If one word can characterize the period covered by Euromoney’s latest survey of the global foreign exchange market it is volatility – which is ironic given that over the past 12 months actual FX market volatility was pretty much as low as it has ever been.
Before Russia’s invasion of Ukraine, the world was already being buffeted by a global supply-chain crisis, rising energy costs, the negative implications of Brexit, extreme weather events linked to climate change and a substantial shift in US foreign policy.
The impact on FX trading volumes of these events is difficult to assess given the lag in the publication of market data. The most recent Bank of England foreign exchange joint standing committee analysis noted that average daily reported UK FX turnover fell by 6% between April and October 2021, whereas the committee reported that North American FX volumes were up 2.4% over the same period.
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Who are the winners in such an uncertain environment?
The top three places in this year’s FX survey are taken by Deutsche Bank, UBS and JPMorgan respectively. Top-ranked Deutsche moves up from third last year, swapping places with JPMorgan, while UBS remains in second place. If short-dated swaps are included in the ranking the top-three banks remain the same, with UBS in second and JPMorgan in third.
The rest of the top 10 is largely unchanged apart from BNY Mellon, which is ranked eighth this year, up from 13th in 2021.
The past 12 months have seen lows in volatility but also pockets of client business where volumes were high despite that, Russell LaScala, global head of FX at Deutsche tells Euromoney.
“If I had to summarize what caused that, I think it is the fact that the global economy was growing and corporates still needed to do a lot of their FX hedging despite market conditions,” he adds.
The importance of having a clear platform and technology strategy has never been greater
Adrian Boehler, UBS
There have also been many M&A-related trades that needed to be done as the result of large, episodic transactions that went through the market.
From a regional perspective, there has been a lot more focus on emerging markets, and LaScala suggests that those banks that have an onshore presence in EM have benefited. But there have been other winners as well.
“It feels like there was a lot of investment into the UK,” he adds. “The majority of deals that went through were buying UK assets and therefore purchasing in sterling.”
Deutsche increased the focus of its FX business on the corporate market in 2019, and one of its strategic developments was to extend its existing electronic trading capabilities in spot into forwards and swaps.
“That was a multi-year build out, and we are seeing some of the results already,” says LaScala. “Our coordination with banking on these large episodic trades was fantastic. We tried to be the go-to bank for these large trades – and that paid off.”
The German bank also believes its joint venture with Google has given it the ability to benchmark some of its machine-learning capabilities and offer a unique edge in the market.
“This part of the market is extremely competitive, so having the slightest edge in performance of our overall offering with unique algos has contributed to our moving up from third to first in the electronic category,” says LaScala.
There is a desire from banks to save on execution costs by developing joint utilities
Mohamed Hajibe, Swissquote
Deutsche also improved its ranking in the spot/forward outrights category this year, where its market share was considerably higher and close to being number one outright. This is another area that has benefitted from the bank’s increased corporate focus over the last three years.
“We realized we had a superior spot offering that we had been investing in over the past decade, and took the best of what we had there to rebuild our forwards and swaps offering,” says LaScala.
“Forward pricing is becoming a lot more quantitative. In a low volatility environment, price compression makes winning business even more competitive and that is where your edge in technology and your quant offering comes through.”
The bank has been through a difficult evolution since it topped the FX survey a decade ago.
“We have gone through some trying periods, with downgrades and reorganizing in 2019,” concludes LaScala. “Since then, we have been upgraded by all three of the rating agencies, and clients can see a clear direction that we are investing in what we are good at; and FX has always been one of these things.”
Crucial data
According to Adrian Boehler, global head of FX distribution at second-ranked UBS, the very different market conditions experienced in 2020 and 2021 tested many aspects of an FX liquidity provider’s ability to partner with clients sustainably.
“Lower volatility, the absence of clear directional bias in FX markets and the continued trend towards electronification across the FX product spectrum resulted in sharp spread compression throughout 2021,” he says. “The importance of having a clear platform and technology strategy has never been greater.”
Boehler believes that in a world of near-zero spreads in much of the linear business, the ability of UBS to extract every last piece of informational advantage from its data is crucial to staying competitive.
“Key developments in this respect include the rollout of our new FX options pricing and analytics platform T-Pricer; the strong market-share gains we have made in electronic NDFs [non-deliverable forwards], leveraging our established expertise in G11 markets; and the new integrated risk-based skewing model in our short-term interest rate business,” he says.
We have developed the ability to use algo-marked volatility surfaces in client pricing
Mathieu Reaud, UBS
UBS took first place in the spot/forward outrights category this year, which Boehler attributes to the building of eFX risk management with multiple layers, allowing the bank to incorporate ideas such as efficient frontiers and portfolio optimization to drive the core internalization model, as well as running medium-term risk-management strategies to optimize liquidity provision for clients.
It has also pushed the boundaries on the amount of liquidity provided to clients electronically, offering up to €500 million notional on its single-dealer platform.
UBS almost doubled its options market share from 2021. According to Mathieu Reaud, the bank’s global head of FX options, this is a result of a multi-year strategy and investments in pricing and distribution.
“We have introduced algo technologies, which enable us to price over 90% of our flows without human intervention in a market still dominated by voice trading,” he says. “To ensure our prices are accurately constructed and permit us to show competitive prices to our clients, we have developed the ability to use algo-marked volatility surfaces in client pricing.”
UBS has also focused on differentiating itself from a market that it believes often underestimates the value of pre- and post-trade analysis.
“Our unique integrated setup across G10, EM FX and precious metals markets allows us to differentiate our offering, delivering seamless and qualitative service across the full suite of products and underlyings,” says Reaud.
Inflation influence
The impact of inflation and interest rate rises has dominated institutional investor concerns over the past 12 months. It has therefore, unsurprisingly, been the most important FX market trend for State Street, explains Guy Kirby, global head of FX sales and trading at State Street Global Markets.
“The influence of inflation on the investment environment has underpinned currency volatility and reinforced the importance of managing currency risk in investment portfolios for institutional investors,” he says. “These investors have been able to make significant alpha in currency markets.”
Short-dated swaps
For the past six years, the overall FX ranking has been calculated based on market volume excluding short-dated swaps, although we also publish the results with short-dated swaps volume included (unadjusted swaps).
The decision to exclude swaps with a tenor of less than one week from the calculation of the headline ranking was taken following an engagement process with stakeholders and independent experts.
The consensus view was that (to take Tom-next as an example, where a currency is simultaneously bought and sold over two separate business days) it is commonplace for a specific set of clients to continue to roll their position on this every day over a specific period of time. In this scenario every roll equates to twice the original trade and thus artificially inflates volume.
Therefore, the view of the majority of the liquidity providers Euromoney spoke to – including some that have a sizeable, short-dated swaps book – was that these swaps should not be included when determining the overall market-share rankings.
Those that disagree with this methodology argue that basing the rankings on total market volume is a cleaner and more consistent approach and that there is risk with all swaps transactions since they represent risk positions of clients that need to roll those risk positions, for whatever reason, from one value date to another.
Increased market access has been a big consideration, so State Street has increased its range of algorithmic tools.
“We have focused heavily on emerging markets – we now have a presence in Brazil and have seen a lot of interest in our ability to provide market insights and liquidity in that market,” says Kirby.
State Street moved up from ninth to fourth overall in this year’s Euromoney FX survey. Its stats have been supercharged by a client base that has been more active over that period because the investment environment has changed, Kirby explains.
“Where there is increased volatility there is also greater risk, so when currency volatility is rising, investment decisions can be reappraised and then re-implemented, which leads to higher volumes and therefore volatility,” he says.
State Street increased its share of the emerging market category of this year’s survey.
“We have found that access to emerging markets and liquidity is very important to institutional investors – as is access to algorithmic tools. And these are two capabilities we have worked very hard on, not just over the last 12 months but over the last number of years,” Kirby says.
There was also a big increase in State Street’s share of unadjusted swaps, which Kirby attributes to being consistent in the provision of liquidity to clients.
Another institution that has risen up the ranking is BNY Mellon. Now in eighth place, just six years ago the bank was barely troubling the top 50.
Almost all sell-side market participants would acknowledge that we have completely rebuilt the business from front to back
Jason Vitale, BNY Mellon
Jason Vitale, global head of FX, fixed income and
equities, attributes this progress to a substantial investment in technology, risk management and distribution capabilities, as well as sales team and client coverage and high-quality research.
“Our business can be divided into traditional sales and trading, and transactional FX, which is an outsourced collection of service offerings for clients,” he explains. “Outsourcing is really our unique offering and the space that this market environment has allowed us to grow the most.”
Vitale suggests that pre-pandemic market trends, such as the use of outsourced service offerings to help manage portfolios, have accelerated over the last two years.
“Clients are looking for a service provider to execute business globally in a way that is electronic and transparent, which highlights the importance of trust,” he adds. “I think almost all sell-side market participants would acknowledge that we have completely rebuilt the business from front to back.”
In terms of specific categories, BNY Mellon has seen an increase in its share of unadjusted swaps and spot/forward outrights over the last 12 months. Vitale puts that down to two key developments.
“The first is our substantial investment in electronic risk and distribution capabilities, allowing us to scale our pricing and service to clients and capture more of their wallet,” he says. “The second is the overall scale of the business, which might sound like we are trying to be everything to everyone, but that is not our strategy. Our approach has been very focused on better servicing our enterprise clients.”
Vitale says he was surprised by how well the bank was able to adapt to a hybrid working environment and still cover large, international financial institutions with fragmented operating models.
“They became more electronic and digital internally, which meant that as an international service provider we were well positioned to service clients in a deep and consistent way,” he says.
Fed errors
Thanos Vamvakidis, global head of G10 FX strategy at Bank of America, observes that the dollar has been the strongest currency performer during the survey period as the overheating US economy led to high inflation and a hawkish Federal Reserve outlook after very loose policies during the pandemic.
Most other central banks have also started normalizing polices in response to inflation pressures, but they are largely dealing with negative supply shocks – particularly from high energy prices – and are more cautious, he explains.
The Fed missed the implications of the massive fiscal stimulus for the post-pandemic recovery and kept its policies on hold for too long
Thanos Vamvakidis, Bank of America
“The Fed missed the implications of the massive fiscal stimulus for the post-pandemic recovery and kept its policies on hold for too long,” says Vamvakidis. “When inflation started increasing, it committed a second mistake by arguing that it was transitory. This could have been very negative for the dollar, but the Fed eventually turned hawkish and is now sticking with its tightening cycle despite the equities sell-off.”
He agrees that FX has once again become a good way to express macro views and hedge, noting that with the dollar reaching 20-year highs against the yen and euro, investors who got it right have been rewarded with FX flows increasing notably this year in response to these strong trends.
Vamvakidis also accepts that disparities between different regions and client groups have been exacerbated to some extent by the events of the last 12 months because investors are dealing with very different economic realities.
In the US, the big theme is the Fed reacting as inflation gets beyond its control, whereas in Europe high energy prices and geopolitical risks have dominated investors’ thinking this year. In Asia, China’s persistence with a zero-tolerance Covid policy and recent renminbi weakness have broader regional implications.
“Investors did not see most of these risks coming and have been forced to chase the market moves,” adds Vamvakidis, who says that from a strategy point of view, understanding the horizon of every client is extremely important.
When FX volatility is high, market drivers can be very different as the market considers the next few weeks, months or years, he continues.
“For example, earlier this year, rates and terms of trade were the main market drivers, whereas more recently risk sentiment has taken over,” says Vamvakidis. “In the medium term, what is likely to matter most is how far each central bank is willing to go in order to bring inflation all the way down to the 2% target.”
The correlation between inflation and FX can shift for central banks not sufficiently committed to the inflation target, Vamvakidis adds. Equilibrium considerations do not matter for markets right now but could become more relevant in the long term.
Banks will have vastly different return hurdles on trades, depending on regulatory rules, bank and client ratings, and documentation
Anthony Kritikides, Commonwealth Bank of Australia
Outside the top 10, Citadel Securities jumped from 18th to 12th in this year’s survey, while the other big mover in the top 20 was TD Securities, up from 24th to 18th. Beyond this, there were notable gains for Tower Research Group (35th to 23rd), Sumitomo Mitsui Banking Corporation (50th to 28th), Commonwealth Bank of Australia (CBA) (56th to 33rd) and Swissquote (48th to 34th).
Anthony Kritikides, managing director and head of institutional sales in Commonwealth Bank of Australia’s institutional banking and markets business, argues that the most important trends in the wider FX market over the past 12 months have been the continuing move to best execution and electronic trading and the pricing of capital in the short-term interest rate and long-term forwards business.
“Banks will have vastly different return hurdles on trades, depending on regulatory rules, bank and client ratings, and documentation – strength of Isda and CSA terms, for example – all of which has a big influence on the ultimate price the client receives,” he says. “Short-term interest-rate pricing and volumes have had a big impact on our North American ranking.”
Kritikides explains that CBA has restructured its business into a single, global institutional sales team, enhanced its electronic offering and increased its focus on short-term interest-rate and long-term forwards business liquidity for clients.
On the execution front, Swissquote has seen more transparency from market makers, with reduced hold time for trades subject to last look, notes Mohamed Hajibe, head of its global institutional desk.
“There is also a desire from banks to save on execution costs by developing joint utilities like FXSpotstream,” he says.
Swissquote’s institutional FX franchise is immature compared with its retail offering, but it is focused on covering all important institutional FX platforms in spot and derivatives by the end of this year.
“We are one of the few banks that can serve a large retail broker in CFDs [contract for differences] using PrimeXM and show a two-way price in a 10-month USD/ILS swap for corporate trading in 360T,” says Hajibe. “The development of our electronic offering in FX derivatives will impact our ranking in short-term swaps.”
