In a 1999 edition of Profit & Loss, David Clark, now chairman of the European Venues and Intermediaries Association (EVIA), reflected on 30 years in the foreign exchange industry. Now he talks about what has – and hasn’t – changed in the industry since then and makes some bold predictions for the future.
Profit & Loss: In 1999 you highlighted that your experiences in FX had taken place “against a backdrop of a market dominated by very few major currency pairs, but many players”. Do you feel that this market has changed in this regard since then?
David Clark: That requires a two-part answer. Firstly, I would say that you still don’t have enough major players on the banking side, given that we were looking to try and get more and more big players involved in 1999. Don’t forget, this was 10 years after the collapse of the Berlin Wall so there was a big rush of globalisation and internationalisation, which was very beneficial to the markets, but it meant that big banks just got bigger.
Well, the problem is that since 1999 the big banks have gotten even bigger still, and that’s happened in part because of the financial crisis. The survivors of this have actually outgrown the competition, you’ve seen the huge growth in the power of the investment banks in the FX market, and let’s be honest, if I wrote down a list of the top 20 FX players at the end of 1999 and the start of 2019 there would be a massive overlap.
But the second part of the answer is that we cannot ignore the massive disruption caused by the 2008/2009 financial crisis and the regulatory and political aftershocks, and of course as a result of that we now have many more big, non-bank players in this marketplace. We hadn’t seen that in 1999, there were a few conspicuous players, but it was patchy and it tended to be hedge fund operators rather than firms looking to build a platform as a market maker.
P&L: So have we seen an increase in market making capacity as a result of this?
DC: We might have done a bit on the non-bank side, people tell us we have but I’m suspicious on that front. What we have seen though is that the market making capacity of the banks has been handicapped by the Volcker Rule and so I do worry, even in a $5.1 trillion per day market, that liquidity is concentrated in too few hands. So the shape and the type of players has changed in the last 20 years much more than in the previous 30.
P&L: You also claimed in your article that “we will not, for a very long time, see anything like the political turmoil that accompanied the ‘60s, ‘70s and ‘80s”. How do you feel about that prediction?
DC: I think that it was perhaps true until very recently! What I was talking about was events like the escalation of the Cold War in the ‘70s, the collapse of the Berlin Wall and Communism in Europe and Tiananmen Square in Beijing. What we’ve seen in the last two years is totally different, with the unexpected political development of the rise of nationalism and populism, which we thought we’d sort of knocked on the head at the end of the Second World War. I would still say that the period since 1999 until very, very recently has been one of relative political calm in comparison with the previous 20 or 30 years.
P&L: To be fair, you did conclude that as a result, the FX markets would “react more to factors that revolve around economic analysis” rather than political events. I’d say you were fairly spot on there…
DC: …And would like to take a moment to bask in the sunshine of this one, it was a good prediction! However, I have to admit that I didn’t arrive at it through any clever macroeconomic insights, it was because I was convinced that all the major political events of my lifetime were actually behind me.
I remember speaking at an ACI event in the late nineties and I said that all the big foreign exchange movements of my lifetime had been caused, not by economic developments, but by political ones. That was true at the time, but what we’ve seen in the last couple of years is that, despite significant geopolitical agitation, the market has responded in a much more rational way in terms of the impact that has on the real economy. I think that marks a slightly new era, and I think this might be a result of the fact that there are fewer market makers around and they’re now looking at what a given piece of news means for the real economy before they do anything.
The other thing you can’t ignore is the impact of quantitative easing (QE). These days I don’t know which is the sideshow, QE or FX, but I’m not sure that it really matters. These two things are theoretically connected, but they don’t actually seem to be when you look at the way that the FX market reacts these days.
P&L: When you think back to the big events of the first 30 years of your career, how do they compare to the last 20?
DC: Looking at things that impacted on markets other than FX, 9/11 is a clear example of something that had massive political overtones and did remind me a little bit of the sort of stuff we saw during the worst part of the Cold War in terms of an event coming absolutely out of the blue, like Reagan being shot or the Pope being shot (both in spring 1981). But there haven’t been many of those types of headline grabbing events which had huge impacts. Actually, the biggest shock we’ve had in the past 20 years was the global financial crisis.
What I think is remarkable about the crisis is that it was an accident in slow motion – I still look back at that period between the spring of 2007 and September of 2008 and wonder: why did it take so long for Bear Stearns and Lehmans to go under? It still surprises me even now.
Because of those events, we had the G20 meeting in 2009, the results of which, along with quantitative easing, have had a much bigger impact on the markets than any one event in the past 20 years.
P&L: Has there been anything about the last 20 years in FX that has surprised you?
DC: So it hasn’t been a surprise because people have been writing about the 21st century belonging to Asia since the 1990s, but the rise of China has been an amazingly dramatic event over the past 20 years.
A couple of years ago we saw the RMB enter into the IMF’s Special Drawing Rights (SDR) basket and while most people don’t really understand what this means, I think that it will prove to be a big move in the very, very long term.
P&L: Anything else?
DC: Yes, I would have expected to see more emerging market currencies being traded and with higher volumes. I guess I am disappointed that we haven’t seen that, we’re still dominated by a handful, or less than a handful really, of major currency pairs.
If you look at the WMR, we now use 23 currencies for purely traded data, so that does imply there’s more trading, and there is, but you still don’t have enough emerging market pairs. And it’s not just emerging markets, I want to see the development of more cross currency pairs – the Chinese renminbi against the Russian ruble or the ruble against the Malaysian ringgit. But I predict that we will start seeing the growth of such currency pair trading in the next 20 years.
P&L: What’s held this back so far? Is it just that some of these currencies are still not trading electronically that much yet?
DC: It might be, but that’s a chicken and egg problem, isn’t it? If they were traded in enough volume, people would put the investment in to put them on the platforms.
I think part of the explanation has to be about the distribution of global currency reserves. If you look at the IMF reserves, it’s still very much dominated by the dollar and the euro which – along with the yen, sterling, Aussie dollar, Swiss franc and Canadian dollar – account for probably over 80% of the reserves, but one thing I think will make a big difference will be the advent of same day clearing, whether it’s through CLS or blockchain or both. I think that will make a big difference to cross currency and emerging market trading because it’s much easier to manage your risk if you’ve got same day settlement.
So I think this is something that we’ll see really take off, because we are moving further into a global world where there are other currencies than the dollar, the euro and the sterling and it’s about time that the FX market reflected that. But it does need same day settlement and the technology to go with it in order to reduce the operational and credit risk.
P&L: What other predictions would you make for the future then?
DC: I think we’re going to see more buy side involvement in the market, and that eventually these players will become as important and as apparent as the sell side in FX. This is already happening, but we’re going to see it accelerate because at the moment I can’t see any way that the banks are going to be motivated to increase their market making and risk taking capacity when they’ve got the regulators all over them and the costs are so high.
I also think that, and I’m not just saying this because of the FX Global Code of Conduct, we’re entering into a period of definite change from rules-based regulation to principles-based supervision. This will be a good thing and it will be supported by prudential regulation coming out of Basel.
Although Basel is a moving feast, to say the least, I think that now we’re seeing a triangle between regulation – particularly in the retail markets – accompanied by principles-based supervision (which includes conduct) that go hand-in-hand with prudential supervision, which is all about capital and liquidity. I think that triangle is better understood now and that it’s possibly going to give the buy side a boost to try and take advantage of the position that they’re in as mainly unregulated entities.
P&L: What about Brexit? Do you have any thoughts on what this means for London as a financial centre and as the biggest hub for FX trading?
DC: Okay, here’s a prediction for you: In 20 to 25 years’ time, London will still be the biggest financial centre in Europe and it will still be the biggest financial centre for FX, full-stop, but its role and its presence will have diminished much more than I would want it to, and I think that is the price of Brexit. I think Brexit will cause fragmentation in Europe in terms of where some FX business is done, particularly on the derivatives side. Although London will lose some market share to other financial centres, I think it will be a very slow but continuous diminution of its importance as a financial centre and volumes will change as a result.
P&L: Any other predictions for the future?
DC: Yes, I have one more to chuck in! I think that we’re going to see FX as an asset class taking much more notice of climate change. We know that massive expenditures will be necessary to try and handle the dynamics of climate change, some of that will come from private equity but a lot of it will come from the banks.
So the banks will be much more engaged in the currencies of countries which are going to be dominant in the climate change field, starting in places like Canada and Australia, perhaps Malaysia and Indonesia and parts of Latin America.
Climate change will impact financial markets much more than people think, and it will impact FX much more than people think. If you’re looking over a 50-year period, I think that the greatest threat of war isn’t coming from a belligerent country head, but from some consequence of climate change. So I think it will play an increasing role in geopolitics and will have to be taken into consideration by the foreign exchange market.