The house of Deutsche: 10 years of the euro

There wasn’t a great deal of optimism from currency traders when the euro began trading in 1999. The FX playing field had just become much smaller, trading floors were quieter, and no one quite knew what to make of this new currency. Many traders concluded that the most profitable days of foreign exchange were behind them.

"If I look back now, I probably thought: ‘This is definitely going to contract the amount of money we can make,’" says Kevin Rodgers, Deutsche Bank’s global head of FX trading and options. Then at Bankers Trust, Rodgers had been an ERM trader, which through the 1990s had been a hugely profitable trade, if a trader managed to understand the idiosyncrasies of the cross rates, trading bands and interest rates. The late 1990s had been heady days for those looking to second-guess what the euro’s conversion rate would be at launch by trading the old European currencies in bands against each other. However, when the euro was introduced, "the inefficiencies and the technicalities were no longer there, so fewer currency pairs meant there was less going on, and so therefore less money," says Rodgers, who was so attached to the ERM that he considered calling his son Mark Lira.

As things turned out, traders, especially at the big European banks, needn’t have worried. Volumes rocketed over the next decade, and Deutsche Bank in particular cemented its place as the leading player in the foreign exchange markets. In fact, the big banks just got bigger. In 1999, the top-five banks accounted for one-third of the total market share. That rose to almost two-thirds of the total market by 2008, before a post-crisis race for low capital-intensive flow brought on a race for market share that had the top-five banks’ share dropping to just over half. During that decade, Deutsche cemented its position as the top player in foreign exchange. According to Rodgers, the euro is by far the biggest book the bank runs, and although it doesn’t quite dwarf the next most traded currency, it is multiples bigger in terms of flow.

Glancing at the leading banks in Euromoney’s 2001 poll, which took into account the first year of trading in the euro, Deutsche was sandwiched in second position between Citibank and Chase Manhattan. Fast-forward a decade and Deutsche’s closest rivals are European banks: Barclays Capital and UBS.

Stephen Jen, the former head of currency strategy at Morgan Stanley over much of the past decade, argues that Deutsche’s supremacy is built on a fundamental logic. "It’s rational, it’s really their home currency," he says. Jen has now set up his own currency hedge fund, called SLJ Macro Partners. "Obviously UBS and Barclays benefit by being in the European timezone too, but the incentive is not as great if your home currency isn’t being replaced," he adds.

While the single currency tended to favour those European banks that had a natural customer base to transact euros, it is the introduction of electronic trading to the FX market that is largely responsible for the surge in currency trading, with average daily trading volumes having risen from $1.4 trillion in 2001 to $4 trillion in 2010. "That has tended to favour the banks that had the resources, and then spent the resources wisely, which has enabled them to be at the forefront of the market," says Rodgers. "That’s definitely helped Deutsche Bank." David Clark, now chairman of the Wholesale Market Brokers Association, who was a managing director at Bankgesellschaft Berlin in London when the euro was introduced, charts the rise of the euro with the rise of algo trading, based on models imported from booming equity markets. "The size of the euro, in comparison with its component parts, was such that it was much easier to create the metrics and algo equations with a highly liquid, highly deep currency," he explains, adding that there is a greater depth of liquidity thanks to the concentration factor of 11 currencies pooling to form one. Timezones, too, have played an important role, says Jen: "The London timezone is the best trading-wise, because it includes the tail-end of Asia, all of Europe and some of the US." Chris Walker, G10 FX strategist at UBS in London, adds: "A majority of euro trade passes through London."

While the eurozone is not without its drawbacks, and its fair share of detractors since the European sovereign debt crisis erupted last year, few would have predicted just how important the euro would become. After all, the currency union was all about creating a competitive trading bloc.

"We’ve suddenly got a new and significant reserve currency in the world," argues Clark. "What we couldn’t have known in 1997/98 – though we could have guessed – was that China would grow so quickly and so easily, and become by far the world’s largest foreign exchange holder in euros." Previously, total global foreign exchange reserves were approximately 71% dollars and 15% Deutschmarks. Today it’s more like 66% dollars – maybe even less now – and about 23% in euros, says Clark.