Given how important customers are deemed to be by the FX industry, I have had some worrying conversations over the past few days, specifically currency managers wondering how to maintain sufficient credit and in some cases heading in what I believe to be the wrong direction to find it.
The root of the problem has been the very natural reaction to the collapse of MF Global, which was prime broking a number of managers, albeit in second or third place in the PB pecking order. Following the collapse, as I noted in this column last week, credit lines for hedge funds have been curtailed, not necessarily because of fears over the funds themselves – far from it – but over the prime brokers of those funds.
This article prompted a couple of calls in addition to other conversations I had planned and the general tone from these conversations is that things are getting worse for currency managers seeking to get prime broked. Not only are other banks wary of extending credit lines due to the aforementioned problems, but the prime brokers themselves are, in some cases, having painful conversations with potential clients during which they are turning down these prospective clients. The reasons seem to be varied, according to my sources at the managers, but capacity and the overall level of exposure to the hedge fund sector appear foremost in the PB’s minds.
I find this a little surprising given how the past three years has seen two or three credible players enter the prime brokerage space, but as one currency manager pointed out to me, some PBs are only interested in high frequency clients. These PBs, the manager claims, have built technology to handle the HFT volumes, and they are chasing it hard to the exclusion of everyone else. This, of course, narrows the field down again for the more “traditional” managers.
This is probably the last thing currency managers need at this time given how the industry – and I am talking about the lower end of the spectrum here, younger managers or smaller funds – has struggled to recover from the Lehman debacle and subsequent credit crunch. Indeed the reason some of these firms were with MF Global in the first place was the result of an increasingly desperate search for credit.
Struggles like those described above can be overcome with time and a bit of luck, however for those that don’t have time I am also hearing what I consider to be worrying stories.
Specifically, there appears to be an acceptance on the part of some managers that the major prime brokers are unable to help them at this time, therefore they are looking in the opposite direction – at the retail end of the industry.
This is not the first time I have observed such a shift, as noted, the last time came during the credit crunch, but it is a concern when a number of managers feel they are being forced, as a result of the collapse of MF Global, into the arms of firms of a similar or lesser standing. As one manager pointed out to me, its either a firm with a similar business model to MF Global – and the resulting sleepless nights – or it’s a retail brokerage shop, with the same lack of sleep.
In no way should this column be seen as criticising anyone, there are no (external) villains of the piece in the MF Global saga (indeed there may be no internal villains either), rather I thought it worthwhile highlighting the challenges a very important sector of the market is facing.
Over the past decade, trading by Other Financial Institutions, as judged by the Bank for International Settlements in its triennial FX turnover surveys, has grown tremendously. It has become probably the most important sector to the industry and it is sad that it is facing yet another challenge to its ability to operate day-to-day in a fashion it wishes (not to mention the tricky market conditions in which they have to achieve returns). I have no doubt that things will recover and credit and trust (or risk appetite for PBs) will return, but for now I fear we have to cross our fingers and hope that those managers looking down the value chain for PB services come out unscathed.
Ultimately, a strong currency management industry is good for the FX industry as a whole. It is an outlet for good traders who may be restricted by bank rules or wider regulatory pressure to cut risk taking. It is also a source of good revenue for everyone in the industry: brokers, bankers, technology providers and sundry other segments. More to the point, the segment is innovative and helps the entire industry raise the service bar – to that end we should hope that desperation does not takeover from innovation.