I have long been a sceptic over the market
share model in FX, to me the question should always be about the quality of
business, not the quantity, but that is not to say that a reasonable share of
flow isn’t important – it is.
Market share is equally important – I would
argue much more important actually – when it comes to someone offering agency
execution services. The past few years have seen the number of providers in
this space grow exponentially, driven to a large extent by those banks that
have shifted towards agency from principal as advocates of the equity model got
control of the FX business in those institutions.
This has led to a burgeoning agency
sector…at the same time as FX volumes appear to be in decline. Looking at the
latest FX committee surveys spot volume – and agency remains very much a spot
game – is significantly lower than the previous year and, more worryingly
perhaps, it is off more than 22% from three years ago when so many of these businesses
were set up.
The decline could be temporary of course,
but given how macro-economic and geo-political conditions have been uncertain –
and these are two traditional drivers of FX activity – one would have expected
less of a decline, or, if we are being blunt, an increase.
I read recently that implied vol in FX
markets is now back to levels prior to SNB Day in January 2015, which,
considering everything that has happened, is remarkable. With this lower
volatility has come more stable exchange rates, a surge in liquidity as
everyone tries to jump on the bandwagon and grab market share, and an
environment in which the target audience for agency businesses – asset managers
and large corporates – suddenly feel a whole deal more comfortable executing their
FX hedges themselves.
The agency providers’ cause is not helping
by how traditional service providers to these sectors have tightened up their
act and are now explicit about how they handle the business in terms of mark up
etc. One of the factors the agency businesses were counting on – the break up
of this traditional relationship – is unlikely to happen and as such another
obstacle has been placed in the path to success.
Events could help the agency sector as
asset managers and corporates lose that confidence, and there are potentially
dates to watch on the horizon. The US election could (should in many eyes) be a
one horse race but there may be a surprise, overall though, it’s hard to see
something big enough to undermine that confidence. The FX industry’s main event
in 2016 was, and is likely to remain, the UK referendum and clearly the
majority of hedgers acted before June 23 and are comfortable with how the
market handled their flow.
So how does the outlook seem for agency
providers? For independents I don’t think much has changed. They have struggled
since inception to grab market share and they will most probably continue to
struggle. The good news, such as it is, is that some have deep pockets and a
low cost base.
The bad news, could well be for those
institutions that have bet the bank (pun intended) on agency becoming the
dominant aspect of the business. If I am right and current market conditions –
and the current market structure – remain in
situ then fee-based businesses are going to struggle because they are
predicated upon volume.
It strikes me that this is a time players
should be in the market making prices and earning spread through skill (not
mark up). This is how they squeeze every single dollar out of the flow they
In other words, now is the time to be a
principal risk taker in the FX business – the agency business just doesn’t seem
to have legs, and if it did have I would have thought it would have been
successful by now.
I have been critical of some banks’
decision-making processes over FX in the past and yet again it seems as though
some have got it wrong. This is not an FX-business level issue, it is way above
It actually reminds me of an old car advert
in the UK that depicted a man who had got every decision wrong at the casino.
The inference was his timing was horrible but at least he drove a good car. The
car concerned was a Volkswagen, so like the banks and agency, he probably even
made that decision based upon dodgy data!