FX poll 2007 results
THE FOREIGN EXCHANGE market and the authoritative Euromoney poll that analyzes it are both growing fast. Although it might not be completely true that FX is one of the biggest financial markets in existence, it is certainly in that league. It may not be perfect, but most of its participants could also rightly claim it is one of the best.
This year’s poll was the largest ever. A total of 8,364 validated respondents, accounting for $124.8 trillion of annual turnover, voted. This was up from 6,322 votes in 2006, which represented $85 trillion of annual activity. In 2005, the sample size was just $40 trillion.
This year Deutsche Bank has once again set the benchmark by which other participants are judged. It captured a 19.27% market share – almost identical to 2006 – representing just over $24 trillion-worth of activity. Just as impressive is the bank’s strong showing in all of the qualitative categories clients voted for. It features in either first or second spot all the way down the list.
"It’s great to be recognized by our clients. FX is one of the fastest changing and innovation-rich markets out there," says Zar Amrolia, Deutsche’s global head of FX. "We have changed our business model by 20% or 25% every year for three or four years running. That’s challenging. And innovation is not just about new products: it encompasses all parts of the value chain – developing new products, new delivery mechanisms, new risk management techniques and new services. We are committed to it, focused on our clients and driven to continue raising the bar on ourselves and the industry," he adds.
The one chink the poll shows in Deutsche’s obviously strong Teutonic armour is its standing in certain currency pairs. For instance, it ranks "only" fifth in cable, something that Amrolia will no doubt seek to rectify next year. So given that Deutsche has managed to consolidate its leading position, both in market share and delivery of client satisfaction, should the other banks now give up chasing it?
Obviously not – although Deutsche’s position is, for the moment, dominant, its pursuers will take heart that several of them have narrowed the gap. UBS is still in second place but its market share has risen to an impressive 14.82% from 11.86%, something that should please the masters in Zurich.
The competition for third slot was so tight that if the FX poll had taken place in Florida, there would be a recount to make sure no chads on the voting papers had distorted the outcome. Statistically speaking, there is nothing to choose between Citi in third, RBS in fourth and Barclays Capital, which drops one place to fifth even though it has increased its market share by 2.16 percentage points, continuing the strong progress it has made over the past five years.
The poll shows that the top five are increasingly outpacing the rest of the market. Last year, they accounted for 54.5% of the reported volume; this year their share has risen to 60.7%. Few would argue against the conclusion that a bulge bracket has emerged in FX. Even though Bank of America in sixth spot managed to increase its market share, there is clear daylight between it and Barclays, Citi and RBS.
Those outside the top five might not be overly concerned, because many of them are still making good money from the business. But the fear must be that if the FX market of the future becomes totally dominated by a big five, all they will ultimately have left to scavenge are the crumbs from the proverbial rich man’s table. As has been written before, FX is becoming a volume business.
"The clients’ need for bank FX provision is becoming increasing modular. They need to be able to swiftly plug in different components of a product offering in a format that best matches their own needs. They emphatically do not want a ‘Bang & Olufsen solution’"
Peter Nielsen, RBS
Peter Nielsen, head of treasury and investor products at RBS, agrees. "Volume is absolutely key to facilitating our provision of liquidity to clients," he says. "Scale of services is paramount, because moving forwards the market will become two or even three tier."
Perhaps not surprisingly, Richard Leighton, global head of FX at Standard Chartered Bank, has a slightly different take on this. Standard Chartered comes in 23rd and the bank is perceived by its peers as having carved out one of the ultimate niches. But Leighton feels banks such as Standard Chartered are not wholly understood. "The concept of a niche player is often a misnomer," he says. "Standard Chartered is often referred to in this way because we concentrate on being the number one provider in our core markets and currencies of Asia, the Middle East and Africa. Since many of these markets have restricted access to global players today, the dominant position that we hold in FX is not well understood by high-volume G7 traders who do not have direct access to these markets. Our ability to handle a multi-billion dollar spot trade in the Indian rupee market possibly requires more skill than handling algo trading flows many times larger in highly developed liquid G3 markets."
But as the top five continue to gain market share, those further down the results, including Standard Chartered, will no doubt be considering what they need to do to maintain viable businesses. It is all very well to become a niche player, but as the business becomes more commoditized, the fear must be that profits will only be achievable for service providers that capture enough flow to be able to capitalize on the bespoke services they can provide.
Just outside the top five, HSBC stands out as a major anomaly in the results. It does exceptionally well in most of the qualitative surveys yet it fails to convert this into market share. In fact, HSBC’s market share this year has fallen to 4.36% from 5.04%.
"There is a strong correlation between volume and profitability but it is critical to understand the requirements of your key clients to ensure your business evolves correctly," says Andrew Brown, global head of FX at HSBC.
HSBC’s position in the poll raises several questions. One is whether or not the bank will be left behind by the bulge bracket, ultimately undermining its ability to deliver the service its clients clearly appreciate at the moment. Another is whether HSBC is the bank that is outside the bulge bracket with the most potential to crack into it.
Brown recognizes how important market share is. "Volume is key to us, which has been a part of our strategy. We always focus on being long term but in an environment with finite investment have chosen our partners carefully where we believe mutual value exists," he says.
All of the members of the FX bulge bracket offer a service that HSBC tellingly does not – prime brokerage. They all also have, as the poll substantiates, stronger e-commerce platforms. The implication is that HSBC has not invested in these two areas as much as the others and has suffered as a consequence, at least in terms of overall market share. That might not be of any concern to HSBC, as long as its FX area performs strongly. But the fact that its rivals are possibly pulling away for reasons it could perhaps, if it chose, address, possibly raises some questions in the bank.
Although prime brokerage is not a standalone business, it has become an increasingly important part of the overall package that FX service providers need to deliver. "PB is not just growing, it’s broadening the customer base. As more segments begin taking advantage of this well-priced service it will become more important," argues Jeff Feig, global head of FX at Citi.
Amrolia agrees. "PB is a vital component of the business," he says. "And there’s no doubt its importance is growing. It’s important, however, to realize that clients’ needs have already gone beyond traditional FX PB. At Deutsche, we have used PB as a building block to create other innovative services for our clients, such as our FX Fund Derivatives Platform that connects investors and FX managers together in a more efficient way. Over $2 billion of trading capital is already managed that way, and it didn’t exist in the market 18 months ago. Without PB, it could never have happened."
RBS’s Nielsen points to significant changes in the character of prime brokerage offerings. "The clients’ need for bank FX provision is becoming increasing modular," he says. "They need to be able to swiftly plug in different components of a product offering in a format that best matches their own needs. They emphatically do not want a ‘Bang & Olufsen solution’, something that looks nice but does not plug into anything else. Prime brokerage is an interesting and vital component of this mix. It is both a module in its own right and part of the glue that holds the product offering together. Increasingly, it is in this latter facilitation capacity that PB shines and enhances the overall attractiveness of the FX offering for those institutions that have a strong and integrated PB facility in their suite of products. PB’s importance will only increase over time."
"The top tier of banks is now well established. For a bank outside of this group to break into the top tier with a ‘me too’ strategy could take years and even then there is no real guarantee of success"
Ivan Ritossa, Barclays Capital
Nielsen sounds a warning to those banks that believe that all they have to do to capture a greater market share is to roll out a PB offering. "The associated development costs will represent a significant barrier to entry for any tier two players aspiring to elevate their status," he says.
As for e-commerce, there is no doubt that the banks featuring at the top of the poll all have exceptionally strong offerings. Perhaps surprisingly for someone recognized as a pioneer in FX e-commerce, Shey plays down its importance. "There is no single business strategy that is required for success in FX – there are a wide variety of ways to tackle the business successfully. This maintains a healthy competitive dynamic in the industry," he says.
Amrolia, Feig and Nielsen are more strident in stressing the importance of e-commerce. "It’s critical," says Amrolia. "Having the ability to deliver products electronically has allowed DB to grow the business with our existing client base to reach out to a wider audience and has given us the ability to expand the breadth of products that we can deliver in a truly cost-efficient manner as well as forced us to innovate in the way we manage that risk both in cash and derivatives."
Feig says: "E-trading will grow and dominate delivery of FX execution. Without a strong electronic strategy, there is no chance to compete in the top tier."
Nielsen adds: "It is a given that much of the business will evolve and go electronic. Each tier of client desires various levels of electronic sophistication. The offering has changed for the top end of the market. It is a hybrid of prime brokerage and direct dealing, as the line between fee-based business and margin-based business blurs. It is all about speed, transparency and choice. It stands to reason that no institution will survive and prosper unless it offers a full electronic product suite."
This already includes post-trade services and will later, as in equities, include pre-trade applications. "When a client is coping with thousands of transactions per day, there is a staggering importance placed on post-trade service levels in evaluating their providers. In more and more instances, post-trade services are the most important client touch-point," claims Shey.
Amrolia points out what is becoming a truism. "Banks that do not embrace e-FX will find it hard to grow in the coming years. But that does not mean that they will not have a place in the market. They will adapt to offer a niche service," he says.
All of these factors suggest that FX is becoming a business where only the big, the rich and the powerful will thrive. However, FX is full of contradictions. "Breaking into a top tier position from below top 10 is a challenge in any business," says Feig. "It would take heavy investment in talent and infrastructure, technology and most importantly it would take patience."
However, he does not rule out the emergence of new powerhouses. "Sometimes a clean sheet really lets the creativity flow and stops entrenched interests from preventing the right decisions. It wouldn’t be easy, but I think it is possible [for someone to break into the top 10]," he says.
This has been seen in other areas of FX, in particular with the emergence of retail aggregators and the numerous non-bank financial institutions that are playing an ever increasing part in the market. Yet while it may be true that the lines of demarcation between wholesale and retail, buy side and sell side, bank and non-bank and price maker and price taker are becoming ever more blurred, it seems hard not to come to the conclusion that the provision of a total FX service, rather than a niche offering of some description, is something that only the bulge bracket will be able to afford to do.
"The top tier of banks is now well established, with these institutions accounting for an ever increasing share of the total market. For a bank outside of this group to break into the top tier with a ‘me too’ strategy could take years and even then there is no real guarantee of success," says Ritossa. "Barclays Capital recognized this and has achieved significant gains in market share through being at the forefront of innovation in the FX market."