What to make of the latest round of FX turnover surveys? Obviously the “big daddy” of them all is due in just over a month’s time, but historically the FX committee surveys have done a good job of reflecting what is happening in the world, so why, when so many people are bemoaning the lack of activity and how tough things are the FX market, did the numbers go up?

The simple answer lies in the non-spot product lines, for even within the headline story of the UK’s surge in activity to a new high, spot volumes were only slightly up on the year and down on the last survey in October 2018. Singapore saw a boost in activity in cash products, although unfortunately that committee’s report reveals so little about where and how business is done in the centre that it is impossible to know the drivers. That said, FX swaps played a large role. Elsewhere the story was very mixed, although the US report was pretty nasty with activity there hitting its lowest level since October 2012 and the centre was overtaken by Singapore on swaps daily volume.

Aside from those headlines, the UK survey seems to have cleared up one data point that had been puzzling me – it seems the voice brokers were not handling almost $100 billion of spot every day in London as the two previous reports stated, because April saw a return to what I would call “normal” levels of activity through this channel, around $35-40 billion. The problem was someone likely mis-allocating volume, something that remains an (admittedly small) worry when trying to discern trends in this data.

Another interesting piece of data in the UK report was how, for the third survey in succession, the increase of inter-dealer activity in NDFs was sustained above the $50 billion per day mark. This would seem to be good news for EBS, which dominates this space, but also perhaps for the start up 24 Exchange which is very much looking in this direction.

Notwithstanding that, there is no doubt that in spite of the data, people still tend to dismiss any suggestion that things are anything other than tough in FX markets. This highlights how much people look at spot when it comes to FX and I suppose given the very low volatility in interest rates until maybe last year, this is to be expected. Across the six centres (and 36 hours on Hong Kong has still not published, perhaps someone can drop the TMA a line?) spot activity was down (the details can be found in our report here) and it is that data point that bothers people most. As someone very senior in the FX markets said to me just this week, “I don’t count swaps, especially the under one week stuff – there’s no revenue in it”.

In a world in which interest rate products seem likely to be more volatile than exchange rates (and one can debate how much this is down to the different market structures – the latter very much driven by technology) it would seem logical for players to focus more on this side of the market. Several sales desk sources have told me over the past six months that they talk to their clients more about forwards than they do spot, the latest data would appear to support that approach, but is it right?

There is no doubt that FX swaps markets are technologically behind – in spite of efforts underway it is hard to see that changing too much, therefore the product line will remain subject to an attitude of benign neglect. The real problem is that customers are happy with how their forward exposures are priced and traded so why bother changing? Where FX swaps are traded more electronically of course is in the short end, where the majority of business takes place (just under 60% of all volume in the UK survey was under one week in tenor), but the revenue stream from these products is minimal – indeed historically it has probably been a drain at some institutions as they chased industry awards. So we have a situation where the volume business is offering little room for profit and the more esoteric stuff is protected fervently. Does this sound like an environment ripe for disruption?

The latest report from the UK, however, has some interest nuggets in it concerning non-spot business. Yes, the under one week segment remains the dominant tenor, but year-on-year to April 2019 in the UK the growth was largely driven elsewhere. In April 2018, the under one week bucket was responsible for 63.2% of all FX swaps activity, in the latest report it is down to 59.1%. That is within the bounds of usual variance for this data set, but what grabbed my attention was how the serious growth was in the one-to-six month tenors – in other words by what seemed real hedgers seeking to alleviate longer term risk (there was also a small rise in the six-12 months and over one year buckets).

This number started me thinking that customers were doing more business in the FX swaps market, that the sales desk source was right to be talking swaps and therefore banks especially might want to think about pushing FX swaps innovation up their task lists…however. A quick glance at the customer segment data, which unfortunately is only provided by product, not by tenor, shows that year-on-year much of the growth was driven by inter-dealer counterparties – customer activity in FX swaps actually dropped, by 17.9% with Other Financial Institutions and by 7.4% with Non-Financial Institutions. Back to square one.

Of course, while the banks may not want to waste precious resources innovating in a space in which their customers are only slightly interested in change, there is perhaps an opportunity for the platforms? If the growth is indeed in the interbank space then perhaps the opportunity exists there? It probably matters why the banks were trading with each other of course, it could be a bump in the road thanks to them positioning for the expected interest rate moves and quickly return to normal, although with more interest rate volatility forecast it may be more sustained. It is unlikely to be customers hedging, as noted by the client segment reports, but any platform seeking to innovate in this space will have to be aware that the banks will resist such a move, not least because of the fear that their customers will want – demand – access to the venue. If that happens, more revenue slips out of the window.

It is hard to see banks getting excited about dealing with other banks in FX swaps. In some other products, yes, especially given how a great number of the “reporting dealers” are actually customers of the small group of top banks (and the odd non-bank dealer in certain products), but in swaps, where people can so often deal at mid-market (via a voice broker-moderated negotiation)? I can’t see it.

So the headline numbers look good in the latest surveys, but underneath those the picture is a little less clear, and probably less positive. Growth is growth, however, so it can’t be all bad news, the suspicion is though, that the good news will not be spread that widely. Ultimately it is hard to see how the banks especially will support innovation in the FX swaps market when they are so afraid of that evolution squeezing already tight margins in the one market they feel they still have a competitive edge.

Short of something very surprising happening, the BIS report in September is likely to show an increase in activity thanks to non-spot products, which means the industry will have a good headline on which to hang its hat, but a less than pleasant reality at business level. Clearly, this remains a spot-dominated industry.

Colin_lambert@profit-loss.com

Twitter @lamboPnL

Colin Lambert

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