Probably the big news in markets this week was the swingeing cuts at Deutsche Bank and while I cannot see this through anything other than a prism of regulation – specifically the courage of some regulators to take action while other put their head in the sand and hope it goes away – I wonder if there are warning signs within this story for FX markets.
In my view, this problem – and I have to say I think it could be repeated elsewhere in the European banking sector over the next year or two – has been coming for years, because whereas the US and UK regulators took strong action in the immediate aftermath of the GFC, the Eurozone’s authorities, in typical style some would say, decided to kick the can down the street. The result is a restructured and recapitalised US and UK banking systems (with the odd “bad bank” of course) and a European banking system that is limping along, facing delayed and possibly over-stringent regulation, failing understand the pressures of competition in an over-banked market and is unwilling to do something about it. Until now.
So why do I think the FX industry may want to pay attention to what’s happening – especially as Deutsche’s FX business has been singled out as a core franchise and a target for further investment? Mainly because I suspect that some of the problems at Deutsche’s equities business were also caused by market structure issues. Margins were thin, competition from non-bank firms meant volumes and customers were harder to hold on to, and the advance of technology meant that even those customers who were traditionally with the bank had the opportunity to go a different route. As I understand it, the equities division was not covering its costs and as any trader can tell you, you’re in the game to make money, to create a positive outcome. The minute you don’t, you’re under threat.
This should be food for thought in the FX industry at the moment, not because volatility is low – to my point in Monday’s column, there are still some decent moves in exchange rates – but because FX is flirting heavily with the broker model that has cost so many jobs at Deutsche.
Ask any voice broker in OTC markets, the competition over the past three decades has been crushing at times. I have friends in the business who saw their income decline by literally hundreds of thousands thanks to brokerage rates being slashed by competition, which led to no bonuses and lower salaries – so often it was about “take this pay cut or there’s the door”. If too many firms seek to replicate the equities model in FX, become a quasi-broking shop that offers fee-based services, they are likely to end up in the same place as Deutsche’s equities business. Brokerage and cost of trading is the headline way in which to undercut, and be undercut.
Of course, this may not have much of an impact on end users of the market, it will, as was the case with Deutsche, largely impact those staff losing their jobs (many of whom, thanks to their skill level will be easily employable), but the wider world will, with all due respect to those out of work this week, hardly notice.
In our In the FICC of It podcast a couple of weeks ago I upset a few listeners in the non-bank segment by suggesting that if a few firms from there disappeared from the market no-one would really notice – it’s the same with Deutsche’s equities business. There are dozens of other firms out there who can provide liquidity, make a price and, occasionally, warehouse some risk.
So the message for FX firms who believe the fee-based services are the way forward is to think hard about the possible consequences. Yes, the trading business is not easy at the moment and the risk capital required is often making it harder, as are certain regulations, but there are always medium term trading opportunities in markets with which a good trading business can generate reasonable returns (and into the bargain I would argue this would enhance market quality for everyone).
I would argue that it is better to allocate capital to some skilled risk takers operating in the right environment, than it is to get involved in a dash for market share and the virtual brokerage involved. In other words, any market is a better place with more risk takers and less brokers. If nothing else, I would have thought the Deutsche Bank debacle this week would have highlighted that.