FX profile: Deutsche Bank – doing what it says on the tin
When you are the world’s biggest FX bank, running the most complex derivatives book in the market, a year such as 2011 presents the following challenge: offering constant liquidity in all products in all market conditions while avoiding all of the minefields in its path.
“It was a very peculiar and risky year for the industry,” says Kevin Rodgers, Deutsche Bank’s global head of FX trading. “The most important thing was to avoid blowing up, and making money out of the moves.” The high water mark for risk was September, when the Swiss National Bank placed a floor of 1.20 in EURCHF. Rodgers says the move in EURCHF option volatility was the single biggest market collapse he had seen in his more than 20-year career (one-month EURCHF vols fell from 23% to 6 % within minutes). Nonetheless, it was still open for business. He says his options team was also being inundated with clients wanting to get in on the same trade.
As things turned out, 2011 saw Deutsche’s volumes grow across the board, somewhere between 20% and 40%, without being more specific, though Rodgers says FX derivatives was a “blow-out year”. Its revenue performance was “extraordinary”, he adds, while not surpassing the record profits in 2008, when the bank executed more than one-fifth of the total client volume in the Euromoney FX survey.
Stability and Liquidity
The SNB intervention perhaps provides the best illustration of Deutsche’s continued ability to do what it says on the tin: continuous provision of liquidity for its clients, sound risk management and a stable trading platform.
“The liquidity and the platform were there when our clients needed it,” says Rodgers. Deutsche kept its platforms running throughout the various bouts of intervention in 2011, while also making sure it was supported with traditional voice quoting as well.
Platform reliability across the leading market makers during some of these volatile periods was patchy, though judging that is somewhat subjective. There were well-documented instances – such as with BARX and Velocity, that went down during the SNB intervention.
It has been argued that inbuilt triggers, which effectively shut the platforms down, weren’t designed to withstand the unprecedented price movements, and thus, served the purpose for which they were intended. Others say it was a glitch that has now been ironed out. Rodgers says that keeping the platform on, at all times, should not be underestimated when it comes to clients.
“It’s pretty important, but not the only important thing, and when we talk to our clients they do appreciate it,” says Rodgers. “We try to be really good and really reliable, which costs money.”
Barriers to Entry
Indeed, building state-of-the-art trading platforms, and then maintaining their infrastructure, costs a lot of money on a continual basis. Although it’s hard to quantify, some estimates from industry vendors put it at several hundred million dollars over a period of years. In fact, just to build a platform to start with can cost between $50 million to $80 million, vendors say.
“Although the FX business is becoming more attractive to be in, relative to other businesses, concentration is increasing because the scale factors required to operate a profitable business are now becoming overwhelming,” says Rodgers. “There are very few of the major banks who will compete at everything, and only two or three guys that will be able to do the full service.”
For these leading FX banks, it is a cost they must pay to stay competitive. For Deutsche, that is crucial. The advancement of trading technology and infrastructure in the FX markets has now levelled the playing field. That is reflected in its market share, which has been whittled away by its closest rivals, from 21.7% in 2008, to 15.65% last year, according to Euromoney Market Data. Barclays Capital, UBS and Deutsche have all made large-scale investments and continue to do so.
Deutsche has always made the point that it is continually rebuilding its trading and risk-management engine, but remains coy about revealing the details of its current development phase, other than saying it is fully cognisant of the fact it needs to continue to innovate to maintain its edge.
“We take our market leadership position very seriously and are always looking at ways to improve our client servicing,” says Zar Amrolia, Deutsche Bank’s global head of FX. “This year we will rapidly up our game with technology that will be a quantum leap forward for the FX markets.”
Over the past 12-months, one of the areas where Deutsche saw a need for improvement was in its electronic pricing in swaps and forward. “We put some very particular effort into forwards, in terms of the pricing and in terms of the way ABFX looked and felt.”
In addition, 2012 should be a groundbreaking year for electronic pricing of non-deliverable forwards, as the market ramps up for impending e-trading regulations.
“It’s coming,” says Rodgers. “It’s already come to Deutsche Bank and it will come to the market, in the same way that we’ll see increased electronification of derivatives pricing.”
However, it’s not just in pricing and risk management on Autobahn that has seen investment dollars spent. Deutsche has begun rolling out its updated prime brokerage platform to clients.
“It’s been a major reinvestment over the last 18 months and has been rolled out to clients already,” says Nelius De Groot, head of FX Global Client Solutions. “This will continue, and will provide better reporting, better execution for clients.”
Deutsche has also been developing its infrastructure for non-mandated clearing operations as part of its new integrated FXPB model, as more and more clients move towards clearing across their asset classes. It’s an expensive business, especially as mandated clearing regulations are still unclarified across multiple jurisdictions, and as the number of clearing houses entering the OTC market grows.
“Clients want to have all their products cleared right across their portfolio and for all asset classes,” says De Groot. “Given the overall Deutsche Bank franchise, we’re always going to be driven by clients here, whether they have rates, credit or FX portfolios. The pace of client adoption may exceed the speed of regulatory requirements.”
To further complement that, Deutsche has also made some progress with its FX managed accounts business. DBSelect surpassed the landmark $5 billion assets under management, while dbOverlay, a product only officially launched in the fourth quarter of last year, has quickly accumulated $1.7 billion under management.
Overlay provides a custom-built solution for managers that have multiple share classes but whose core competency isn’t FX, and thus don’t want to manage their FX exposure.
“It has become a core part of the franchise, alongside the PB and the listed derivative businesses, so it’s achieving an awful lot of profile at the moment,” says De Groot.
Here, too, Deutsche is facing fresh competition, from Citi and Morgan Stanley, which brought new products to market. Ironically, it has been good for Deutsche’s business.
“New entrants have been hugely beneficial for the market, because it raises the profile of all the platforms,” says De Groot. “Clients then do competitive analysis and Deutsche Bank is able to show it has got the product range and scale which then attracts these new clients.”
There is no doubt that competition has become more intense in recent years in the FX industry. The democratization of technology has increased the odds for others to garner volume on razor-thin spreads, and stake a claim for top spot. But it is more than just about speed and tight pricing.
Building a whole infrastructure of processing pipes, through from the customer to the bank, and through to clearing houses to comply with a new paradigm for OTC markets, is just as an important driver for a successful large-scale customer franchise.
That may sound a bit boring, just as the story of a 7-year incumbent may sometimes sound. But this is heavy-duty industrial financial markets after all. A big tin is a big tin.