Top FX banks brace for disruption wave
Demand for single-dealer platforms continues to drive adoption of platform-as-a-service (PaaS) in the FX space, allowing smaller players to compete with the top-tier firms in pre- and post-trade services.
PaaS provides a platform for developers to build applications and services over the internet without having to worry about the underlying infrastructure.
Compared with other segments of the cloud computing market, it has developed slowly. However, as smaller cloud computing and IT solution providers have started to develop applications, growth has accelerated and the market is predicted to be worth $7 billion by 2018.
Smaller banks are free of the need to invest millions of dollars and years of development work
The relatively rapid rise of PaaS solutions provided by FX technology vendors – including Apama/Software AG, Broadway Technology, Integral and StreamBase – has allowed tier-2 broker-dealers such as Commerzbank, Danske Bank or Saxo Bank to compete with tier-1 FX broker-dealers by creating software-based solutions that allow for the commoditization of various pre- and post-trade services, explains Russell Dinnage, senior consultant at capital markets consultancy GreySpark Partners.
“Banks can flip various portions of their spot FX or flow FX liquidity provision business models so that – from the perspective of their clients – they become primary providers of currency liquidity via the bank’s own balance sheet as opposed to their traditional role of acting as consumers of tier-1 liquidity, which would then be passed on at a margin to the clients of the tier-2 institutions,” says Dinnage.
This is having a dramatic impact on how banks and brokers compete in global FX markets by enabling them to go head-to-head with much larger institutions, says Harpal Sandhu, CEO of Integral Development Corp, which develops private, branded FX trading solutions.
“By taking advantage of a shared infrastructure, smaller banks are free of the need to invest millions of dollars and years of development work,” he says.
While FX PaaS enables smaller banks to tap into the commercial benefits of single-dealer platforms without having to build their own solution, these banks are using these platforms for more than just pricing and trading. For example, a number of platforms offer a consolidation point for research and ideas, as well as some integration with prime brokerage services.
Sean De Souza, principal consultant at financial services technology consultancy Capco, refers to banks white-labelling their FX platforms. “Prices for a number of the FX products smaller banks trade, such as FX spot/forwards, are becoming increasingly homogeneous, so the single-dealer platform has to have additional bells and whistles to garner interest and retain the customer.”
The banks developing these platforms are looking to diversify their revenue stream away from just bid/offer spread and onto other streams relating to clearing and settlement-type services, continues De Souza.
Tony Salamone, Fundtech
PaaS also allows small financial institutions to offer full correspondent banking services without the need to establish and manage correspondent relationships across the world, adds Tony Salamone, senior vice-president North America at payment solutions provider Fundtech.
As with any outsourcing project, the challenges are around the longevity of the technology provider, the quality of support and service level agreements, and whether or not the vendor has proven its intent to invest in the platform to keep it up to date.
“As a bank, I would pay particular attention to two areas,” says Integral's Sandhu. “Firstly, to make sure that the entire suite of services required to operate the FX business is available as cloud-based services, not just a subset. Secondly, whether everything comes integrated and works out of the box.”
Depending on the national competent authority that is responsible for the particular bank, there can be challenges in relation to concepts such as material outsourcing, where a significant function within a company is outsourced formally in the eyes of the regulator.
“This results in a great deal of legal paperwork and hurdles which must be dealt with in order to make use of the service,” explains Capco's De Souza. “This places an additional burden on the supplier and makes the overall endeavour more of a challenge to support, both commercially and practically.”
In addition, GreySpark's Dinnage refers to the risk of buy-side client disintermediation, where the more FX broker-dealers huddle around PaaS solutions for provisioning liquidity and liquidity services to their clients, the greater the risk that the base of buy-side clients accessing those sell-side services will independently move away from the single bank service model over time as the costs associated with that service model become commoditized.
“Increasingly, buy-side firms are observed taking greater control of the costs transmitted to sell-side broker-dealers to facilitate flow FX trading on their behalf, as evidenced by recent increases in spot volumes executed by institutional buy-side clients on multi-dealer platforms,” he concludes.