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Opinion

The ultimate FX bank

Technology and emerging markets will be key battlegrounds in FX but success lies in the size of the liquidity pool.

As this year’s Euromoney FX survey shows, the race to be a market leader in the foreign exchange markets has never been more competitive. In the post-crisis world, every piece of capital that is employed by banks must be accounted for, and every morsel of value extracted as regulators impose stricter controls on the cost of capital.

Foreign exchange has the tag of ‘value for money’, which is a good starting point as one goes about building the biggest and the best foreign exchange franchise. And so the world’s big commercial banks and investment banks are funnelling hundreds of millions of dollars into doing just that. However, few will actually achieve their goal of achieving sustainable revenues over the longer term.

So what does the top FX bank of the future look like? First, it will have achieved, or got very close to achieving, what many call the holy grail of flow trading: to build a large internal liquidity pool and then use the flow information from the pool to grow trading revenues. Gaining critical mass in a liquidity pool enables a percentage of customer spread business to be automated, meaning sales people will focus less on execution and more on value-added solutions.

Foreign exchange will be a collaborative business, where customers, salespeople and traders interact on the same platform, using tools such as algorithms to execute various trading strategies, while being able to click and trade on spot, forward, and options 24 hours a day.

Overlaying that, the best banks will develop sophisticated risk and information systems that analyse the flows to take better-quality market risk. Some banks that were early into the electronic trading game will argue that they’re already doing that, others will say that they have a greater catchment of global clients to extract more value from the flows they see once they’ve fully built out their electronic offering. Marrying these two sides of the business will to some verge almost on a science, built on a foundation of state-of-the-art technology. The bank with the best technology will be the winner.

Given the competitive nature of G10 currencies, emerging markets is set to be a key battleground over the next five years; it is hugely profitable relative to G10. Indeed, it’s helping to subsidize many banks’ FX revenues, and those that have the ability to price onshore and offshore currencies may get a foothold in currency markets such as the Chinese renminbi.

Finally, the FX market isn’t immune to a regulatory reconfiguration that will occur in other over-the-counter products in the coming years. Central counterparty clearing and prime brokerage services will no doubt form a key part of the future of foreign exchange, as regulators seek to reduce systemic risk. Meanwhile, it allows banks to offer a wider array of services and the ability to unbundle the credit and execution components of foreign exchange.

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