FX Poll 1999: Life after execution

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The pie may be getting smaller but the top players are taking bigger slices. However, as Jack Dyson reports, the largest foreign-exchange firms are having to work ever harder to carve out a point of difference in a mature market with thin margins. In our eagerly-awaited annual foreign-exchange poll, Citigroup stays ahead of Deutsche by a whisker. Research by Rebecca Cicolecchia.

FX Poll: Full Results
FX Poll: Methodology

Walk around the foreign-exchange trading floors this year and the first thing you notice is how quiet they all are. Gone are the squawk boxes and the telephones ringing non-stop. Instead the desks are top-heavy with machinery, and as much of the day seems to be spent watching the Kosovo crisis unfold on CNN as dealing. But Richard Moore, European foreign-exchange manager at Citibank denies that the markets are less exciting than usual. "Although customer and interbank deal volumes are lower so far this year, the need for high-quality market advice and interpretation remains a key requirement for our client base," he says. "After all, the euro has dropped more than 10%, the yen has traded in an 11% range ­ and it's still only April."

Hal Herron, global head of foreign exchange at Deutsche Bank, London, says: "Sure, the market is currently less noisy, but less noise can be good because you get to spend more time with clients working out solutions to their problems."

One big factor accounting for the quietness of the markets is the introduction of the euro. Since the currency has no history, traders are finding it hard to get a feel for the way it moves. "Speculators are less comfortable with the euro," says Drew Gross, head of European foreign-exchange sales and marketing at Chase. "There is less of a comfort zone. The ECB is opaque, but then it is a new institution, and we are all just working it out. It is only a matter of time before the euro sorts itself out."

Alan Clarke, head of corporate and institutional sales at HSBC Midland points out that it is not simply the disappearance of 11 currencies that is making the market quieter, "it is more that the introduction of the euro has introduced a new challenge. The risk parameters have all altered and the market is taking its time to adapt to the change. It will take time for the feel of the market to come back".

But it is clear that trading volumes are down on last year. Volumes traded on the electronic broking service (EBS), the automated trading system which now accounts for the majority of FX turnover, show a sharp decline on last year. In the first quarter of this year 2.2 billion dollar/euro trades were executed on EBS. In the first quarter of last year 3.1 billion trades were executed in dollar/Deutschmark alone. The general consensus is that overall volumes, including non-EBS transactions, are down at least 20% on last year.

Most traders expected the euro to have a slow start, but have been surprised by just how slow trading has been. Says Irene Dorner, head of sales and marketing at HSBC: "The euro is client-driven, and as clients are broadly in a conservative mood its movement has also been conservative. In the old dollar/Deutschmark days, situations like Kosovo would have produced much more of a bumpy ride with much more price volatility."

The reduction in speculative trading is making the market more difficult to read. "The fall-off in speculative flow has resulted in sporadic market moves with large periods of inactivity during the day," says Kevin Moore, head of forex trading at Barclays. "Instinctive price-action trading has changed. Now traders are being forced to become better educated and much more research-oriented."

As volumes have fallen, liquidity has dried up in some parts of the market. "We can't access counterparties' liquidity as easily as we used to, due to the contraction in the banking industry," says Moore at Barclays. "In sterling, for example, there now exists around £100 million ($161 million) in direct, accessible liquidity where once there was was £500 million."

But a drop in liquidity also presents opportunities. Marcus Nysten, head of trading at SEB London says: "Yes, liquidity will be a problem if too many of the smaller players drop out. But it is a two-edged sword because if liquidity is a problem then it will lead to higher volatility and we are even more profitable in a highly volatile environment."

Long-term trends

But the reduction in the excitement levels on the foreign-exchange trading floors is not simply a result of the introduction of the euro. The volume of interbank trading has been falling since EBS was introduced in 1992. "The same business is going through but the increasing emergence of electronic trading has reduced the overall noise levels," points out Clarke at HSBC. "Salespeople have less to compete with to make themselves heard and this has a tendency to reduce the adrenalin flows normally associated with trading rooms."

There has been a big reduction in interbank volumes since EBS arrived. "Electronic systems have had a major impact," says Moore at Barclays Capital. "Lat year on dollar/Deutschmark we would have been making 50 quotes an hour on interbank trading. Now it is as low as 20 a day."

Richard Geering, head of corporate sales at Royal Bank of Canada, laments the rise of electronic trading. "It means you lose the two-way, personal side of the business," he says. "There is a definite loss of rapport. I'll be the first to support technology, but only when it can get around this issue."

But the pace of technology change in the foreign-exchange market is relentless. The big new development is internet trading. Several banks already have systems up and running and can handle a lot of smaller plain-vanilla trades. About 5% of Chase's transactions are now conducted electronically. Deals of up to €1 million ($1.1 million) can be done on SEB's trading centre which now has 1,000 customers. Security for the system has been modeled on the bank's retail internet banking system. Other banks are reported still to be struggling with security issues associated with internet trading.

Banks ignore the issues presented by new technology at their peril, says Philip Vasan global head of foreign exchange at Credit Suisse First Boston. "Electronic trading and fast access to information will disintermediate traditional banks, while others will gain by using technology to deliver value-added services, from research to e-commerce to operations. The challenge for banks is to reinvent themselves in technology rapidly ­ that window will only be open for the next 12 to 18 months."

Investment banks see technology as giving them a big advantage. John Key at Merrill Lynch says: "It levels the playing field. It means that we all have a better shot at the specialized deals. Put it this way, I have a personal banker who I talk to when I need something special, insurance or a mortgage, say. But if I just want £200 for the weekend, then I go to an ATM. That is what FX is going to be like in the future."

In the face of falling volumes and the migration of much of the business to screen-based trading, banks across the spectrum are looking for new ways to add value. Providing "creative solutions" is the favourite buzzword of the larger banks.

Michael Burton, managing director of European foreign exchange at Goldman Sachs says: "We recognize that some of the smaller, plainer deals will be absorbed by electronic trading, and all the banks are readying themselves for this. But also important is the recognition that in price terms there is no difference between what we can provide and what other banks can provide. We can add value by providing creative solutions, bespoke solutions which tie you into a relationship. Our core business is in providing clients with the same access to market liquidity as the other major FX players but we specialize in providing creative solutions when the client's needs require it."

An example of such a solution can be seen during the Asian currency crisis when interest rates blew out so far that it was no longer economic for corporates and utilities to hedge their Asian investments. "One of the products we offered allowed clients with exposure to three of these currencies (for example Thai baht, Indonesian rupiah and Malaysian ringgit) to hedge their exposure using the spot rate instead of the forward rate," explains Burton. "At the end of the agreed period Goldman Sachs would choose which of the currencies the client got to hedge. This product suited clients who would otherwise not have hedged any of the three exposures because of the excessive cost of forward hedging."

Banks which cannot offer a broad range of services face more difficult times than the biggest banks with their global coverage. Herron at Deutsche points out: "Even to be a niche player you still have to be pretty big. It is now more than ever a global business, and without that reach the niche players are going to find it really hard to add value."

Some niche players, though, are doing well. Nick Garnish, treasurer at Merita Bank, London, says: "Now we are a real niche player in London. Since our merger with Nordbanken we have greater access to the Swedish krona as well as a traditional base in the sterling market. We tend not to deal in speculative foreign exchange in London and our focus is core customer business."

One way banks can distinguish themselves from their peers is through the credit advice and research they provide. As a result, many banks are putting emphasis on building up their research capabilities and experience. But the increasing sophistication of their clients makes this a constant challenge.

Peter von Maydell, director and senior currency strategist at Credit Suisse First Boston says: "We now have to provide clients with a great deal more than merely policy insight. The perception that banks have privileged access to special information is gone. Policy makers are less useful as predictors of a market anyway, and the days of dramatic policy U-turns are gone. We need to identify risk factors now more than ever. In general, asset managers and institutional investors want concrete statistical indicators as well as innovative thinking."

This is just one more factor contributing to the increasing polarization of the market between the biggest foreign-exchange players on the one hand and the smaller firms on the other. David Newman of JP Morgan says: "Clients only have so much time to think and are more likely to say to themselves 'these guys are in the top ten and I'll listen to them rather than make time to call those further down the list.'"

The result is that a global elite of the biggest foreign-exchange banks is emerging. And competition among those big players is getting ever more intense.

This year's Euromoney poll (see page 92) shows the difference between the top few banks becoming a lot smaller in terms of market share.

So how do the biggest banks, which all offer such similar services, distinguish themselves from one another? Moore at Citigroup says: "Clients will sharply differentiate between advice and execution. They will be increasingly unwilling to pay for execution which will over time migrate to the most efficient electronic platform. As an industry we are used to being part of the clients' execution; in future, success will depend on becoming part of the clients' decision-making process."