Banks struggle to build FX as liquidity slows

A sharp fall in liquidity this year has taken its toll on the foreign exchange market, with many platforms reporting significantly depleted volumes, but the illiquidity is also affecting banks.

Many large forex players are restructuring their businesses, and banks that have recently sought to grow their forex capabilities are struggling to maintain the momentum.

“Many banks have beefed-up their forex offering in recent years. From a cost-to-income point of view, it is very attractive, but if you are trying to make forex your core offering, going after the big institutional flows, well, those aren’t there. You have to enter into the market with the prospect of not making any money for a long time,” warns a senior foreign exchange trader at one European bank.

The reasons for building up a foreign exchange business in recent years have been fairly widely accepted. It has always been a relatively liquid market with a reliable client base that hasn’t suffered as much as the more exotic asset classes during the crisis, and it stands to be affected less heavily than other asset classes by regulation – particularly Basel III capital requirements.

Lloyds Banking Group is one bank that has been investing heavily in its foreign exchange business, launching a new single-dealer platform, Arena, in September 2011 and making a number of senior hires to its forex team, including Darren Coote, global head of forex spot trading, who joined the bank from UBS last year.

“Our approach has been very focused, with selective hires in key segments. Uncertainty in the banking industry has provided us with excellent opportunities to invest in people and focus on building the right capabilities,” says Coote.

But a lower volume of institutional client activity results in fierce competition for business, in a market that has always been notorious for the level of competition between large banks. Spreads have to remain tight to keep attracting business, and the key to success in this environment is being able to appeal to a diverse range of client types rather than just institutional clients, say bankers.

“If you’re a bank that sees a lot of flow all day long, then it’s fine because you will likely make more money than you lose. However, if you see less flow, are less diverse, have a less broad client base, and you see that flow where there isn’t liquidity, you’re going to struggle,” warns Mark Johnson, global head of foreign exchange cash trading at HSBC in London.

“The net impact of being able to maintain that spread tightness has got to put a whole lot of cost pressure on the overall business model. Your spreads are tighter, volatility is down significantly, and volumes are down. The pie is shrinking fast,” adds Todd Sandoz, co-head of global currencies and emerging markets at Credit Suisse in London.

Some feel spreads have been too tight for too long, and that those prepared to offer more than just a competitive price will benefit in the current environment.

“The spreads have probably been too tight for the past three to four years,” says one spot trader. “There are a lot more professional outfits now that are prepared to stand there and be counted to facilitate that business, even if that means being more expensive. There are fewer bigger trades going through the market, and historically those trades have tended to stimulate other trades and other interest.”

Read more on the foreign exchange market at FX Week.


This article was first published on Risk

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