Since the global financial crisis, most FX markets have enjoyed a decade of extremely low volatility. While there have been initiatives around regulatory compliance, the market has otherwise been quiet, with volatility touching all-time lows as recently as January, exacerbated by a depressed yield curve.
Clients simply had less need to trade in that kind of environment, explains Jason Vitale, global head of FX at BNY Mellon Markets.
Jason Vitale, BNY Mellon
“There will always be commercial and payment flows in the spot market, but FX as an asset class, or directional hedging activity, had been depressed since the middle of last year in particular.”
Now it's different. Equity markets have been left reeling from big sell-offs since the end of January, but FX volumes have rocketed.
Integral reported a 40% increase in average daily volumes in March (driven mainly by euro trading); FX spot volumes on CLS jumped 24% in February; and CME Group’s FX average daily volume reached its highest ever level.
Before January there had been some debate among banks as to whether the benign market was a cyclical or structural trend, but everything changed once details of the coronavirus emerged.
Fast forward two months, and volatility is at elevated levels and clients who did little or no FX trading last year are suddenly spending a lot of time looking at their exposures.
Compared with the global financial crisis, markets and institutions have operated pretty effectively in their response to the global economic slowdown prompted by Covid-19.
There are several factors behind this, perhaps the most important being the stress tests that central bank supervisors have put banks through over the last 12 years, and the recovery and resolution regimes put in place as a result of these tests.
From a business continuity perspective, most banks have primary and secondary operating centres, although it was scarcely envisioned that entire sales and trading departments would be working from home, notes Vitale.
“Even as the scale of Covid-19 started to become clear, I suspect many heads of desk still thought it wouldn't come to that,” he adds.
Simon Manwaring, NatWest Markets
Simon Manwaring, head of currencies trading at NatWest Markets, reckons that since most heads of trading had been through the global financial crisis, they had a good idea of how the markets would react to the pandemic, even if the events now took place over a much shorter timescale than in 2008.
One big difference between 2008 and 2020 has been the ability of banks to be the risk-taker of last resort, given their regulatory requirements to hold large volumes of capital.
“Despite regulators taking swift and significant action, there was a sense initially that policymakers were behind the curve,” says Manwaring. “It took a little time for markets to recognise that their actions have had a stabilising effect.”
Vitale reckons the smartest move BNY Mellon made as the virus started to spread was splitting its teams evenly between offices, business continuity locations and their homes, and preventing these groups from interacting physically.
“We also ensured those working remotely had the hardware they needed. As of today, almost all our trading is being done from home,” he adds. “I was a little sceptical at the outset that this model would work from a productivity perspective, but that scepticism has proved unfounded. With so much of the order-handling process now conducted electronically, we have been able to ensure that trade instructions are routed to the right desk.”
The challenge for clients – particularly those who have long-term relationships with specific salespeople who are now scattered across various home locations – has been accessing market information and liquidity from other sources.
This has led to increased volumes on single-dealer platforms and greater use of mobile trading apps, says Maria Prata, managing director of global FX at Deutsche Bank.
Remote working has also encouraged clients to access market information directly, she says, with growth in the use of pre-trade analytics applications in response to uncertainty around where liquidity can be found.
Maria Prata, Deutsche Bank
“Because liquidity has been constrained across markets, some providers changed their terms around benchmark orders with regard to fees or submission times,” says Prata. “We haven’t done that, but understand that others did.”
To mitigate the impact of the dispersal of teams and to allow them to share insights on flows, Deutsche Bank has organised daily team conference calls and video rooms to ensure that these teams are in contact and speaking throughout the day.
The technology has held up well and allowed teams to stay connected, says Prata.
“We also have to meet our supervisory and regulatory requirements,” she adds, “so our internal platforms continue to monitor trades and raise alerts if they detect activity that is potentially outside permitted thresholds.”
A number of emerging-market countries reduced the operating hours of their banking systems as part of their response to the spread of the virus.
“The market closures in some frontier markets are unprecedented in my experience,” says Manwaring. “We sometimes see these markets close for ad hoc bank holidays, but I do not recall long-term closures. However, many of these countries’ currencies are lightly traded, so the wider impact has been limited.”
More to do
While heads of FX trading express some surprise at how well the move to home working has gone in terms of 'keeping the lights on', there is an acknowledgement that managing client relationships in terms of meetings and engagement and fixing problems as a group presents a challenge for this model of work.
“Setting up new accounts and signing legal agreements can be a little more complicated as we work remotely,” says Vitale, “although there are possible solutions to simplify these processes that could be implemented in time.
“Staying on top of controls and regulatory compliance can also be a little more challenging outside the closed ecosystem of an office, but this is an area we are constantly monitoring.”
Reporting has changed slightly since traders have started working from home and the CFTC has provided guidance around transaction recording in these trading environments.
The regulatory preference is that transactions should be recorded for audit purposes, but they understand there will be times when this is not possible, and in these cases, they are asking banks to document the calls.
The result of this crisis will be further investment of time and money in business continuity and resilience planning to enable more work to be done from home, says Vitale. The ability for staff to work remotely will become a requirement for critical functions in future, he adds.
Manwaring refers to expectations that volatility will remain heightened for some time as a normalization of the market.
“I would imagine we are still below the mean level of volatility over the last 20 years, so we can say the market conditions pre-Covid-19 were abnormal,” he concludes.