictions by many strategists of likely FX trends for 2017 proved to be wrong, as they so often do. The ‘Trump trade’ across asset classes was a bust in its FX incarnation, with expectations for a much higher dollar and parity to the euro, for example.
The mirror image ‘Macron-omics’ trade that became popular after the French presidential election is unlikely to deliver much FX revenue growth to banks, even if the euro continues to strengthen on hopes of economic growth in Europe.
[We are] not going to make our budgets off flow or nickel and diming euro around – New York-based BNPP dealer
Banks need a revival in FX volatility and a way to industrialize the scale of trades that have attractive margins, such as contingent hedges of M&A deals or structured investments.
Subdued FX volatility was the main problem for dealers in the first quarter, but increased flow in options and other derivatives that exploit volatility offers the main hope of a recovery in revenue.
Margins for spot FX trades remain desperately low and the regulatory purge of many former heads of cash trading at banks has undermined both morale and institutional knowledge of how to make a client-based franchise work for both dealers and their customers.
The banished trading heads were expelled because they were accused of colluding to benefit at the expense of clients, of course. Some of them later complained that they had been dismissed without due process on the part of regulators or panicked senior management at their own banks, but with an array of legal cases underway, it is up to current business leaders to try to make FX trading work under a new ethical framework.
Global code
The FX global code that was released in its final form by the Bank for International Settlements on May 25 was preceded by a timely reminder that sanctions for past abuses are far from over.
Less than 24 hours before Reserve Bank of Australia deputy governor Guy Debelle and CLS chief executive David Puth unveiled the new code in London, BNP Paribas announced that it had agreed to pay $350 million to the New York State Department of Financial Services (DFS) for FX market violations.
The DFS detailed, with its usual gusto, what it called “nearly unfettered misconduct” by more than a dozen BNP Paribas FX traders and sales staff between 2007 and 2013. It said that BNPP staff colluded to manipulate prices and spreads; improperly exchanged customer information; manipulated benchmark FX rate fixings; misled customers about substantial mark-ups; and compounded this deception by deliberately under-filling customer orders. The DFS also concluded that the last-look function in BNPP’s electronic FX trading improperly disadvantaged customers without disclosing how the trading was conducted.
These charges neatly encapsulated most of the key issues being addressed by the new FX code of conduct, which was produced as a collaboration between central banks, as represented by the BIS, and market participants of different types.
Public adherence to the principles of the code and work to demonstrate that this commitment is being monitored will be virtually unavoidable for large dealers, if only because the central banks pledged that in the future they will only trade with counterparts that are in compliance.
At issue for banks – beyond reducing future fines for malpractice – is the extent to which compliance with the code will constrict FX revenues, not just by reducing outright market abuse, but also by slowing the pace of certain customer trades and related offsetting by dealers.
Excerpts from the consent order that the DFS agreed with BNPP demonstrate the extent to which bankers felt they needed to engage in sharp practices to meet FX revenue targets, which suggests the current slump in income for banks may be related to the costs of moving towards more ethical behaviour, rather than just a reflection of low volatility at the start of 2017.
The DFS helpfully provided details from chatroom conversations that portrayed BNPP FX staff and their peers at other banks as unprincipled scoundrels whose appetite for abusing their customers was matched only by their incompetence in covering their tracks.
One New York-based BNPP dealer described a South African rand price manipulation scheme as “a little cartel really brewing… (we can) call it ZAR domination.” The trader went on to explain the rationale for forming a cartel in electronic chat with counterparts at other banks, describing the rand (or ZAR to use its currency trading code) as ripe for exploitation.
“(We are) not going to make our budgets off flow or nickel and diming euro around,” concluded the pitch by the trader.
‘Custys’
Was he right? Is flow business in important FX markets, especially the most liquid crosses like euros against dollars, simply unsustainable for banks if it is not augmented by trades that exploit customers (or “custys” as they were disparagingly known in chatroom slang)?
A renewed recent appetite for hiring FX traders and sales staff suggests that some banks think they can make a cleaner market work and that the slump in first-quarter 2017 revenue to barely half the level of $3.5 billion seen in the first quarter of 2015 is seen as an aberration due to low volatility.
The impact of adoption of the final version of the new FX code could affect which banks remain contenders for leadership in market share, however. For many years Citigroup and Deutsche Bank battled for top spot, with UBS and Barclays leading the following pack. More recently, JPMorgan made a successful push for market share, and to a lesser extent so has BAML, and non-bank trader XTX Markets is making big inroads in flow dealing, with Citadel Securities also gaining market share.
The results of the latest Euromoney FX survey showed Citi maintaining its lead in overall volumes despite a big drop in market share: at 10.7%, Citi’s share is the lowest of any winning bank in the survey for 15 years. JPMorgan is hot on its heels at 10.3%. Deutsche Bank now ranks a lowly fifth, while Barclays has slumped to seventh place.
Appetite for hiring despite the costs of higher business standards may also indicate that an ethical FX market is not the oxymoron that it might appear from reading transcripts of electronic chats between former practitioners.
